[Senate Hearing 107-509]
[From the U.S. Government Printing Office]



                                                        S. Hrg. 107-509
 
                  GAS PRICES: HOW ARE THEY REALLY SET?
=======================================================================



                                HEARINGS

                               before the


                PERMANENT SUBCOMMITTEE OF INVESTIGATIONS

                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                        APRIL 30 AND MAY 2, 2002
                               __________

      Printed for the use of the Committee on Governmental Affairs





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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
RICHARD J. DURBIN, Illinois          SUSAN M. COLLINS, Maine
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
           Joyce A. Rechtschaffen, Staff Director and Counsel
              Richard A. Hertling, Minority Staff Director
                     Darla D. Cassell, Chief Clerk

                                 ------                                

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                     CARL LEVIN, Michigan, Chairman
DANIEL K. AKAKA, Hawaii,             SUSAN M. COLLINS, Maine
RICHARD J. DURBIN, Illinois          TED STEVENS, Alaska
ROBERT G. TORRICELLI, New Jersey     GEORGE V. VOINOVICH, Ohio
MAX CLELAND, Georgia                 THAD COCHRAN, Mississippi
THOMAS R. CARPER, Delaware           ROBERT F. BENNETT, Utah
JEAN CARNAHAN, Missouri              JIM BUNNING, Kentucky
MARK DAYTON, Minnesota               PETER G. FITZGERALD, Illinois
         Elise J. Bean, Acting Staff Director and Chief Counsel
                       Dan M. Berkovitz, Counsel
                       Laura E. Stuber,  Counsel
                 Kim Corthell, Minority Staff Director
                     Mary D. Robertson, Chief Clerk











                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Levin................................................ 1, 79
    Senator Collins..............................................10, 81
    Senator Akaka................................................    12
    Senator Lieberman............................................13, 82
    Senator Carnahan.............................................    15
    Senator Voinovich............................................    16
    Senator Bunning..............................................    18
Prepared statement for May 2, 2002:
    Senator Bunning..............................................   129

                               WITNESSES
                        Tuesday, April 30, 2002

James S. Carter, Regional Director, U.S., ExxonMobil Fuels 
  Marketing Company, Fairfax, Virginia...........................    20
Gary Heminger, President, Marathon Ashland Petroleum, Findlay, 
  Ohio...........................................................    21
Ross J. Pillari, Group Vice President, U.S. Marketing, BP, 
  Warrenville, Illinois..........................................    24
David C. Reeves, President, North America Products, ChevronTexaco 
  Corporation, San Ramon, California.............................    26
Rob Routs, President and Chief Executive Officer, Shell Oil 
  Products U.S., Houston, Texas..................................    29

                         Thursday, May 2, 2002

Hon. Ron Wyden, a U.S. Senator from the State of Oregon..........    85
Richard Blumenthal, Attorney General, State of Connecticut, 
  Hartford, Connecticut..........................................    89
Jennifer M. Granholm, Attorney General, State of Michigan, 
  Lansing, Michigan..............................................    91
Tom Greene, Senior Assistant Attorney General for Antitrust, 
  California Department of Justice, Sacramento, California.......    95
Peter Ashton, President, Innovation and Information Consultants, 
  Inc., Concord, Massachusetts...................................   108
Justine S. Hastings, Assistant Professor of Economics, Dartmouth 
  College, Hanover, New Hampshire................................   112
R. Preston McAfee, Murray S. Johnson Professor of Economics, 
  University of Texas, Austin, Texas.............................   115
Philip K. Verleger, Jr., President, PK Verleger, LLC, Newport 
  Beach, California..............................................   118

                     Alphabetical List of Witnesses

Ashton, Peter K.:
    Testimony....................................................   108
    Prepared statement with attachments..........................   204
Blumenthal, Richard:
    Testimony....................................................    89
    Prepared statement...........................................   179
Carter, James S.:
    Testimony....................................................    20
    Prepared statement with an attachment........................   130
Granholm, Jennifer M.:
    Testimony....................................................    91
    Prepared statement...........................................   187
Greene, Tom:
    Testimony....................................................    95
    Prepared statement...........................................   198
Hastings, Justine S.:
    Testimony....................................................   112
    Prepared statement with attachments..........................   215
Heminger, Gary:
    Testimony....................................................    21
    Prepared statement...........................................   146
McAfee, R. Preston:
    Testimony....................................................   115
    Prepared statement...........................................   227
Pillari, Ross J.:
    Testimony....................................................    24
    Prepared statement...........................................   157
Reeves, David C.:
    Testimony....................................................    26
    Prepared statement...........................................   161
Routs, Rob:
    Testimony....................................................    29
    Prepared statement...........................................   170
Verleger, Philip K., Jr.:
    Testimony....................................................   118
    Prepared statement...........................................   239
Wyden, Hon. Ron:
    Testimony....................................................    85
    Prepared statement, May 2, 2002..............................   175

                                Exhibits

 1. GChart: Average Midwestern Retail Gasoline Prices, January 
  1999-April 2002................................................   250
 2. GChart: Michigan Retail and Rack Prices, January-August 2001.   251
 3. GChart: Average United States Retail Gasoline Prices, January 
  1995-April 2002................................................   252
 4. GRecent Mergers..............................................   253
 5. GChart: HHI Index for United States Gasoline Wholesale Market 
  in 1994........................................................   254
 6. GChart: HHI Index for United States Gasoline Wholesale Market 
  in 2000........................................................   255
 7. GChart: Market Share of Top 4 Firms in the Gasoline Wholesale 
  Market in 1994.................................................   256
 8. GChart: Market Share of Top 4 Firms in the Gasoline Wholesale 
  Market in 2000.................................................   257
 9. GChart: Illinois Retail Prices (Net Taxes), June 2001........   258
10. GChart: Maine Retail Prices (Net Taxes) by Brand, January-
  August 2001....................................................   259
11. GChart: Michigan Retail, Rack, and Spot Market Prices, 
  January-August 2001............................................   260
12. GChart: Michigan Retail Prices (Net Taxes) by Brand, April 
  2001...........................................................   261
13. GBP Amoco Midwest/Mid Continent Strategy.....................   262
14. GBP Amoco CEO Statements.....................................   266
15. GPowerine Memo...............................................   267
16. GARCO West Coast Market Fundamentals.........................   268
17. GARCO Memo on Role In Market.................................   269
18. G1992 Texaco Memo............................................   271
19. G1993 Chevron Memo...........................................   272
20. G1996 Texaco Memo............................................   273
21. G1997 Pricing Strategy Emails................................   274
22. GChart: Wolverine Pipeline System Overview...................   276
23. GChart: Pipeline Transportation Charges in 1999..............   277
24. GChart: Michigan Daily Retail Price Changes (Net Taxes) by 
  Brand, April 9-14, 2001........................................   278
25. GChart: Petroleum Administration for Defense Districts (PADD)   279
26. GMarathon Oil Company, Summary: Short-Term Price Outlook.....   280
27. GLetter from Gary R. Heminger, President, Marathon Ashland 
  Petroleum, dated May 13, 2002, to the Permanent Subcommittee on 
  Investigations, clarifying April 30th testimony................   281
28. GLetter from James S. Carter, Regional Director, U.S., 
  ExxonMobil Fuels Marketing Company, dated May 17, 2002, to the 
  Permanent Subcommittee on Investigations, clarifying April 30th 
  testimony......................................................   282
29. GLetter from Ross J. Pillari, President, BP America Inc., 
  dated May 16, 2002, to the Permanent Subcommittee on 
  Investigations, clarifying April 30th testimony................   285
30. GLetter from ChevronTexaco, dated May 14, 2002, to the 
  Permanent Subcommittee on Investigations, clarifying April 30th 
  testimony of David C. Reeves...................................   287
31. GMemorandum from James S. Carter, Regional Director U.S., 
  ExxonMobil Fuels Marketing Company, dated May 2, 2002, to the 
  Permanent Subcommittee on Investigations, clarifying the record 
  on zone pricing................................................   288
32. GSupplemental questions and answers for the record of Ross J. 
  Pillari, BP America, Inc.......................................   289
33. GSupplemental questions and answers for the record of Gary R. 
  Heminger, Marathon Ashland Petroleum...........................   294
34. GSupplemental questions and answers for the record of Rob J. 
  Routs, Shell Oil Products......................................   299
35. GSupplemental questions and answers for the record of David 
  C. Reeves, ChevronTexaco Corporation...........................   302
36. GSupplemental questions and answers for the record of James 
  S. Carter, ExxonMobil Fuels Marketing Company..................   311
37. GChevronTexaco's comments on the Permanent Subcommittee on 
  Investigations' Majority Staff Report entitled Gas Prices: How 
  Are They Really Set?...........................................   314
38. GAttachments to prepared statement of David C. Reeves, 
  President, North American Products, ChevronTexaco Corporation..     *
39. GReport of the Permanent Subcommittee on Investigations' 
  Majority Staff entitled, Gas Prices: How Are They Really Set?..   322

* May be found in the files of the Subcommittee












                  GAS PRICES: HOW ARE THEY REALLY SET?

                              ----------                              


                        TUESDAY, APRIL 30, 2002

                                       U.S. Senate,
                Permanent Subcommittee on Investigations,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 9:34 a.m., in 
room SH-216, Hart Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, Lieberman, Akaka, Durbin, 
Carnahan, Dayton, Collins, Stevens, Voinovich, and Bunning.
    Staff Present: Linda J. Gustitus, Chief of Staff for 
Senator Levin; Mary D. Robertson, Chief Clerk; Laura Stuber, 
Counsel; Dan Berkovitz, Counsel; Edna Falk Curtin, Detailee/
General Accounting Office; Cliff Tomaszewski, Detailee/
Department of Energy; Kim Corthell, Minority Staff Director; 
Eileen Fisher, Investigator to the Minority; David Mount, 
Detailee/Secret Service; Joyce Rechtschaffen, Staff Director 
and Counsel, Governmental Affairs Committee; and Laurie 
Rubenstein (Senator Lieberman).

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Good morning, everybody. Today the Permanent 
Subcommittee on Investigations opens 2 days of hearings on how 
gas prices are set in the United States. Gas is the lifeblood 
of our economy, and through luck, pluck, hard work, and 
ingenuity, we have been able to have the gasoline that we need 
in this country.
    Most of us take for granted the fact that in most urban 
areas we can go a few blocks and find a gas station that has 
gas, and with the 5 minutes it now takes to fill up our tanks, 
we can be off and about our business in no time. It is easy to 
lose sight of the fact that the gas that we put in our tanks is 
the product of an incredibly complicated, worldwide network of 
countries, companies, and individuals who, using advanced 
technology and science, take crude oil from under the ground or 
under the seas, then put it in tankers the size of two football 
fields, ship it across oceans or through long pipelines to 
ports in the United States, pipe it into refineries, heat it 
under the most dangerous circumstances, and produce gasoline in 
that process. That gas is then piped or barged across the 
country to terminals where trucks unload and deliver it to 
individual gas stations. It is an amazing process that goes on 
day after day, hour after hour--24/7, as they say--to enable 
America's ready access to the liquid that makes our lives run.
    With the central role that gas plays in all of our lives, 
it is no wonder that the public is highly attuned and sensitive 
to its price. And when the price of gas jumps dramatically at 
the pump without any apparent reason, and when all stations 
regardless of brand appear to raise and lower their prices at 
the same time and by the same amount, the public understandably 
gets suspicious. That is what happened over 11 months ago when 
we started this investigation. The Midwest had just experienced 
for the second year in a row a price spike leading into the 
Memorial Day holiday. Exhibit 1 \1\ over to my left shows those 
gas spikes. Exhibit 11 \2\ shows the 2001 spike and shows that 
it was not due to increases in the price of crude oil. Exhibit 
11 over there is the one that is on the left, and Exhibit 1 is 
the one that is on the right. Consumers were upset. They didn't 
trust the answers from the oil companies that the price spikes 
were just supply and demand at work.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1 which appears in the Appendix on page 250.
    \2\ See Exhibit No. 11 which appears in the Appendix on page 260.
---------------------------------------------------------------------------
    Since the spikes in spring of 2000 and 2001, the Midwest 
also witnessed a Labor Day price spike last year, and 
nationwide, gas prices have increased in the last few months 
faster than at any time in the past 50 years. Price spikes are 
becoming a way of life in the United States and not without 
serious consequences.
    As we can see from the next exhibit, Exhibit 3,\3\ at the 
same time approximately each year not only does the groundhog 
look for his shadow but for rising gas prices as well. But 
there are serious consequences to this new pattern. Sudden 
increases in gasoline prices are costly to the consumer and 
disrupt our economy, because the cost of transportation, which 
is based on the cost of fuel, affects the cost of all of our 
goods and services. Last year's increases in the price of 
gasoline helped push the American economy into a recession, and 
this year's increases are threatening the current recovery.
---------------------------------------------------------------------------
    \3\ See Exhibit No. 3 which appears in the Appendix on page 252.
---------------------------------------------------------------------------
    For every 1 cent per gallon increase in the price of gas, 
the income to oil companies goes up $1 billion a year.
    To try to get to the bottom of questions about gas prices, 
I asked the staff of our Permanent Subcommittee to investigate 
just how gas prices are set. After an extensive investigation, 
the Majority staff of the Subcommittee issued a 400-page report 
laying out their findings. The report looks in detail at three 
regions of the country: The West Coast (California in 
particular); the Midwest (Michigan, Ohio, and Illinois in 
particular); and the East Coast (Maine and the Washington, DC, 
area in particular).
    The Majority staff found that the mergers in the oil 
industry over the last few years and the closing of many 
refineries over the past 20 years have increased the 
concentration in the refining industry, that is, there are far 
fewer refining companies. And as we can see from Exhibit 4,\4\ 
there have been many, many mergers that have been approved in 
recent years. And just to list a few of them, in 1998 Marathon 
and Ashland Oil merged their downstream assets; in 1998, 
British Petroleum (BP), merged with Amoco; in 1999, Exxon 
Corporation merged with Mobil Corporation; in 2000, BP Amoco 
acquired ARCO. Many of these are mega-mergers.
---------------------------------------------------------------------------
    \4\ See Exhibit No. 4 which appears in the Appendix on page 253.
---------------------------------------------------------------------------
    Under one accepted test for concentration, 28 States would 
now be considered tight oligopolies. Now, Exhibits 7 and 8 \5\ 
will demonstrate this. As you can see from these two exhibits, 
which use the 4-firm concentration ratios--and that is an 
accepted measurement of concentration of oil companies and 
their control of the market in a particular area--there has 
been a dramatic increase in the number of States with high 
levels of concentration between 1994 and 2000. In fact, the 
number of States which have a high level of concentration have 
doubled from 14 to 28 during those 6 years.
---------------------------------------------------------------------------
    \5\ See Exhibits No. 7 and 8 appear in the Appendix on pages 256 
and 257.
---------------------------------------------------------------------------
    The red areas show the levels at which the numbers reflect 
a tight oligopoly, which is a 4-firm concentration ratio of 
more than 60 percent of the market. And as you can see from 
these charts, the District of Columbia is the most concentrated 
market, followed by Hawaii, Alaska, and a number of States in 
the Midwest, including my home State of Michigan.
    As is true in this industry, as in any other industry, the 
more competition, the better for the consumer; the less 
competition, the worse for the consumer. But when an industry 
is concentrated, individual companies can have a significant 
effect on the price of a product, like gasoline, by the 
decisions that they make on supply. And that is what is 
happening today, in a number of markets, at least, in the 
United States. The reality is that a tight balance between 
demand and supply and low inventories are major contributors to 
price spikes, because in that tenuous condition, with the 
demand for gas being inelastic, that is, staying pretty 
constant despite the price, two things happen: In normal times 
when the market is concentrated, prices can be spiked before 
holidays, for instance, with less fear of competition driving 
it back down; and in times when there is a market disruption, 
the market responds wildly to the slightest problem or 
potential problem. We experienced major price spikes in the 
Midwest in just 2 years for these reasons.
    Internal documents from several oil companies confirm that 
oil companies view it to be in their economic interest to keep 
gas inventories low and supply tight. Several documents from 
California show that refiners in California sought in the mid-
1990's to prevent imports into California in order to make the 
market tight. One external Exxon memo advises the company to 
``not do deals that supports other's importing barrels to the 
West Coast.''
    Similarly, an internal Mobil memo counsels against 
importing gasoline, saying that it would depress profit 
margins.
    California refiners also sought to limit the overall 
refinery capacity in that State.
    One Mobil document talks about how to block the proposed 
startup of the Powerine refinery. ``Needless to say, we would 
all like to see Powerine stay down.'' It then proposes 
accomplishing this by buying all its product and marketing it 
themselves. ``Especially,'' this memo says, ``if they start to 
market below our incremental cost of production.'' And then the 
memo notes that buying Powerine's product the previous year had 
worked and it was ``a major reason that the RGF premium''--the 
reformulated gas premium--``. . . went from 1 cent per gallon 
to 3 to 5 cents per gallon.''
    A Texaco memo discusses how to use changes in fuel 
specifications to reduce supplies. The memo says, ``Significant 
events need to occur to assist in reducing supplies and/or 
increasing the demand for gasoline.'' One example of a 
significant event, the memo says, would be to seek the 
elimination of the requirement for an oxygenate which, the memo 
says, would make oxygenate usage go down, which would then have 
to be replaced by gasoline and, therefore, reduce the supply of 
gasoline. The memo says, ``Much effort is being exerted to see 
that this happens in the Pacific Northwest.''
    California refiners also exported gas, that is, shipped gas 
out of California--to keep the market in that State tight.
    An ARCO internal document discusses the need to export to 
prevent supply from building up in the State. The memo 
indicates that ARCO should export in order to intentionally 
alter the supply/demand balance within California and not just 
as a passive response to prevailing economic conditions. In 
that same presentation, one strategy discussed is to ``exchange 
and trade selectively to preserve market discipline.''
    Another document in the Subcommittee files indicates that 
one company would export gasoline out of California to the Gulf 
Coast, even at a loss, with the rationale that such losses 
``would be more than offset by an incremental improvement in 
the market price of the much larger volumes of [gas] left 
behind.''
    Another company's plan indicates that exporting gasoline 
can ``improve market conditions,'' and that the company was 
willing to ``take [a] hit on price to firm up the market.''
    An internal BP document from 1999 reflects similar thinking 
with respect to the Midwest. The document reflects a discussion 
among senior BP executives of possible strategies to increase 
refining margins by reducing the supply of gasoline in the 
Midwest. It discusses ``opportunities'' to increase Midwestern 
gas prices by 1 to 3 cents per gallon by reducing the supply of 
gasoline. Options included: Shutting down refining capacity; 
convincing cities outside of the Midwest to require 
reformulated gas that was not readily available in their areas, 
thereby pulling supplies from the Midwest; exporting product to 
Canada; lobbying for environmental regulations that would slow 
down the movement of gasoline in pipelines; shipping products 
other than gasoline in pipelines; and providing incentives to 
others not to provide gasoline in Chicago.
    BP officials told the Subcommittee staff that these ideas 
were only part of a ``brainstorming'' session. Well, what they 
were brainstorming about at a high level was manipulating 
supply in ways that are deeply troubling, and we will go 
through that document in some detail later this morning.
    In another document from the Midwest, an internal Marathon 
document, Marathon even called Hurricane Georges a ``helping 
hand'' to oil producers because it ``caused some major refinery 
closures, threatened offshore oil production and imports, and 
generally lent some bullishness to the oil futures market.''
    And that is the heart of the problem with respect to gas 
prices in the United States, at least in certain regions of the 
country. The refining market is so concentrated that oil 
companies can act to limit supply and from time to time spike 
prices to maximize profits, and because there is insufficient 
competition, and other companies' supplies are also kept tight, 
there is little to no challenge to that action. That is the 
major problem, or at least one major problem, as I see it. The 
ability to control supply allows oil companies to spike prices 
in a concentrated market without adequate competition to 
challenge them. And, also, the few companies that control the 
market often keep their prices in sync with each other, going 
up and down together in a fixed relationship to each other.
    That is another part of the staff analysis. Most oil 
companies and gas stations, at least in these concentrated 
markets, try to keep their prices at a constant price 
differential with respect to one or more competitors. For 
example, one company decided that its station in Los Angeles 
should price the lower of ARCO stations plus 6 cents per 
gallon, or the average price of major branded stations in the 
area. Another oil company followed a pricing policy in 
Baltimore as follows, ``We will initiate upward, we will follow 
Amoco, and Shell quickly.''
    Different companies' prices in specific markets tend to go 
up and down together, with companies tending to stake out a 
position in each market vis-a-vis the competitors and holding 
that position. Hence, it will often appear that, over time, 
gasoline prices in that market move together in a ribbon-like 
manner, so that as a brand moves up and down, it nevertheless 
remains at a constant differential with respect to other 
brands. Look at the retail pricing chart for Illinois for June 
2001, and one from Maine for January to August 2002. Those are 
Exhibits 9 and 10,\1\ and you see that ribbon-like move with 
brands of gasoline staying in the same relationship to each 
other price-wise as prices go up and down.
---------------------------------------------------------------------------
    \1\ See Exhibits No. 9 and 10 appear in the Appendix on pages 258 
and 259.
---------------------------------------------------------------------------
    In Michigan and Ohio we found a clear leader-follower 
pricing practice. Speedway, owned by Marathon, has a pricing 
practice that bumps up the retail price of gasoline on 
Wednesdays and Thursdays, and that is Exhibit 2.\2\ As the 
price leader in Michigan, once Speedway goes up, the other 
brands follow. And you can see those bumps on that chart on the 
right. The typical pattern after that is for Speedway to come 
down pretty quickly in price, while the other brands follow 
them down more slowly. Other companies follow similar practices 
in other areas.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 2 which appears in the Appendix on page 251.
---------------------------------------------------------------------------
    The Majority staff report also addresses several other 
important issues with respect to gasoline pricing, including 
zone pricing, recommended retail prices, the advent of hyper-
markets, which are the discount superstores like Wal-Mart and 
Cosco that now sell the lowest priced gasoline in the market, 
and the impact of boutique fuels, which are fuels required for 
specific locations to address particular environmental 
situations.
    This morning we are going to hear from top marketing 
executives of five major oil companies: Marathon Ashland, 
British Petroleum or BP, ExxonMobil, ChevronTexaco, and Shell 
Oil.
    And then on Thursday, we will hear from Senator Wyden, who 
has been looking into the subject of gas prices for a long 
time; from three Attorneys General (the Attorneys General from 
California, Connecticut, and Michigan), all of whom have been 
active in challenging gasoline price increases in their States; 
and we will hear from a panel of economists and industry 
experts on the issues that are raised in the report.
    I want to just take a moment to say a special thanks to the 
Majority staff who worked so hard on this report and put 
together such a thorough product. I also want to express my 
appreciation to Senator Collins and her staff for their support 
and to Senator Durbin and his staff, who assisted in the 
interviews.
    When you think about the complexity of the issues and the 
size of this industry and the task of reading through tens of 
thousands of pages of material, a small team produced a well-
written report in less than a year, and we are grateful to them 
for that effort.
    [The prepared statement of Senator Levin follows:]
                    STATEMENT OF SENATOR CARL LEVIN
    Good morning ladies and gentlemen. Today the Permanent Subcommittee 
on Investigations opens two days of hearings on how gas prices are set 
in the United States. Gas is the lifeblood of our economy, and through 
luck, pluck, hard work and ingenuity we've been able to have the 
gasoline we need in this country.
    Most of us take for granted the fact that in most urban areas, we 
can go a few blocks and find a gas station that has gas and with the 
five minutes it now takes to fill up our tanks, we can be off and about 
our business in no time. It's easy to lose sight of the fact that the 
gas we put in our tanks is the product of an incredibly complicated, 
worldwide network of countries, companies, and individuals who, using 
advanced technology and science, take crude oil from under the ground 
or under the seas, put it in tankers the size of two football fields, 
ship it across the ocean to ports in New York, California, and the Gulf 
Coast, pipe it into refineries, heat it under the most dangerous 
circumstances and produce gas in that process. That gas is then piped 
or barged across the country to terminals where trucks unload it and 
deliver it to individual gas stations. It's an amazing process that 
goes on day after day, hour after hour, 24-7 as they say, to enable 
America's ready access to the liquid that makes our lives run.
    With the central role that gas plays in all of our lives, it is no 
wonder that the public is highly attuned and sensitive to its price. 
And when the price of gas jumps dramatically at the pump without any 
apparent reason, and when all stations regardless of brand appear to 
raise and lower their prices at the same time and by the same amount, 
the public gets suspicious. That's what happened over 11 months ago 
when we started this investigation. The Midwest had just experienced 
for the second year in a row a price spike leading into the Memorial 
Day holiday. (Exhibits 1 and 2) Consumers were upset; they didn't trust 
the answers from the oil companies that the price spikes were just 
supply and demand at work.
    In Michigan, the price of gas seemed to leap up overnight by the 
same amount across all brands of gas at all stations. If there were 
real competition in the industry, people asked, why would the prices of 
different brands go up and down together and just before the holidays?
    Since the spikes in spring of 2000 and 2001, the Midwest has also 
witnessed a Labor Day price spike last year and nationwide, gas prices 
have increased in the last few months faster than at any time in the 
past 50 years. Price spikes are becoming a way of life in the United 
States and not without serious consequences. (Exhibit 3.) At the same 
time each year not only does the groundhog look for his shadow but for 
rising gas prices as well. But there are serious consequences to this 
new pattern. Sudden increases in gasoline prices are costly to the 
consumer and disrupt our economy, because the cost of transportation, 
which is based on the cost of fuel, affects the cost of all our goods 
and services. Last year's increases in the price of gasoline helped 
push the American economy into a recession, and this year's increases 
are threatening the current recovery.
    Increased gas prices also represent a significant shift in wealth. 
For every 1 cent/gallon increase in the price of gas, the income to the 
oil companies goes up $1 billion a year.
    To try to get to the bottom of questions about gas prices, I asked 
the staff of our Permanent Subcommittee to investigate just how gas 
prices are set. After interviewing representatives from the oil 
companies, distributors, service station owners and dealers, trade 
association representatives, lawyers and economists; after analyzing 
data from the Energy Information Administration and wholesale and 
retail price data purchased from the Oil Price Information Service; 
after reviewing over 250,000 documents subpoenaed from a number of 
major oil companies and one pipeline company, the Majority Staff of the 
Subcommittee issued a 400 page report yesterday laying out their 
findings.
    The report includes an analysis of the operations and structure of 
the oil industry with particular focus on the downstream portion--that 
is, from the refinery to the pump. Due to staff and time constraints, 
the staff looked in detail at just three regions of the country: the 
West Coast (California in particular); the Midwest (Michigan, Ohio and 
Illinois, in particular); and the East Coast (Maine and the Washington, 
D.C. area, in particular).
    The Majority Staff's findings are contained in the Executive 
Summary at the front of the report and provide the basis for these two 
days of hearings. (For those unable to obtain a hard copy, the report 
is available on the PSI website.) The Majority Staff found that the 
mergers in the oil industry over the last few years and the closing of 
many refineries over the past 20 years have increased the concentration 
in the refining industry, that is there are fewer refining companies. 
(Exhibit 4.) Under one test for concentration in at least 9 states the 
refining and marketing industry is highly concentrated and in at least 
28 states it is at least moderately concentrated. Under another test 
for concentration, 28 states would be considered tight oligopolies. Let 
me explain.
    The Department of Justice and the Federal Trade Commission measure 
market concentration in two ways. One is the Herfindahl-Hirshman Index 
or HHI; the other is the 4-firm concentration ratio. The report 
describes how each of these measures of concentration works. This 
morning, we have charts showing these measures for all 50 states and 
the District of Columbia. (Exhibits 5-8.) As you can see from these 
charts, there's been a dramatic increase in the number of states with 
moderate to high levels of concentration between 1994 and 2000. The red 
areas show the levels at which the numbers reflect high concentration. 
Under Department of Justice Guidelines, an HHI of between 1000 and 1800 
is ``moderately concentrated,'' and an HHI over 1800 is considered to 
be ``highly concentrated.'' A 4-firm concentration ratio of more than 
60 percent shows a ``tight oligopoly.'' As you can see from these 
charts, D.C. is the most concentrated market, followed by Hawaii, 
Alaska, and a number of states in the Midwest; my home state of 
Michigan is considered a ``tight oligopoly'' under the 4-firm ratio and 
just below ``highly concentrated'' using the HHI index.
    As is true in this industry as in any other, the more competition, 
the better for the consumer; the less competition, the worse of the 
consumer. But when an industry is concentrated, individual companies 
can have a significant effect on the price of a product, like gasoline, 
by the decisions they make on supply. That's what's happening today, in 
a number of markets in the United States. The reality is, that a tight 
balance between demand and supply and low inventories are major 
contributors to price spikes, because in that tenuous condition, with 
the demand for gas being inelastic, that is, staying pretty constant 
despite the price, two things happen: 1) in normal times when the 
market is concentrated, prices can be spiked before holidays, for 
instance with less fear of competition driving it back down; 2) in 
times when there is a market disruption, the market responds wildly to 
the slightest problem or potential problem. We experienced major price 
spikes in the Midwest in just two years for those reasons. Let's walk 
through each of those prices spikes.
    Low inventories have helped to create the conditions for price 
spikes in the Midwest, which have occurred when demand has increased 
(near driving holidays) and/or the supply of gasoline was disrupted. 
Not unlike oil companies nationwide, oil companies in the Midwest have 
adopted just-in-time inventory practices, resulting in crude oil and 
product stocks that frequently are just above minimum operating levels. 
And, in the spring of 2000 and 2001, the conversion from the production 
and supply of winter-grade gasoline to summer-grade gasoline further 
contributed to low inventories just prior to a seasonal increase in 
demand. With the stage set by those two factors, the oil companies took 
actions over these past two years in accordance with their profit 
maximizing strategies that significantly contributed to the price 
spikes when disruptions in supply occurred:
    --During the spring of 2000, three major refiners determined it 
wasn't in their economic self interest to produce any more RFG 
[reformulated gas] than that required to meet the demands of their own 
customers, and so in that year they produced 23% less RFG than in the 
prior year, not enough to supply everyone who wanted to purchase it. 
That contributed to the short supply in the spot market for RFG, 
contributing to the price spike of spring 2000. While Marathon did have 
surplus RFG, it withheld some of it from the market so as to not lower 
prices.
    --In the summer of 2001, major refiners deliberately reduced 
gasoline production, even in the face of unusually high demand at the 
end of the summer driving season, contributing significantly to the 
price spike of 2001.
    Nationwide, in the winter of 2001-2002, demand fell and inventories 
rose following the tragic events of September 11, 2001. With reduced 
demand and higher inventories, prices fell. As a result, refining 
profits fell and refiners cut back on production in order to obtain 
higher profits. Along with the increase in the price of crude oil and 
market speculation, these reductions in production and the increase in 
industry concentration significantly contributed to the run-up in price 
in the late winter and continuing into the early spring of this year.
    Internal documents from several oil companies confirm that the oil 
companies view it to be in their economic interest to keep gas 
inventories low and the supply and demand balance tight.
    Several documents from California show that refiners in California 
sought in the mid-90's to prevent imports into California in order to 
make the market ``tight.''

     One internal Exxon memo advises the company to ``not do 
deals that supports other's importing barrels to the West Coast.''
     Similarly, an internal Mobil memo counsels against 
importing gasoline, saying it would depress margins.

    California refiners also sought to limit the overall refinery 
capacity in the state.

     One Mobil document talks about how to block the proposed 
startup of the Powerine refinery. ``Needless to say,'' the memo says, 
``we would all like to see Powerine stay down.'' It then proposes 
accomplishing this by buying all its product and marketing it 
themselves. ``Especially,'' the memo says, ``if they start to market 
below our incremental cost of production.'' The memo then notes that 
buying Powerine's product the previous year, when it was below Mobil's 
``incremental cost of production'' had worked and it was ``a major 
reason that the RFG premium . . . went from 1 cent per gallon to 3-5 
cents per gallon.''
     A Texaco memo discusses how to use changes in fuel 
specifications to reduce supplies. The memo says, ``Significant events 
need to occur to assist in reducing supplies and/or increasing the 
demand for gasoline.'' One example of a significant event, the memo 
says would be to eliminate the requirement for an oxygenate which, the 
memo says, would make oxygenate usage go down which reduces total 
volume of gasoline supplies. The memo says, ``Much effort is being 
exerted to see that this happens in the Pacific Northwest.''

    California refiners also exported gas--that is, shipped gas out of 
California--to keep the market in that state tight.

     An ARCO internal document discusses the need to export to 
prevent supply from building up in the state. The memo indicates that 
ARCO should export in order to intentionally alter the supply/demand 
balance within California and not just as a passive response to the 
prevailing economic conditions. In that same presentation, one strategy 
discussed is to ``exchange and trade selectively to preserve market 
discipline.''
     Another document in the Subcommittee files indicates that 
one company would export gasoline out of California to the Gulf Coast, 
even at a loss, with the rationale that such losses ``would be more 
than offset by an incremental improvement in the market price of the 
much larger volumes of [gas] left behind.''
     Another company's plan indicates that exporting gasoline 
can ``improve market conditions,'' and that the company was willing to 
``take [a] hit on price to firm up market.''

    An internal BP document from 1999 reflects similar thinking with 
respect to the Midwest. The document reflects a discussion amongst 
senior BP executives of possible strategies to increase refining 
margins, and it mentions ``significant opportunities to influence the 
crude supply/demand balance.'' It notes that these ``opportunities'' 
can increase Midwestern prices by 1 to 3 cents per gallon.'' The memo 
discusses strategies to reduce the supply of gasoline in the Midwest. 
It lists some possible options, including: shutting down refining 
capacity, convincing cities to require reformulated gas that is not 
readily available, exporting product to Canada, lobbying for 
environmental regulations that would slow down the movement of gasoline 
in pipelines, shipping products other than gasoline on pipelines that 
can carry gasoline, and providing incentives to others not to provide 
gasoline in Chicago. BP officials told the Subcommittee staff that 
these ideas were only part of a ``brainstorming'' session and that none 
of the options for reducing supply were adopted. We'll go through this 
document in some detail later this morning. In another document from 
the Midwest, an internal Marathon document, Marathon even called 
Hurricane George a ``helping hand'' to oil producers because it 
``caused some major refinery closures, threatened off-shore oil 
production and imports, and generally lent some bullishness to the oil 
futures market.''
    And that is the heart of the problem with respect to gas prices in 
the United States today--in certain regions of the country--the 
refining market is so concentrated, that oil companies can act to limit 
supply and from time to time spike prices to maximize profits, and 
because there is insufficient competition, there is little-to-no 
challenge to that action. That's the major problem as I see it. The 
ability to control supply allows oil companies to spike prices in a 
concentrated market without adequate competition to challenge them.
    The Majority Staff made some other significant findings. Oil 
companies do not set wholesale (rack) or retail prices based solely 
upon the cost to manufacture and sell gasoline; rather wholesale (rack) 
and retail prices are set on the basis of market conditions, including 
the prices of competitors. Most oil companies and gasoline stations try 
to keep their prices at a constant price differential with respect to 
one or more competitors. For example one company decided that its 
station in Los Angeles should price the lower of ARCO stations plus 6 
cents per gallon, or the average price of major branded stations in the 
area. Another oil company followed a pricing policy in Baltimore as 
follows:
    ``We will initiate upward, we will follow Amoco, Shell quickly . . 
. we will be slow to come down in a dropping market.''
    Because many oil companies and gasoline retailers set their retail 
price on the basis of the prices of their retail competitors, prices in 
each specific market tend to go up and down together. And oil companies 
tend to stake out a position in each market vis-a-vis the competitors 
and hold that position. Hence, it will often appear that, over time, 
gasoline prices in that market move together in a ``ribbon-like'' 
manner--so that as a brand moves up and down it nonetheless remains at 
a constant differential with respect to the other brands. Look at this 
retail pricing chart for Illinois for June 2001, and this one from 
Maine for January-August 2001. (Exhibits 9 and 10.)
    In Michigan and Ohio we found a clear leader-follower pricing 
practice. Speedway, owned by Marathon, has a pricing practice that 
bumps up the price of gasoline on Wednesdays or Thursdays. As the price 
leader in Michigan, once Speedway goes up, the other brand follows. The 
typical pattern after that is for Speedway to come down in price pretty 
quickly, while the other brands follow them down more slowly. You can 
see this very clearly in these charts from January to August 2001 and 
April 2001. (Exhibits 11 and 12.)
    Oil companies also use a system of what they call ``zone pricing'' 
in order to maximize the prices and revenues at each gas station. Since 
under the antitrust law, they are prohibited from selling wholesale 
product at a different price to similarly situated retailers, the oil 
companies have developed a system for differentiating among retailers 
in the same immediate area. In doing so, they can charge the retailers 
different wholesale prices for their gasoline. The way they accomplish 
this is by dividing a state or region into zones. A zone is supposed to 
represent a particular market, and the stations in that zone are 
supposed to be in competition with each other. The oil companies use a 
highly sophisticated combination of factors to identify particular 
zones. For example, if most people buy their gas on their way home from 
work instead of on their way to work, a station on one side of a rush 
hour street may be treated as in one zone and the same brand station on 
the other side of the street in another zone. The oil company will then 
charge those two gas stations different prices for their gasoline, 
because the station on the side of the street with easy access for 
evening rush hour traffic may be able to get a higher price for its gas 
than the station on the other side of the street. That's the kind of 
thinking that goes into the zone pricing system, and it allows the oil 
companies to charge the highest possible amount for their gas in a 
given area.
    Another pricing practice the Majority Staff uncovered has to do 
with how gas station owners set their retail prices. The Majority Staff 
learned that for those stations that lease from a major oil company 
(about one-fourth of the 117,000 branded stations) the oil company 
actually recommends to the station dealer a retail price. Now by law, 
the oil company is prohibited from telling a lessee dealer what it can 
charge for gasoline, but that doesn't keep oil companies from 
``recommending'' a price. And the Majority Staff was told by several 
dealers that if they don't charge their retail customers the 
recommended price, the next delivery of gas from the oil company will 
reflect any increase instituted by the dealer. These dealers are saying 
that if they decide to price their gas at $1.40/gallon when the oil 
company recommends $1.35, the next delivery of gasoline to the station 
(and deliveries are sometimes daily for busy stations) will have a 5 
cent/gallon increase in the price to the retailer. If these allegations 
are true, then the practical effect would be that the recommended price 
is subtly or not so subtly being enforced.
    The Majority Staff report also address several other important 
issues with respect to gasoline pricing--including the advent of 
hypermarkets, those are the discount super-stores like Wal-Mart and 
Cosco that now sell the lowest priced gasoline in the market; and the 
impact of boutique fuels, fuels required for specific locations to 
address particular environmental situations. This morning we will hear 
from the top marketing executives of five major oil companies: Marathon 
Ashland, BP, ExxonMobil, ChevronTexaco, and Shell Oil.
    On Thursday we will hear from Senator Wyden, who has also been 
looking into the subject of gas prices; three Attorneys General, from 
California, Connecticut and Michigan, all of whom have been active in 
challenging gasolines price increases in their states; and we will hear 
from a panel of economists and industry experts on the issues raised in 
the report.
    I want to take this opportunity to say a special thanks to the 
Majority Staff who worked so hard on this report and put together such 
a thorough product. The Subcommittee's thanks go to Dan Berkovitz, the 
lead writer of the report; Laura Stuber, counsel to the Subcommittee 
who oversaw the dozens of interviews with individual gas station owners 
and operators and ably drafted portions of the report and oversaw its 
development; Edna Curtin, a detailee from the General Accounting Office 
who did a substantial portion of the price analysis and chart 
development; Cliff Tomaszewski, a detailee from the Department of 
Energy who provided background research on the oil industry and the 
production and marketing of gasoline; Bob Roach, chief investigator who 
was responsible for the discussion of the Wolverine Pipeline case; and 
Mary Robertson, the Subcommittee's Chief Clerk who again, amazed us all 
with her ability to pull together a complex report for production.
    I also want to express my appreciation to Senator Collins and her 
staff for their support and to Senator Durbin and his staff who 
assisted in the interviews.
    It has been a team effort, and when you think about the complexity 
of the issues, the size of the industry, and the task of reading 
through tens of thousands of pages of materials, it is highly 
impressive that such a small team produced such a well-written report 
in less than a year.

    Senator Levin. Senator Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you, Mr. Chairman.
    First, let me thank the Subcommittee Chairman, Senator 
Levin, for convening these hearings to examine the pricing of 
gasoline and the causes of price spikes. Oil and gasoline are 
vital to virtually every aspect of our economy, which depends 
on stable and reasonable energy prices to prosper.
    Consumers are justifiably concerned and confused about the 
high price of gasoline. From the first week to the last week of 
March, for example, gasoline prices rose about 23 cents per 
gallon nationwide. This increase is a record for a 4-week 
period. This price jump is particularly noteworthy as it pre-
dates both the seasonal transition from winter to summer 
gasoline that takes place beginning May 1, as well as the 
beginning of the driving season that typically starts around 
Memorial Day.
    While price spikes have been most dramatic in the Midwest, 
Maine and other regions of the country have not been immune to 
price spikes and price volatility. In recent weeks, gas prices 
in Maine have edged up sharply, with recent price increases 
ranging from 8 to 20 cents in just 1 week's time.
    Just as inexplicable are gasoline prices that are 
significantly higher in one Maine town than in other towns 
further from supply points.
    High gasoline prices have a negative effect on the U.S. 
economy overall, but particularly on low-income families and 
small businesses.
    Geographically, Maine is a large State, and many Mainers 
have to commute long distances to get to work, to go to school, 
and to go shopping. Gasoline prices affect all sectors of the 
economy by raising the cost of transportation. I have met 
frequently with truckers, for example, in my State who talk 
about the impact of rising diesel prices on their ability to 
earn a living. As our country struggles to strengthen the 
economy, it is vital that high gasoline prices or price spikes 
not derail these efforts.
    The gasoline industry has changed dramatically over the 
past 20 years. Perhaps the most significant change that has 
occurred is the increased concentration in the industry that 
the Chairman has mentioned, including such mergers as Marathon 
and Ashland Oil; Exxon and Mobil; BP and Amoco, and then ARCO; 
and Chevron and Texaco, to name just a few. The two largest 
mergers, I would note, between Exxon and Mobil, and BP and 
Amoco, were approved during the Clinton Administration, as was 
the Marathon and Ashland Oil merger. Clearly these mergers have 
had an impact on competition within the marketplace. This trend 
has resulted in increasingly concentrated refining and 
marketing industries, which can then result in higher prices 
for consumers.
    According to the 2002 annual report on competition in the 
retail petroleum markets prepared by Maine's Attorney General, 
Maine's gasoline markets are relatively concentrated, which 
means that the level of competition within these markets is 
generally low. Maine's more rural counties tend to be extremely 
concentrated, meaning that there is even less competition. 
Competition is more healthy in the more populous areas of my 
State. Overall, however, the Attorney General's report 
indicates that concentration has been inching up gradually over 
the past few years, a troubling development.
    Another change is the closure of more than half of the 
refineries in the United States. Yet refining capacity has 
remained nearly what it was before the refinery closures. This 
is due to increased efficiencies and a very high rate of 
capacity operation, about 96 percent. By contrast, the average 
capacity utilization rate in other U.S. industries is 82 
percent. This means that the 150 refineries still operating in 
the United States are responsible for producing ever more 
product as demand continues to grow. It also means that there 
is no room for error, either through a refinery breakdown or a 
demand miscalculation on the part of refiners.
    Yet another significant development has been the 
proliferation of gasoline blends. Prior to 1995, only 
conventional gasoline was sold in the United States. Now there 
are more than 16 different blends of gasoline due to various 
Federal, State, and local fuel requirements. As a result, when 
an area has a supply disruption due, for example, to a refinery 
fire or a pipeline rupture, it is more difficult to meet the 
demand with gasoline from another area, particularly if one of 
those areas also requires a unique blend.
    Many of Maine's gasoline distributors have told me that 
they are very concerned about the impact of the proliferation 
of gasoline blends and the difficulties this creates in getting 
enough of the appropriate type for each market. Not only do the 
number of blends make it harder to get each type of gasoline 
for each market, but it also creates the need for additional 
infrastructure. In particular, terminals need more tanks to 
store each type of gasoline. These are other costs that are 
undoubtedly passed on to the consumer in the form of higher 
prices, and I want to explore with our witnesses the impact of 
boutique fuels on prices.
    In Maine, we have two types of gasoline. Conventional 
gasoline is sold year round in much of the State. But during 
the summer, in the southern counties, because of concerns over 
water quality, we use a State-required blend that helps to 
improve water quality, yet doesn't appear to result in as 
severe groundwater pollution as the Federal reformulated fuel. 
In Massachusetts, eastern New Hampshire, and Connecticut, 
however, Federal RFG is sold, which makes a total of three 
types of gasoline required in just one small corner of New 
England.
    Today we will hear testimony from representatives of 
several of the largest oil companies. I look forward to 
discussing with them the increased concentration in the 
industry, which I view as a negative development, as well as to 
hear their explanation of gasoline price spikes and the recent 
price hikes that people in Maine have been experiencing, as 
well as citizens elsewhere. I look forward to hearing what can 
be done to avert price spikes that cost consumers millions of 
dollars and threaten our economic recovery.
    Senator Levin. Thank you, Senator Collins. We will use the 
early-bird rule here. Senator Akaka.

               OPENING STATEMENT OF SENATOR AKAKA

    Senator Akaka. Thank you very much, Mr. Chairman. I want to 
thank you for holding the first of 2 days of hearings on this 
very important and timely matter.
    The rising cost of gasoline across the United States is 
alarming, and I applaud your efforts to uncover the reasons for 
this trend so that we may devise a plan to protect American 
consumers. I would like to take this opportunity to thank you 
for this report and the good work by your staff.
    High gasoline prices are not new to Hawaii. According to 
the Subcommittee report, Midwestern gasoline prices spiked to 
the highest in the Nation during the spring of 2000 and 2001. 
During this time, prices in the Midwest eclipsed those in the 
State of Hawaii to earn the dubious distinction of highest in 
the Nation.
    For more than 20 years, Hawaii has consistently had the 
highest gasoline prices in the Nation. From 1995 through the 
first half of 1998, gasoline prices in Hawaii averaged more 
than 30 cents per gallon higher than the U.S. mainland prices.
    We don't have price spikes in Hawaii. We have had one long 
continuous spike.
    On any day that you check www.gaspricewatch.com, you will 
find a gas station in Hawaii at the top of the list. On Monday, 
for example, the record for the highest price for regular 
unleaded gas in the Nation was held by a station in Pukalani, 
Hawaii, at $1.89 per gallon.
    According to the Attorney General of Hawaii, higher prices 
cannot be attributed to higher refining costs within the State 
of Hawaii or higher transportation costs to the State. For 
example, the price of gasoline in Hawaii has exceeded the cost 
of buying refined gasoline in California and transporting it to 
Hawaii by more than 20 cents per gallon. Moreover, the cost of 
transporting crude oil to Hawaii or refining gasoline in Hawaii 
is not higher than similar costs on the mainland. As such, the 
State's higher retail prices may be the result of having a 
highly concentrated market. Hawaii has only two refineries and 
four firms selling wholesale gasoline. This leaves the State 
with one of the highest concentration levels of refining and 
gasoline supply in the Nation--a significant problem according 
to your report, Mr. Chairman.
    Once again, Hawaii has the highest gasoline prices in the 
Nation. Just last week the American Automobile Association 
reported that the national average price of regular unleaded 
gasoline was $1.41 per gallon. At the same time the average 
regular unleaded gas price in Hawaii was approximately $1.69 
per gallon. California was second with an average of $1.66 per 
gallon. Such high prices hurt the hard-working men and women in 
Hawaii and in the rest of the country. As your report states, 
this could push the American economy back into a recession.
    Currently Hawaii State lawmakers are seeking information on 
how gas prices are set as they look at ways to bring the 
State's gas prices more in line with the national average. Over 
the weekend a conference committee of the Hawaii State 
legislature reached an agreement on a bill to regulate gas 
prices in Hawaii. I understand that many other States are 
concerned with this issue and may be looking at similar 
proposals. I am hopeful that Chairman Levin's interest in 
gasoline prices will spur continued attention to this issue, 
specifically for States with higher prices such as Hawaii. 
Because Hawaii has such consistently high gasoline prices, it 
generally does not draw the attention that unusual price spikes 
command.
    I would like to know, and my constituents would like to 
know, what happens at the pump. Why are some States always 
faced with higher gasoline prices than others? I anticipate the 
testimony we receive today and the information in your report, 
Mr. Chairman, will aid in answering this critical question and 
lead to lower prices for States like Hawaii.
    Thank you very much, Mr. Chairman.
    Senator Levin. Thank you, Senator Akaka. Senator Lieberman.

             OPENING STATEMENT OF SENATOR LIEBERMAN

    Senator Lieberman. Thanks very much, Senator Levin. I want 
to commend you and your staff and Senator Collins and her staff 
for working so hard on a matter of such critical importance to 
the American economy and to millions of American consumers. You 
have produced a very substantive, thoughtful and important 
report, and as Chairman of the full Senate Governmental Affairs 
Committee, may I say I am very proud of the quality and 
constructiveness of this report.
    When gasoline gets dramatically more expensive, as it seems 
to do every spring, summer and other times of the year, all 
Americans pay the price. The entire economy feels the pinch. 
Just this spring, as the Permanent Subcommittee on 
Investigation's Report points out, retail prices have increased 
faster than at any time in the past 50 years. American 
consumers obviously remain wary of future price hikes, puzzled 
and angered by the forces that seem to make the price of gas as 
volatile as gasoline is combustible. They are not alone. Even 
those in government with a statutory responsibility to 
understand the energy industry have been working hard to learn 
precisely how gas prices are set. This Permanent Subcommittee 
on Investigation's Report is a major contribution to that 
effort, and it appropriately focuses our concentration on the 
oil industry's growing concentration.
    Over the past 20 years and particularly over the past 5 
years, big oil companies have been merging, and these larger 
and larger corporations have been squeezing small refineries 
out of the market. They are also controlling more and more gas 
stations, setting prices and carving out market share through 
sole supplier agreements and zone pricing plans.
    But the American consumer is often left at the short end of 
the pump, at the mercy of wild price fluctuations and big price 
spikes. That is made worse by the fact that while their own 
pocketbooks are being pinched, consumers see the oil companies 
making huge profits. As PSI's report points out, the increase 
in gas prices from 1999 to 2000 had been matched only once in 
history, and the year 2000 income for major energy companies 
from refining and marketing was up 57 percent from 1999. In 
other words, the hundreds of additional dollars paid by the 
average consumer for gasoline resulted in unusually large 
profits for the oil industry. Over the course of a year every 
10-cent increase in the price of gasoline results in 
approximately $10 billion in additional oil company revenues.
    Now, a free market economy like ours is a wonderful thing, 
but the price of that freedom, as we have learned from the 
Enron debacle, is constant vigilance against market abuses. And 
the question before us today is: Are the interests of consumers 
being served by the increasing domination of the gasoline and 
oil markets by fewer and fewer large companies? Each of the 
mergers that has changed the landscape of the oil industry has 
been approved by the Federal Trade Commission, but given the 
effects of these mergers on the marketplace, it does seem to me 
to be worth asking whether the Federal Trade Commission is 
using all the right criteria for evaluating these mergers, and 
whether its policy of ordering newly-merged companies to divest 
their refineries is in fact good for the American consumer. The 
net effect of those divestitures, as has been pointed out, has 
been to reduce the responsiveness of the marketplace when 
demand goes up and therefore increase the likelihood of price 
spikes.
    As William Baer, then Director of the FTC's Bureau of 
Competition, said in 1999, ``Competition is critical to this 
industry, and that concentration, as well as increases in 
concentration, even to the levels that the antitrust agencies 
call moderately concentrated, can have substantial adverse 
effects on competition.'' The main point being that 
concentration can have adverse effects, and from this report 
certainly appears to have had such effects on competition.
    Mr. Chairman, I want to conclude by pointing out how 
critical an energy policy priority today's hearing should 
underline, and that of course is energy diversification. The 
tremendous volatility of gas prices is in part the result of 
volatility of global politics and economics. We have had 
turmoil in Venezuela, fourth largest provider of imported 
American oil. We have had, obviously, a serious and ongoing 
crisis in the Middle East. So that even in a maximally 
competitive and healthy marketplace, these global changes would 
make oil prices volatile, and therefore would put periodic 
price pinches on American gasoline consumers. That calls on us 
to have the foresight to diversify our energy supply to plan 
new sources of energy, rather than continuing our long-term 
reliance on oil so that the U.S. economy and policy is not at 
the mercy of such fluctuations. The energy bill passed by the 
Senate last week, in my opinion, offers us an opportunity to 
start doing that.
    But let me come back to the beginning, Mr. Chairman. I 
thank you and your staff for an extraordinary piece of work 
that is clearly in the public interest. Thank you very much.
    Senator Levin. Thank you very much, Senator Lieberman. 
Senator Carnahan.

             OPENING STATEMENT BY SENATOR CARNAHAN

    Senator Carnahan. Thank you, Mr. Chairman.
    If you were to ask most Americans what the current price of 
gasoline is, I am certain that they would be able to tell you. 
They can probably even tell you what the price is at two 
different stations in comparison. Americans pay attention to 
gas prices. Why? Because travel, and thus fuel, impact 
virtually every part of their lives, from driving to work, to 
taking the kids to after-school activities, to whether or not 
they can afford a family vacation. And the ripple effects of 
gas price spikes extend to businesses as well. As gas prices 
rise, costs to businesses also increase. And when the cost of 
doing business is greater, someone has to pay.
    Whether directly or indirectly, gas prices have a 
tremendous impact on the American family's bottom line. 
Consumers are the ones that bear the burden of spikes and 
increases in gas prices. For those living on a fixed income, 
like most seniors in Missouri, the price spikes have an even 
greater negative effect. Last summer, for the second year in a 
row, the Midwest experienced significant increases and 
fluctuations in gas prices, and we want to know why.
    So I applaud Senator Levin for initiating and overseeing 
this investigation. When constituents ask why our gas prices 
are increasing, they deserve an answer, and this report 
provides that answer.
    However, that answer is complex, and we find it is not just 
one factor that is the cause, but rather, a set of market 
trends that have combined to cause price spikes. Several of 
these trends are troubling. First is the more frequent 
fluctuation in gas prices. Oftentimes prices fluctuate more in 
a month than they previously did in years. Second, there is the 
refiners' ability and willingness to influence prices by 
controlling supply. And third, the decrease in competition 
brought on by mergers in oil companies and with it an increase 
in prices.
    The message of this report is unsettling. The situation is 
worse than it has been in a long time, and there are no signs 
that these trends that have caused volatility will end any time 
soon. These are significant findings that we need to keep in 
mind as we develop policies that impact the gasoline market. In 
such a volatile and concentrated market, we must be vigilant on 
behalf of consumers. And I hope that this Subcommittee will 
continue monitoring this issue and help us to develop policies 
that protect our economy, our businesses, and our consumers.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Carnahan. 
Senator Voinovich.

             OPENING STATEMENT OF SENATOR VOINOVICH

    Senator Voinovich. Thank you, Mr. Chairman, for holding 
this hearing.
    The impact of high and unpredictable gasoline prices is a 
problem that has plagued consumers in my home State of Ohio for 
the past few years, and I would like to commend the Chairman 
for the time that you and your staff have put in on this 
important issue.
    I would also like to welcome our witnesses, particularly 
Gary Heminger, who is the President of Marathon Ashland Oil and 
who has a large installation in the State of Ohio, and one of 
our great corporate citizens; and Mr. Pillari, even though I am 
very unhappy with BP moving their North American Headquarters 
out of Cleveland, Ohio, to Chicago, you still have a large 
presence in our State. I will never forget that while I was 
Governor of Ohio, because of an enormous investment of money 
made by BP, we brought down the emissions in the Toledo area 
and helped us obtain our ambient air standards there which was 
very, very helpful.
    Two years ago the full Committee, at my request and several 
other Senators, held a series of hearings looking into this 
same issue: Gasoline price spikes. It is very interesting that 
the players have changed but the companies are the same here 
before us.
    At that time, politicians, analysts, and business owners 
were busy pointing to a whole host of reasons for the 2000 
price hikes. Alleged price gouging and collusion among oil 
companies was one thing. Lack of domestic production, 
reformulated gasoline, economics and the law of supply and 
demand; pipeline and other transportation problems; you name 
it.
    At the time the Federal Trade Commission also was asked to 
investigate the Midwest gasoline price situation. I would like 
to point out that that was the Federal Trade Commission that 
was under the jurisdiction of President Clinton. I supported 
the investigation, because I believed that my constituents had 
the right to know why their gasoline prices were high and if 
the actions by the oil companies were behind the high prices. 
In March 2001 the FTC issued their report and found that there 
was no evidence of collusion. The report did find that the high 
gas prices were caused by a mixture of structural and operating 
decisions with primary factors including refinery production 
problems, low inventory levels, and pipeline breaks.
    And, Senator Levin, you and I experienced them. We had a 
break in the Wolverine pipeline coming down from Michigan and 
then there was another one, the Explorer coming up from Texas, 
that were both ruptured.
    The FTC report also found that the damage was minimized 
because the industry responded quickly with an increased supply 
of gasoline to the Midwest. Unfortunately, similar price 
increases were seen last year and we have seen similar gas 
prices this year and will, I am sure, see even more of them 
with what is going on in the Middle East and Persian Gulf.
    Well, there have been signs that gasoline prices are 
dropping. That is of little consolation to families in the 
Midwest where prices are still high. I am concerned about that, 
just like everyone else. I watch those gas station prices.
    Most people who have been around, as long as I have been, 
remember the Arab oil embargo of 1973, when costs went up, gas 
shortages were everywhere, and people sat in long lines to get 
gas. Some of the younger people in this country do not remember 
it. I remember it. At that time the United States only relied 
on 35 percent foreign oil to meet our domestic needs. Today our 
reliance on foreign oil averages 58 percent. And when we had 
the crisis a couple of years ago, it got up to over 60 percent.
    The American people want to know why nothing has been done 
in the last 29 years to reduce our dependence on foreign oil. 
In my opinion, we botched one opportunity when we in the Senate 
did not provide for exploratory drilling in ANWR. I have been 
around this business over 35 years. All too often in 
government, when a problem comes up, we have a tendency to 
treat it as if it were a barking dog. Give it a bone, a little 
attention and it stops barking, and when it stops barking, 
ignore it until it starts barking again. That is what we have 
done in this country in terms of the supply of gasoline.
    Such neglectful treatment of such a vital component of our 
Nation's economy is unconscionable. We lack an energy policy by 
this country, and hopefully we are going to have one by the end 
of this session.
    With the Senate's passage last week of the energy bill, I 
think we are one step closer to preventing these unpredictable 
gas price spikes. However, in my opinion, there are still many 
issues that must be addressed before we are going to be able to 
have a reliable and predictable gasoline supply.
    The report prepared by the Democratic staff of the 
Subcommittee recognizes that the number of refineries in this 
country went from a high of 324 in 1981 to 155 in 2001. 
Additionally, I think it is important to remind my colleagues 
that there have been no refineries constructed since 1976. 
Additionally, it is extremely unlikely that a new refinery will 
be built because of the difficulties with siting new 
refineries, many of them environmental, and many of them have 
to do with the rate of return on building a new refinery. I 
would like to hear from the witnesses why we cannot get more 
refineries built in the United States of America. In 1982 there 
were over 300 refineries in this country; just over 68 percent 
of their capacity was being utilized. Today our Nation's 
refineries operate at near peak capacity. If a refinery has a 
problem, you can almost see it immediately reflected in the 
price of gasoline. While increased refining capacity has 
increased by nearly 1 million barrels per day since 1986, that 
still does not replace the 3 million barrels per day that was 
lost in the closure of 120 refineries during the 1980's.
    At the same time I am concerned about our Nation's 
infrastructure for distributing gasoline. In 2000, distribution 
problems were one of the major contributing factors to the 
extreme price hikes experienced by my constituents. I already 
mentioned the two pipelines. Until they were back operating at 
full capacity, they significantly limited the amount of 
gasoline that was being brought into Ohio, resulting in higher 
prices. This situation is not unique. Nationwide our pipelines 
are operating at capacity, and if a break or other problem is 
experienced, then the gasoline being distributed to gas 
stations will be limited. The best way to eliminate this 
problem with our distribution system is to improve our 
infrastructure. Only by expanding pipeline capacity can we 
improve reliability and competition and lessen the risk of 
unexpected price hikes.
    Finally, I would like to point out that the report prepared 
by the Subcommittee focuses only on the downstream industry, 
leaving out one of the most variable factors in gasoline 
pricing, the price of crude oil. According to the Energy 
Information Administration, in March this year crude oil 
accounted for 41 percent of the cost of gasoline. Over the last 
4 years crude oil prices have varied dramatically--listen to 
this--from $11 a barrel to $33 a barrel. It only makes sense 
that if you have significant differences in crude oil prices, 
then you will see price spike in gasoline.
    I would like to thank the witnesses for being with us today 
and I look forward to your testimony.
    Senator Levin. Thank you very much, Senator Voinovich. 
Senator Bunning.

              OPENING STATEMENT OF SENATOR BUNNING

    Senator Bunning. Thank you, Mr. Chairman.
    Gasoline is what makes this country move. We rely on it to 
get to work, pick up our kids from school, travel on business, 
and deliver goods and services to companies and homes across 
this country. Americans use 123 billion gallons of gasoline 
each year. Did you hear me? 123 billion gallons. In the 
Commonwealth of Kentucky we used about 2.1 billion gallons in 
the year 2000. We are all concerned about fluctuations in 
gasoline prices. It affects how much disposable income 
Americans have left over at the end of the week. It determines 
the health of our economy and the ability of businesses to 
operate. I routinely hear from Kentuckians who are concerned 
about gasoline prices, particularly after prices spiked last 
year post September 11. Gas companies and gasoline stations 
should be fair with their customers, and any activity like 
price gouging or collusion should not be allowed.
    There is probably no other commodity Americans regularly 
purchase that fluctuates as much as gasoline. Refiners and 
retail stores should be held to the highest standards. Recently 
price fluctuations seem to have become wilder and lots of 
people want to know what has been going on. If they are like me 
the average consumer does not know why prices have been going 
up and down, but they would like to know more. So this hearing 
gives everyone a chance to explain things and gives us a chance 
to look at the regulatory and delivery systems we have now. I 
have heard reports that margins between supply and demand in 
the gas market have become smaller in recent years, and so 
mistakes in matching up the two can lead to price swings.
    Some also complained about market concentration among 
retail brands and how that affects price and availability. I do 
not know if either of those claims are true, but I am 
interested in hearing from those in the industry who have come 
here today. Also as a part of any discussion, we also have to 
make sure that the government role as regulators does not 
contribute to the problem. In fact we need to know what we can 
do in the opposite direction to encourage companies to make 
investments in our Nation's infrastructure, including what 
Senator Voinovich said, in new refineries that will help ease 
this problem in the future. For example, I understand some 
producers are having problems building a pipeline that could 
move gas and help alleviate some of the gas price problems that 
occurred last summer in the Midwest. The industry is trying to 
build a new pipeline called the Cardinal that would run 150 
miles through Ohio and West Virginia and would end up in 
Kentucky. The Corps of Engineers is hassling this project, not 
allowing it to be completed and making it very difficult to 
complete. Red tape has slowed this process. We need to work 
harder to construct a smarter more efficient regulatory 
framework.
    I appreciate the time our witnesses have taken to come and 
testify. I look forward to hearing from them.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Bunning.
    Let me also note the presence of Senator Wyden, who I 
indicated will be testifying before us on Thursday. He has 
joined our panel and he has been long involved in investigating 
gas prices and trying to understand and transmit to the public 
the reasons for the gas price spikes that we face.
    Senator Levin. Let me now introduce our panel of witnesses 
who are with us this morning. We are grateful for their 
presence and appreciate their presence. They are all executives 
from five of the top oil companies in the world. And we invited 
these witnesses because they are in charge of U.S. operations 
for each company, so that they have the expertise to answer 
some of the questions that we will be asking. We have at the 
witness table James Carter, who is the U.S. Regional Director 
of ExxonMobil; Gary Heminger, President of Marathon Ashland 
Petroleum; Ross Pillari, Group Vice President for U.S. 
Marketing of BP; David Reeves, President of North American 
Products for ChevronTexaco; and finally, Rob Routs, President 
and CEO of Shell Oil.
    And we look forward to hearing your views, and pursuant to 
Rule VI, all witnesses who testify before this Subcommittee are 
required to be sworn, and I would ask you to please stand and 
to raise your right hand.
    Do you swear that the testimony that you will give before 
this Subcommittee this morning will be the truth, the whole 
truth, and nothing but the truth, so help you, God?
    WITNESSES: I do.
    Senator Levin. Thank you. We will be using a timing system 
today, and approximately 1 minute before the red light comes 
on, you will see lights change from green to yellow, giving you 
an opportunity to conclude your remarks. All your testimony 
will be printed in the record as written. We ask that you limit 
your oral testimony to no more than 10 minutes. We will have a 
lunch break approximately at 12:30.
    Mr. Carter, please proceed.

   TESTIMONY OF JAMES S. CARTER,\1\ REGIONAL DIRECTOR, U.S., 
     EXXONMOBIL FUELS MARKETING COMPANY, FAIRFAX, VIRGINIA

    Mr. Carter. Thank you, Mr. Chairman. I am Jim Carter, 
Regional Director, U.S., ExxonMobil Fuels Marketing Company. I 
appreciate this opportunity to discuss the causes for price 
volatility in the gasoline marketplace and our recommendations 
to help deal with these fluctuations.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Carter with an attachment appear 
in the Appendix on page 130.
---------------------------------------------------------------------------
    ExxonMobil markets fuel products in 47 States and the 
District of Columbia. Our goal is to provide reliable supplies 
to our customers at competitive prices while respecting the 
environment and protecting the safety of the communities we 
serve. In the interest of time, I will summarize my remarks and 
ask that my written testimony be entered in the record.
    Senator Levin. It will be. Thank you.
    Mr. Carter. Our company understands the public sensitivity 
to price swings and the impact of fluctuating prices on 
consumers' budgets. The market for gasoline is one of the most 
visible of all consumer goods. Customers see our prices every 
day, as some of you have mentioned, and readily know when they 
are rising and falling. In fact, customers often contact us 
when they are rising.
    I aim to leave you today with the following messages: 
Gasoline prices reflect a fiercely competitive market operating 
with high transparency and a tight supply/demand balance. The 
market efficiently sets gasoline prices that reflect supply and 
demand balances, and consumers benefit in the long term when 
the free market is allowed to work. U.S. refiners and gasoline 
marketers compete vigorously, as evidenced by low margins and 
returns. Over the last 20 years, combined refining and 
marketing returns on capital have averaged 5 percent. New 
players have recently entered both of these businesses.
    Marketing has evolved over the past several decades from a 
focus on automotive needs such as service and gasoline to now 
service and convenience. The market today includes not only so-
called major brands such as Exxon and Mobil but also 
convenience store chains, supermarkets and discount retailers 
or hyper-markets. The traditional major suppliers combined have 
45 percent of the gasoline retail market today. Over the next 3 
to 5 years the hypermarket share is projected to grow from 3 to 
4 percent today to almost 16 percent, which is higher than 
ExxonMobil's current market share.
    With more choices than ever before, gasoline consumers are 
clearly benefited by this increased competition. Both gasoline 
margins and retail prices have declined over time. After 
adjusting for inflation, average retail gasoline prices have 
exhibited a general downward trend during the past 80 years. Of 
course, there has been some interim fluctuation based on true 
oil prices.
    Measured in 1999 dollars, gasoline prices have declined 
from around $2.50 in 1920 to about $1.50 in 2000, even as taxes 
have increased. Today taxes make up 30 percent of the retail 
price.
    There are three main causes for gasoline price volatility: 
Changes in crude oil prices, market transparency, and the 
proliferation of fuel specifications. Crude oil prices 
currently comprise about 40 percent of the retail gasoline 
price. Since late January crude oil prices have increased by 
over $7 a barrel, accounting for 15 to 20 cents of the total 
gasoline price increase of roughly 30 cents per gallon.
    Instant availability of global news has made markets highly 
transparent. Prices in commodity futures markets respond 
quickly to world events. High transparency makes markets more 
efficient, but it can also increase volatility.
    Today's many boutique gasoline specifications place 
significant demands on the refining industry. Summer grades are 
more difficult and expensive to make because they require 
additional processing to meet environmental standards. This 
reduces refining capacity in the summer when demand is the 
highest. A disruption at a single refinery can quickly upset 
the balance. Boutique gasolines also present logistics 
challenges. They limit distribution system flexibility and 
reduce interchangeability of supply among terminals.
    Industry consolidation, which the Subcommittee has raised 
as an issue, based on refining concentration analysis by State, 
has not contributed to increased price volatility. Refining 
concentration should be analyzed regionally, as most States are 
not self-contained refining markets. Even with recent mergers, 
there are still a large number of independent refiners and 
marketers.
    To minimize the effects of market disruptions and increase 
industry capacity we recommend three changes. First, reduce the 
number of boutique gasolines. That will increase our 
flexibility in refining and distribution. Second, appropriately 
sequence future changes in product specifications to eliminate 
overlap and bunching of requirements, which will help ensure 
that necessary investments can be completed without affecting 
supply stability. Finally, ensure appropriate interpretation 
and enforcement of regulations that affect capacity and supply.
    I would be happy to address your questions that you might 
have. However, I hope that you will understand that due to the 
competitive concerns, it would not be appropriate for us to 
discuss company sensitive data. I'd prefer to address that in 
another setting.
    Thank you for the opportunity to comment.
    Senator Levin. Thank you very much, Mr. Carter, and we in 
our exhibits have also tried to protect those proprietary 
matters that would cause disclosure of information which would 
not be appropriate to competitors, and we have made that effort 
as well.
    Mr. Heminger.

  TESTIMONY OF GARY HEMINGER,\1\ PRESIDENT, MARATHON ASHLAND 
                    PETROLEUM, FINDLAY, OHIO

    Mr. Heminger. Thank you, Mr. Chairman, and Members of the 
Subcommittee. I thank you for allowing me the opportunity to 
meet with you today.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Heminger with attachments appear 
in the Appendix on page 146.
---------------------------------------------------------------------------
    I am Gary Heminger, President of Marathon Ashland 
Petroleum. Mr. Chairman, I, too, have a written report for the 
record.
    Senator Levin. Thank you.
    Mr. Heminger. We are a Midwest company headquartered in 
Findlay, Ohio. We have major facilities and a number of 
employees in several of the States of the Members, including 
2,000 employees in Illinois, 2,500 in Indiana, 3,200 in 
Kentucky, 3,200 in Michigan, and 8,000 in Ohio.
    Unlike many refiners we consistently supply all segments of 
the gasoline market including independent distributors and 
retailers. In fact, these customers represent our largest 
single customer market.
    We appreciate the Subcommittee's interest in this very 
important topic and agree with a number of findings in the 
just-released report of the Subcommittee staff, including No. 
1, the finding that our new Cardinal and Centennial Pipeline 
projects should make a positive difference to the Midwest 
consumer. We obviously agree. No. 2, the finding that the 
mandated winter to summer fuel changeover reduces inventories 
just before the warm weather driving season, that has a price 
effect. And No. 3, the finding that our company made and sold 
33 percent more reformulated gasoline in 2000, a period when 
many other refiners had cut back their production.
    A central question in this hearing is whether my company 
deliberately withheld reformulated gasoline from the market in 
the spring of 2000 to boost prices. The answer is an emphatic 
no. The fact is that Marathon Ashland Petroleum produced 33 
percent more reformulated gasoline than the year before and we 
sold every drop. Let me repeat that. We produced 33 percent 
more and sold every drop. Any assertion to the contrary is just 
plain wrong.
    Our pricing procedures also follow sound business models. 
We consider our cost of supply, the amount of supply, the 
anticipated demand and a range of market indicators. Fuel 
markets everywhere follow the price of crude oil. However, 
individual markets have their own unique sensitivities. In the 
Midwest, for example, consumers use 25 percent more fuel than 
the Midwest refineries produce. The balance is shipped to the 
region by pipeline or barge usually from the Gulf Coast. Any 
disruption in transportation service has the potential to 
produce price volatility. We understand that the ups and downs 
of gasoline price upset consumers. Despite volatility, the 
Lundberg survey found that motorists in the Midwest actually 
paid 1.6 cents per gallon less than the U.S. average from 1998 
to 2001. In fact, adjusted for inflation gasoline now sells at 
close to an all-time low. This is true for very few other 
products. But then few markets are as uniquely competitive as 
the one that brings America's motorists to approximately 
180,000 retail gasoline outlets, a market that is growing even 
more competitive with the emergence of hypermarket gasoline 
retailers.
    I believe that few companies have been as responsive and 
customer focused as Marathon Ashland. I am extremely proud of 
the people and how they responded during the periods of supply 
imbalance in 2000 and 2001. During those years we increased our 
refining throughput, testing to the design limits, our plants 
already running at the high end of historic norms. When a major 
pipeline failure took about 400 million gallons out of the 
market, we ran additional transport trucks 24 hours a day, 7 
days a week to supply our customers as best we could. We flew 
in additional drivers to fill the greatly expanded route 
schedules and driving times. We also took the highly unusual 
step of shipping gasoline from far away as Newfoundland. We 
increased our sales. In fact we sold more product than we 
produced. In 2000, for example, we sold approximately 2 billion 
gallons more gasoline than our plants refined, an outcome 
possible only because we dedicated our logistics resources to 
bringing fuel from where it was made to where it was needed. We 
took extraordinary steps to keep our customers supplied.
    One reason the supply disruption of 2000 and 2001 produced 
such dramatic price effects is that the Nation's refining and 
delivery systems are severely constrained, particularly during 
periods of peak demand. Understanding this context is important 
to appreciating why prices may spike when a refinery goes down 
or a pipeline connection to the Gulf Coast is interrupted. It 
is estimated that the Midwest has a refined product shortage of 
about 42 million gallons a day, and this puts a great burden on 
our ability to move fuel from where it is made to where it is 
needed. Yet our distribution is highly constrained.
    During periods of peak demand pipelines can't grant 
suppliers all the shipping capacity they need. If there is an 
outage for a reason, there is very little if any makeup 
capacity. At Marathon Ashland we're trying to address these 
issues. On the production side we have a new coker at our 
Garyville, Louisiana, refinery that produces enough gasoline 
for about 60,000 cars a day with no additional crude oil 
throughput. A major capital investment project is now under way 
at our Catlettsburg, Kentucky, refinery in addition to numerous 
smaller projects completed or under way. We are constantly 
looking at cost effective ways to improve our refineries to 
increase production, reduce emissions, and improve efficiency.
    We're also working to address the delivery issue. Earlier 
this month the Marathon Ashland joint venture began operation 
on Centennial Pipeline, a new refined products pipeline that 
connects the Midwest with the Gulf Coast. We also plan to build 
the Cardinal Products Pipeline to link one of the Midwest 
fastest-growing markets, Columbus, Ohio, with the Ohio River 
and our Catlettsburg, Kentucky, refinery. These projects are 
expensive. In fact, just since its inception in 1998 Marathon 
Ashland has invested a total of more than $2.5 billion in 
refining, marketing and transportation. We plan to continue to 
invest heavily to meet clean fuel regulations and the growing 
needs of our customers.
    Three of our Midwest refineries, St. Paul Park, Minnesota; 
Canton, Ohio; and Detroit, Michigan, are very small. They lack 
either the inherent efficiencies of larger facilities or the 
location advantage of Gulf Coast refineries. Every refinery in 
this size or class is vulnerable. Were it not for the 
efficiencies realized from the combination of the downstream 
assets of Marathon Oil and Ashland, Incorporated, it is 
questionable whether either company would have been able to 
survive as an independent refining and marketing company.
    Marathon Ashland and its employees are committed to help 
the Midwest growing energy needs. These government measures 
would help: Regulatory certainty, appropriate rule phase-in, 
policies that encourage investment in the industry, and 
expedited permitting. The Department of Energy indicates 
petroleum hydrocarbons are likely to be the predominant source 
of transportation fuel in America for at least the next 20 
years. Government and industry need to work together to help 
assure supply reliability and affordability for America's fuel 
customers.
    I look forward to making the effort a productive and long-
lasting one. And I appreciate the opportunity to appear before 
this Subcommittee. Thank you, Mr. Chairman.
    Senator Levin. Mr. Heminger, thank you very much. Mr. 
Pillari.

  TESTIMONY OF ROSS J. PILLARI,\1\ GROUP VICE PRESIDENT, U.S. 
            MARKETING FOR BP, WARRENVILLE, ILLINOIS

    Mr. Pillari. Thank you, Mr. Chairman. Good morning. My name 
is Ross Pillari and I am a Group Vice President of Marketing 
for BP. BP is a supplier of fuels for transport and power in 
the United States under the BP, Amoco, and Arco brands. I, too, 
have submitted a written report for the record, Mr. Chairman.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Pillari appears in the Appendix 
on page 157.
---------------------------------------------------------------------------
    Senator Levin. Thank you.
    Mr. Pillari. I am pleased to appear here this morning to 
speak on behalf of my company and address the issues of 
gasoline price volatility. It is a subject that attracts the 
attention of many interested parties, but most importantly is 
on the minds of our customers as they make their buying 
decisions.
    The price of gasoline is also a business issue for the 
thousands of gasoline dealers, distributors, refiners, and 
energy companies who invest their personal and corporate funds 
in this volatile and intensely competitive business. As each of 
these businesses works to manage within this complex market 
volatility, they are faced with trying to explain increasing 
gasoline prices such as we have seen in the last 60 days. 
However, when gasoline prices are low, as they were in January, 
in some markets reaching as low as $1.05 a gallon, there are 
generally few questions, and little understanding that this 
effect is also a function of volatility. Yet it is important to 
note that in this period and in similar periods of volatility, 
this country has, on average, maintained the most reliable 
supply and the most efficient distribution system at the lowest 
prices in the world. This is an important fact because it 
demonstrates our ability to dampen at least some of the effects 
of volatility.
    In the long run gasoline prices are directly related to 
crude oil prices. Over 90 percent of the change in gasoline 
prices is directly related to changes in the price of crude. In 
just the past 24 months crude prices have bounced from lows of 
around $10 per barrel to highs of over $28 per barrel, as have 
already been mentioned. And gasoline prices have moved in 
tandem. The increased gasoline price volatility over the last 
18 months is consistent with the volatility in the price of 
crude oil. Crude oil prices react to world events. Crude oil 
prices react to world economic demand. The market will 
naturally adapt to the ebbs and flows of this demand, resulting 
in normal market-based volatility. As crude demand increase, 
crude supply has historically increased to meet it. We have 
seen additional resources brought online in the Gulf of Mexico 
and other locations around the world. In just one of these 
areas, the Gulf of Mexico, my company is spending billions of 
dollars to find these new resources. These investments for 
additional supplies are based on an assumed long-term price for 
crude oil. But this is not likely to be a static price. It is 
more likely to be a volatile price based on the many factors I 
have already mentioned. This same volatility will naturally 
flow through and have an effect on the gasoline product 
markets.
    However, the cost of crude oil is just one of the factors 
that influences gasoline price volatility. As we have seen in 
the past, supply disruptions from unexpected and in some cases 
catastrophic refinery problems, pipeline outages, and import 
patterns will also cause volatility in our gasoline markets.
    Volatility tends to rectify itself with the natural actions 
of the marketplace. Changes in gasoline price affects supply so 
that the market reaches the equilibrium price where supply and 
demand is in balance. During this balancing process, the market 
experiences price volatility and initiates the market-based 
actions that will attract the very supply that will dampen this 
affect.
    Nowhere was this more in evidence than in the actions taken 
by our company to supply gasoline to the Midwest and the West 
Coast during supply disruptions of the past two summers. BP 
reacted to these market conditions by taking a number of 
actions including blending chemical feedstocks into the 
gasoline pool to maximize volumes, moving barrels from our 
Toledo refinery into Detroit to free up Chicago-based refinery 
barrels for sale or supply in that market, transporting 
gasoline from European refineries to the Midwest, moving 
gasoline components from our Kwinana, Australia, refinery to 
the West Coast, and delivering additional volumes into Chicago 
via Explorer Pipeline when space was available.
    As a result of these efforts, BP was able to make more of 
its gasoline available to the Midwest and West Coast, and also 
to dampen the price effect of the disruptions, but not without 
temporary price volatility as the market corrected itself. At 
the street level the U.S. gasoline market has gone through a 
dramatic change over the last 10 years, primarily driven by 
consumer demands for quick service, convenience products, and 
low prices. These changes continue. And the driver of these 
changes is the consumer. The consumer is demanding better and 
more progressive retail options for purchasing gasoline. These 
new outlets, whether investments by a jobber, an integrated oil 
company, or a grocery store chain, are complex and multi-
faceted businesses. They require multimillion dollars 
investments. There is no slack in the economic drivers of this 
system that would allow for increasing costs or inventory to 
dampen or absorb price volatility. But we must look at the 
facts and analyze the impact of these market factors over the 
last few months.
    While we have seen volatility in gasoline prices due to 
world crude oil market volatility, we have actually experienced 
lower retail prices over the first part of this year. According 
to DOE statistics, the price of gasoline during the first 
quarter of this year has averaged about $1.20 per gallon 
compared with $1.48 during the same period last year. We have 
seen the price move from a low in January of nearly a dollar, 
as I mentioned before, in some markets to their recent highs, 
in some cases as high as $1.60 in the Illinois market, which 
are still nearly 15 to 20 cents below the highs of last year. 
But as the price of crude oil has begun to stabilize, so have 
retail gasoline prices. They are beginning to come down 
already.
    At the same time gasoline production in the United States 
has increased by 3.6 percent over last year, and nationwide 
inventories of both RFG and regular gasoline are at or above 
their prior year levels. No single factor is the cause of 
volatility. It is the totality of these factors that makes the 
market work so effectively in achieving each period of 
equilibrium. Consumers in the United States continue to benefit 
from the intensely competitive U.S. refining and marketing 
industry. More sophisticated and cost efficient business models 
are constantly evolving in the marketplace at an ever-
quickening pace. In the last few years the market has seen the 
entry and growth of large format independents, convenience 
store chains, the addition of gasoline at hypermarkets and 
grocery store chains, and the accompanying growth in their 
market share. The consumer has more offers and better offers to 
choose from.
    At the same time the need to realize economies of scale, 
reduce costs, access new markets and better manage risks, while 
continuing to deliver value to shareholders has resulted in a 
number of mergers, acquisitions, and consolidations. The net 
result is that cost reductions and efficiencies from mergers 
have resulted in greater value for the consumer as evidenced by 
prices the same or lower than in previous years. To this end we 
continue to operate our refineries at high levels of 
production, maintain our inventories at levels required to meet 
our customers' needs, and establish our role as a preferred 
supplier.
    The marketplace works. And while it is working, it will 
reflect the realities of the actions required to balance supply 
and demand. Artificial interventions are likely to result in 
consequences and unpredictable results.
    As we have throughout this discussion, BP is prepared to 
continue to work with this Subcommittee and to be as helpful to 
you as possible. I will be pleased to take questions.
    Senator Levin. Thank you very much, Mr. Pillari, and we 
thank you all, by the way, and your companies, for your 
cooperation with this Subcommittee. We have sought out a 
significant amount of information. We have obtained that 
information, and we are appreciative of it, and we appreciate 
your willingness to continue to work with the Subcommittee on 
that basis.
    Mr. Reeves.

   TESTIMONY OF DAVID C. REEVES,\1\ PRESIDENT, NORTH AMERICA 
   PRODUCTS, CHEVRONTEXACO CORPORATION, SAN RAMON, CALIFORNIA

    Mr. Reeves. Thank you, Mr. Chairman and Senators. It's my 
pleasure to be here today to testify before the Subcommittee. 
My name is Dave Reeves and I'm the President of North America 
Products, which is the ChevronTexaco entity responsible for 
refining, marketing, and distribution in the United States.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Reeves appears in the Appendix on 
page 161.
---------------------------------------------------------------------------
    In the United States we refine and market gasoline under 
the Chevron brand, and I'll be referring throughout my 
testimony to our United States' operations as Chevron. Although 
our corporate name is ChevronTexaco, we do not own, operate, or 
supply any of the former Texaco refineries or retail outlets in 
the United States. The FTC required that those facilities be 
sold as a condition of our merger last year.
    To cover the issues the Subcommittee asked us to address, 
let me talk briefly about gasoline production and delivery. 
Chevron operates six fuel refineries in the United States with 
a total refining capacity of roughly 900,000 barrels a day. Our 
largest refineries are located in Pascagoula, Mississippi, and 
El Segundo and Richmond, California. We have one medium-sized 
refinery in El Paso, Texas, and two smaller refineries, one in 
Hawaii and one in Salt Lake City.
    Chevron's share of the gasoline market in the United States 
is roughly 6 to 7 percent. We sell gasoline in 28 States and 
the District of Columbia through about 8,000 Chevron branded 
retail service stations. Over 90 percent of our stations are 
operated by independent jobbers or dealers who choose to brand 
with Chevron. Less than 10 percent of our stations are owned 
and operated directly by Chevron. We market on the West Coast, 
throughout the South, Hawaii, Alaska, and in portions of the 
Rocky Mountains. We are a smaller marketer in the Mid-Atlantic 
region through jobber-served stations. We do not refine or 
market in the Midwest or the Northeast.
    With respect to the Subcommittee's question about the 
adequacy of the industry infrastructure, I can best comment on 
my company. We continue to invest substantial sums to ensure 
that our infrastructure is adequate to meet our customers' 
needs. For example, our Pascagoula, Mississippi, refinery has 
begun work on its clean fuels project. When completed next year 
it will be one of the first refineries in the Nation capable of 
producing both low-sulfur gasoline and on-highway diesel fuel 
outside California. The project will be completed in advance of 
the national deadlines, primarily to meet local fuel 
requirements in Birmingham, Alabama, and Atlanta, Georgia, 
which are key marketing locations for the Pascagoula refinery. 
In general, while I think it has been noted that the capacity 
of the industry is strained in some parts, I do believe it will 
continue to grow to meet demand as long as the conditions to do 
so are economic.
    One concern of the Subcommittee is the series of mergers 
over the last 6 or 7 years, and like mergers in other business 
sectors, the mergers have been driven, I believe, by both a 
need to improve efficiency by reducing costs, and a need to 
compete in a world that requires strong companies capable of 
finding, developing, and delivering energy for the future 
generations. Those were major factors in the merger with 
Chevron and Texaco.
    Turning to gasoline pricing, I believe the Subcommittee's 
report accurately reflects that gasoline prices are set based 
on competition. They are the result of the combination of 
complex factors of supply, demand, and competitive forces. At 
Chevron our primary aim is to keep our independent dealers and 
jobbers competitive with the station down the street. As a 
result of competition, gasoline prices in constant dollars have 
been generally declining over a 20-year period and are a good 
value compared to many other goods and services, and to 
gasoline prices in many other countries.
    I recognize that those facts alone may be little comfort to 
families whose budgets are strained when gasoline prices 
increase rapidly, and I recognize that gasoline prices do tend 
to fluctuate, both up and down, more than many or most other 
products. It's important to recognize in addition that there 
are many factors that cause price fluctuations, including 
rapidly-changing crude oil prices, the ever-growing demand for 
gasoline, temporary refinery outages, and in some cases the 
annual changeover from winter grade to summer grade gasoline 
specifications. That changeover reduces inventories at the same 
time seasonal demand begins to increase for the summer driving 
season.
    Gasoline prices have also been a concern of many government 
agencies, and there have been obviously many investigations of 
gasoline pricing and fluctuations in the last several years. 
Those investigations have consistently shown that there have 
not been any conspiracies or antitrust violations, but rather 
that the fluctuations simply reflect that the market is working 
as it should. For example, the California Energy Commission 
concluded that the price spike in California in 1996 was caused 
primarily by a fire at a competitor's refinery, which removed 
some 10 percent of the supply for several months. Gasoline 
prices did in fact increase rapidly, which dampened demand and 
created the incentive to import gasoline from as far away as 
Finland. Prices then returned to lower levels. And as the 
Energy Commission put it, ``The market worked.''
    I've reviewed the Subcommittee's report, and while I can't 
say that I have fully digested all 396 pages, I'd like to offer 
a few additional comments on it. First of all the report 
appears to miss the most basic reason for fluctuations in 
gasoline prices, and that is the changes in crude oil. The 
report notes that the average gasoline price across the United 
States went up by 35 cents from early 1999 to 2000. Two things 
are important about that observation. First, the report uses 
early 1999 as the starting point even though gasoline prices 
were at historic lows at that point so that the increase 
appears larger than if the report focused on a different time 
period. And more importantly, as Senator Voinovich noted 
earlier, it fails to take into account that the cost of raw 
materials, crude oil, increased by an even greater amount 
during that period of time.
    In addition the report refers to the various mergers and 
acquisitions that have taken place, most of them in the last 
decade, and suggests that they have reduced competition. I 
believe that they have increased competition. The mergers 
created stronger companies which were more efficient and thus 
better able to compete. The FTC also typically required the 
merging companies to divest refining and marketing assets, 
where retaining the assets could have been a competitive 
problem. The end result, as shown by the Subcommittee's 
charts--I think it's on page 84 in your report \1\--is that 
industry gross margins and operating costs have been declining, 
while net margins and rates of returns have remained fairly 
constant and low. Industry rates of returns have averaged about 
5 to 6 percent, reflecting the fierce competition that we face. 
Consumers have been the beneficiary of the competition.
---------------------------------------------------------------------------
    \1\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    One more observation on the report. It refers to documents 
used in a California case entitled Aguilar dealing with 
California gasoline prices. What is not particularly clear in 
the report, however, is that all three levels of courts in 
California considered those very same documents and determined 
that they did not establish any wrongdoing. The trial court and 
the California Court of Appeals threw out the case as 
unfounded, and the California Supreme Court unanimously 
affirmed that decision.
    Finally, the Subcommittee has asked what can be done 
regarding gasoline price fluctuations. Speaking for Chevron, 
our people are doing our very best to operate our refineries 
and distribution system safely and reliably. It is our No. 1 
priority. We devote a lot of resources to making sure that we 
continue progress to being world class in reliability. We're 
also doing our best to be fully ready to meet new government 
requirements for fuels. The government can also take steps to 
ensure that reliable supplies of gasoline and other fuels are 
available for the American consumer. For example, the 
government can set performance-based standards for fuels, so 
that refiners have the freedom to use the most efficient 
methods to meet those standards. The government can also take 
steps to minimize and eliminate things that interfere with 
markets such as mandates and subsidies, and the government can 
streamline permitting wherever possible, which we believe can 
be done without compromising environmental protections.
    Thank you again, Mr. Chairman and Senators for the 
opportunity to testify before your Subcommittee today, and I 
would be happy to answer any questions as the hearing goes on.
    Senator Levin. Thank you very much, Mr. Reeves. Mr. Routs.

   TESTIMONY OF ROB ROUTS,\1\ PRESIDENT AND CHIEF EXECUTIVE 
         OFFICER, SHELL OIL PRODUCTS US, HOUSTON, TEXAS

    Mr. Routs. Thank you, Mr. Chairman. Whatever I am going to 
say is going to be a repeat by now, but I would like to go 
through my remarks, anyway.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Routs appears in the Appendix on 
page 170.
---------------------------------------------------------------------------
    Mr. Chairman, Members of the Subcommittee, for the record, 
my name is Rob Routs, and I am the president and CEO of Shell 
Oil Products US
    Shell Oil Products US is a marketer of fuels, lubricants, 
services, and solutions to consumer and business-to-business 
customers in the automotive, commercial, and industrial 
sectors. Shell Oil Products US operates refineries, a 
lubricants business, and a pipeline and terminal system. 
Together with its affiliate Motiva Enterprises LLC, Shell Oil 
Products US supplies nearly 22,000 branded service stations.
    I have been asked to share with the Subcommittee our 
thoughts on the United States' motor fuels market and the 
factors that contribute to the volatility of the price our 
customers pay at the pump.
    America's growth has been fueled in large part by the 
stable supply of reasonably priced energy. In fact, the price 
of gasoline has remained fairly constant when adjusted for 
inflation.
    A recent analysis by the American Petroleum Institute 
stated: ``In inflation-adjusted 2002-dollar terms, today's 
price is low compared to the historical 84-year record of 
recorded pump prices. In fact, motor gasoline prices are 45 
percent lower than the 1981 record high of $2.64 per gallon. 
Between then and now, the real cost of motor gasoline to 
consumers fell by $1.19 per gallon. This decline can be 
attributed largely to lower crude costs, but manufacturing, 
distribution, and marketing costs are lower as well.''
    Shell remains committed to ensuring that we meet the needs 
of our customers by providing them with a reliable supply of 
quality products at competitive prices.
    Still, there are a number of factors that have contributed 
to the volatility of the recent past. These factors still exist 
today and will continue to influence the price of gasoline in 
the future.
    One of the greatest challenges we face as an industry is 
supplying an ever increasing number of boutique fuels to an 
ever expanding number of niche markets. Prior to 1990, there 
were six kinds of gasoline sold in the United States. Today, 
requirements imposed by Federal, State, and local governments 
have contributed to the creation of an ever expanding number of 
motor fuels and other petroleum products. Again, according to 
the American Petroleum Institute, ``One pipeline company, 
Atlanta-based Colonial, delivers 90 different products for 85 
shippers to 270 terminals and more than 1,000 storage tanks. In 
any given month, Colonial may ship 30 different grades of 
gasoline.''
    When a region, State, or city requires a unique fuel, it 
becomes a fuel island, unable to use nearby supply should the 
delivery of their special blend be interrupted. The smaller the 
market, the more isolated they become, and the more difficult 
it is for us to move products into that area on short notice.
    Not only are we being asked to supply a greater number of 
fuels, but the specifications of these fuels often change with 
the seasons. These seasonal fuel variations require us to draw 
down inventories as we switch from one fuel to another. We 
conduct this fuel switch in April and May and September and 
October. When we switch fuels in the spring, we must draw down 
inventories to ensure that our fuel remains compliant. During 
this time markets are particularly exposed to volatility should 
a supply disruption occur.
    In an effort to address the proliferation of the fuels in 
America, we have been working with Congress on the 
establishment of a study to look at the issue. This study is 
included in the Senate's energy bill. We look forward to 
participating in the development of policies and programs 
intended to reduce the number of fuels used in this country 
without compromising environmental quality.
    At the same time, the infrastructure for producing and 
distributing fuels has been running at a very high utilization 
rate. America's refineries, for example, were running at 94 
percent utilization last summer. At these high rates, there is 
little reserve capacity that can be turned on when demand peaks 
or another source of supply shuts down. Likewise, pipelines, 
particularly those that bring product to inland markets, are 
also operating at or near capacity.
    In recent years, oil has been as low as $10 a barrel and as 
high as $30 a barrel. Today that same barrel costs $25.
    The factors influencing the cost of crude are global in 
nature. Crude oil is a commodity that is traded on various 
exchanges around the world. As with most commodities, supply 
and demand--real and perceived--determine what participants in 
the market are willing to pay for a barrel of oil. As a result, 
factors that range from regional conflict to the shut-in of 
platforms in the Gulf of Mexico can all influence the price of 
crude oil. These types of events can often contribute to short-
term price volatility.
    Finally, the business of refining and marketing fuel is 
itself changing as merchant refiners and non-integrated 
marketers have grown. They rely on the spot market for selling 
and acquiring product, and it is often the gasoline spot market 
that leads prices higher during disruptions in the supply and 
distribution system.
    Together, boutique fuels, high utilization rates, seasonal 
fuel requirements, fluctuating crude prices, and the growth of 
merchant refiners have all contributed to the volatility in the 
price of gasoline that has become common over the last couple 
of years.
    Given that the price of a gallon of gasoline is determined 
by a marketplace that is influenced by a variety of factors, 
many of which are not within the control of those who refine, 
market, and distribute fuel, is there anything that can be done 
to ease this volatility?
    First, we must stem the proliferation of boutique fuels so 
that product can be shifted from one market to another when 
supply disruptions occur or demand peaks. As I said earlier, we 
support the establishment of a study to look at this issue and 
provide recommendations.
    Second, we must look for ways to streamline the permitting 
and construction of new and expanded facilities used in the 
production, transportation, and distribution of fuels.
    More importantly, we must let the free market work and 
avoid the development of schemes intended to control or 
influence the price of gasoline.
    In the years ahead, I expect that we will continue to see 
mergers, acquisitions, and divestments in the oil industry. 
Like any business, we continually search for opportunities that 
will make us more competitive relative to our peers. The 
efficiencies and synergies we often recognize through these 
types of transactions allow us to continue to provide our 
customers with a competitively priced product.
    In some instances, the consolidation in the industry, 
particularly in refining, is being driven by the huge capital 
investments needed to meet ever more demanding regulatory 
requirements. Many smaller companies simply cannot justify the 
investment in plants and facilities needed to produce today's 
cleaner burning fuels.
    Finally, the Subcommittee has expressed an interest in how 
we price our product. Let me first say that the members of our 
industry never discuss amongst themselves how we price our 
product. Not only would that be illegal under Federal antitrust 
statutes, but it would also disadvantage our ability to stay 
competitive in the marketplace. I can tell you that we price 
our product relative to the market and that we are constantly 
striving to provide our customers quality motor fuels at a 
price that is competitive. Of course, the cost of crude is the 
single greatest cost in a gallon of gasoline. Many other 
elements contribute to the price of a gallon of gasoline. 
According to the Energy Information Agency, ``Federal, State, 
and local taxes are a large component of the retail price of 
gasoline. Taxes, not including county and local taxes, account 
for about 28 percent of the cost of a gallon. Within this 
national average, Federal excise taxes are 18.4 cents per 
gallon, and State excise taxes about 20 cents a gallon. Also, 
some States levy additional sales taxes, some applied to the 
Federal and State excise taxes. Additional local county and 
city taxes can have a significant impact on the price of 
gasoline.
    ``Refining costs and profits comprise about 14 percent of 
the retail price of gasoline. This component varies from region 
to region due to the different formulations required in the 
different parts of the country.
    ``Distribution, marketing, and retail station costs and 
profits combined make up about 12 percent of the cost of a 
gallon of gasoline. From the refiner, most gasoline is shipped 
first by pipeline to terminals near consuming areas, then 
loaded into trucks for delivery to individual stations. Some 
retail outlets are owned and operated by refiners, while others 
are independent businesses which purchase gasoline for resale 
to the public. The price on the pump reflects both the 
retailer's purchase price cost and the other costs of operating 
the service station. It also reflects local market conditions 
and factors, such as the desirability of the location and the 
marketing strategy of the owner.''
    Remember, the final price for a gallon of gasoline is 
determined by the retailer. And that price, which is included 
in the last 12 percent from the above, is set after he or she 
adds their costs or profits to the price they pay for the 
product.
    I hope that I have helped you understand the many factors 
that influence the price of a gallon of gasoline and why that 
price sometimes can be volatile. I hope you can also appreciate 
the substantial capital investments and long-range planning 
that is required for the oil industry to quench the thirst our 
country has for the fuels that keep us mobile.
    Yet despite all of the challenges I have outlined, and many 
more I have not, I believe a gallon of gasoline remains a great 
bargain in constant dollars. I look forward to answering any 
questions you might have. Thank you.
    Senator Levin. Thank you very much, Mr. Routs. Thank you 
all for your statements.
    Let me just say at the outset that I think we all recognize 
that the price of gas is directly affected by the factors that 
you have all identified. That is not in dispute. We chose to 
look at the downstream market. We did not look at, for 
instance, the price of crude oil as a factor, even though it is 
obviously a major factor.
    By the way, the price of crude oil was not a factor in the 
price spikes of 2000 and 2001. It was those price spikes which 
really caused me to begin this investigation. And as we saw 
from the earlier charts, those spikes had nothing to do with 
the price of crude oil.
    There are other factors which you have mentioned: The 
growing number of boutique fuels, increasing and inelastic 
demand for gasoline in the United States, supply disruptions, 
reduction in the number of refineries, and a number of other 
factors which you mentioned. Those are factors. But what we 
want to focus on is what our staff investigation disclosed, 
which is strong evidence that you don't simply respond to 
market factors, but that you actively help to create and 
maintain a tight market.
    Now, where there is little competition--in other words, in 
areas of high concentration--the creation and maintenance of 
tight supply gives undue power over price to those companies 
that are engaged in that market. I want to go through some of 
the documents that the staff identified and go through the 
words of the company--not mine, not consultants, not my staff, 
but the words of the companies themselves in these documents.
    I want to start with a document that is found in the BP 
files from 1999. This is found on pages 274 and 282 of the 
staff report.\1\ I have enlarged portions of it so we can all 
look at it. It is from a meeting of the Business Unit Leaders, 
or BULs, at BP on June 1, 1999, and it discusses BP's Midwest/
Mid-Continent strategy, in the words of the document.
---------------------------------------------------------------------------
    \1\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    Now, we were told that the BULs, as they are called, are 
companies' executives at the senior vice president level, so 
these are top people in the BP organization.
    First of all, Mr. Pillari, how many are of these senior 
executives who attended this meeting? About how many?
    Mr. Pillari. Probably about six or seven.
    Senator Levin. Thank you. Now, this meeting is not just a 
casual meeting. It is taking up the time of top executives at 
BP. It is a continuation of a discussion that started in April 
because the first part of the agenda for the meeting is a recap 
of the presentation from that April meeting.
    The presentation makes it clear that the purpose of the 
meeting was to come up with a strategy for the company, and 
this was not just presented by a low-ranking employee to the 
top executives, some employee who was dreaming up options on 
his own or her own. To be presented at this level, it had to 
have had some direction or support from a high level, 
presumably under the supervision of a senior officials. And, 
obviously, it is the product of a lot of work and a lot of 
thought.
    One part of this document refers to the Midwest/Mid 
Continent as a niche, I assume a market niche. I am just 
wondering first, Mr. Pillari, what is----
    Mr. Pillari. Those are actually designations of two of the 
business units. There was a Midwest Business Unit and a Mid 
Continent Business Unit. So it would be describing those two 
organizational functions.
    Senator Levin. What is meant by niche?
    Mr. Pillari. Well, since I wasn't there, I don't actually 
know. I'm assuming if you look at it, that given we were 
organized around the Midwest and the mid-continent, they would 
look at that geographic market and refer to it as the geography 
of the mid-continent and the Midwest.
    Senator Levin. Now, at the top box on page 277,\1\ the 
presentation says that, ``We can influence niche value [1 to 3 
cents per gallon] but our actions need to be significant 
[greater than 50,000 barrels per day] to be sustainable [more 
than 3 years].'' I take that to mean that you can affect the 
price of gasoline in the Midwest by 1 to 3 cents a gallon if 
you take certain actions, and just stop me if that is an 
inaccurate presentation of what it is because I want to get to 
the point.
    Then the memo goes on to present ways that you can achieve 
that increase in the price of gasoline. And so to achieve that 
goal, there are a number of options that are discussed at that 
meeting and presented, I gather many of which or most of which 
were not adopted but nonetheless considered as options to 
achieve that goal. And the rest of the page goes on to make 
some general observations about the Midwest market.
    The second dot from the bottom says that, ``There are 
significant opportunities to influence the crude supply/demand 
balance.''
    And then it goes on to say--or to discuss the market levers 
that are available to BP to influence the supply/demand balance 
in the Midwest, and I want to look at market lever No. 1, and 
this is on page 281.\1\ This is the product short market lever. 
There are two pages in the presentation on product short market 
levers. One is product short (1), which is page 281, and then 
there is product short (2), and I want to go over these 
thoughts that were presented to these executives, these options 
that were presented.
---------------------------------------------------------------------------
    \1\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    On product short (1)--Exhibits 13,\2\ I am informed. On 
product short (1), the first bullet is ``shut down niche 
internal supply.'' That would mean reducing supply inside of 
the Midwest. Then it goes through a number of ways to achieve 
that. The first way to achieve that reduction of supply is ``to 
offer supply agreements in exchange for capacity shutdown,'' 
which means that BP would promise to supply gasoline if other 
refiners would agree to shut down their refineries or their 
capacity at their refineries, which would give BP greater 
control over supply.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 13 which appears in the Appendix on page 262.
---------------------------------------------------------------------------
    I understand you did not adopt that recommendation. First, 
I am wondering why you did not adopt that recommendation.
    Mr. Pillari. Well, sir, first of all, I would say you are 
correct when you say these were presented to the business unit 
leaders. They were rejected by the business unit leaders. They 
were rejected because it is inappropriate to have this kind of 
activity in the marketplace, and it's naive to think that 
activities like this could influence the marketplace.
    Senator Levin. So the people who were presenting these 
options to the senior executives were presenting a bunch of 
inappropriate options. They had been first presented in April 
and then presumably not rejected in April but then recapped in 
June. Is that correct?
    Mr. Pillari. The issues presented in April--and if I could, 
the context for this group, it was a study group that was 
involved in the integration of the company back then. So we 
were looking at the Midwest and the mid-continent where we had 
two refineries, two logistics systems, and two of everything. 
And the study group was asked to go away and think through 
scenarios or possibilities or options as a result of this 
integration.
    In April, they returned to the business unit leaders and to 
the group and said there were some obvious things. We could 
rationalize the number of trucks that we had because we were 
now going past similar retail outlets. So we had synergies that 
we could make that were very obvious. In April, none of these 
issues was discussed.
    In June, it's my understanding--because I wasn't there, but 
it's my understanding that these options were presented to the 
BULs, who rejected them and they never went past that group.
    Senator Levin. All right. Did the people who presented 
these inappropriate options, were they fired or disciplined in 
some way?
    Mr. Pillari. They have certainly been counseled and trained 
on understanding the appropriate way to behave and the 
regulations in the marketplace. These were not senior people 
who did the studies.
    Senator Levin. To the other oil companies here, have you 
ever entered into a supply agreement or offered to enter into a 
supply agreement in exchange for the shutdown of refinery--
excuse me, in exchange for the shutdown or reduction of 
refinery capacity? Mr. Carter.
    Mr. Carter. Absolutely not.
    Senator Levin. Mr. Heminger.
    Mr. Heminger. No, Mr. Chairman.
    Senator Levin. Mr. Reeves.
    Mr. Reeves. No, Mr. Chairman.
    Senator Levin. Mr. Routs.
    Mr. Routs. No, Mr. Chairman.
    Senator Levin. Thank you.
    The second option presented to the BULs was to purchase 
capacity and to shut it down. I assume that that means to buy a 
refinery and shut it down. Have any of you ever engaged in that 
activity? Mr. Carter.
    Mr. Carter. No, Mr. Chairman.
    Senator Levin. Mr. Heminger.
    Mr. Heminger. No, Mr. Chairman.
    Senator Levin. Mr. Pillari.
    Mr. Pillari. No, Mr. Chairman.
    Senator Levin. Mr. Reeves.
    Mr. Reeves. I'm sorry. I missed the question, Senator.
    Senator Levin. Have any of your companies ever purchased 
capacity and then shut it down?
    Mr. Reeves. No, sir.
    Senator Levin. Mr. Routs.
    Mr. Routs. To my knowledge, no, sir.
    Senator Levin. OK. We are going to talk a little bit later 
about a Mobil memo from California when Mobil was considering 
what to do with the Powerine refinery. Is that the right 
pronunciation of ``Powerine''?
    Mr. Carter. Mr. Chairman, I believe it's ``Powerine.''
    Senator Levin. What to do with the Powerine refinery that 
was undercutting the price of gasoline by providing 
reformulated gas, or RFG, at a low price. The memo discussed 
buying all of Powerine's output as well as just shutting it 
down. We will come back to that memo.
    The third option, back to BP's memo, lobby for the 
elimination of oxygenates/tax breaks for same, and the two 
oxygenates are MTBE and ethanol.
    Now, the thinking here in presenting this option is that 
oxygenates as an additive reduces the amount of gasoline 
otherwise needed, so that by eliminating oxygenates, you 
replace the oxygenates with gasoline and thereby increase the 
demand for gasoline.
    Now, as a matter of fact, is it not true, Mr. Pillari, that 
BP has lobbied for the elimination of MTBE?
    Mr. Pillari. Sir, we've done a number of things. First of 
all, we're the largest buyer of ethanol in the United States. 
We are concerned about some of the health issues around MTBE, 
and we have discussed openly with many constituencies our 
concern about that and how it could be alleviated.
    Senator Levin. My question was a little different from 
that, not whether you have discussed with other entities or 
other people, but whether or not BP has lobbied for the 
elimination of MTBE and the oxygenate requirement.
    Mr. Pillari. I'm not aware of lobbying to eliminate MTBE. 
We still use MTBE. I am aware of the discussions around----
    Senator Levin. If it were eliminated, you wouldn't be using 
it, though. My question is: Have you lobbied for the 
elimination of the requirement? Has your company lobbied? It is 
a very direct question.
    Mr. Pillari. I'm not aware of it, sir.
    Senator Levin. OK. Let me ask the other companies: Do you 
agree with the assessment that the elimination of the oxygenate 
requirement will increase the demand for gasoline in the 
Midwest, thus tightening the available supply? First of all, do 
you agree with that? I am not asking you yet whether you 
lobbied for it, just whether you agree with the--that the 
elimination of that requirement would have that effect. Mr. 
Carter.
    Mr. Carter. I haven't looked at that specifically, but I'd 
be happy to answer the question about the lobbying.
    Senator Levin. OK. Mr. Heminger.
    Mr. Heminger. Mr. Chairman, taking MTBE out will reduce 
available supply; however, it would be replaced by ethanol.
    Senator Levin. OK. Thank you. Would you agree with that?
    Mr. Pillari. Yes, I agree with that statement.
    Senator Levin. Mr. Reeves.
    Mr. Reeves. We don't market in the Midwest, so I'd rather 
not answer conditions there, but directionally, I agree with 
these gentlemen on that.
    Senator Levin. OK. Mr. Routs.
    Mr. Routs. Directionally, I agree. I believe, though, that 
there will be enough ethanol around to replace MTBE.
    Senator Levin. I am talking about elimination of the 
oxygenate requirement period. Now the question is: Have you 
lobbied for the elimination of that requirement? Mr. Carter.
    Mr. Carter. We have been opposed to the oxygenate mandate 
because it, in fact, requires us to use MTBE, and we have been 
in favor of phasing down the use of MTBE in gasoline.
    Senator Levin. OK. So is it fair to say you have lobbied 
for the elimination of that requirement?
    Mr. Carter. Yes.
    Senator Levin. Thank you. Mr. Heminger.
    Mr. Heminger. Yes, Mr. Chairman, we have lobbied to reduce 
MTBE.
    Senator Levin. And to eliminate oxygenate requirement 
generally?
    Mr. Heminger. I would say not to eliminate oxygenate 
requirements generally. We believe there should be no 
backsliding whatsoever in the Clean Air Act.
    Senator Levin. In the what?
    Mr. Heminger. In the Clean Air Act.
    Senator Levin. So you have not lobbied for the elimination 
of the oxygenate requirement.
    Mr. Heminger. Not to the best of my knowledge.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 27, May 13, 2001 clarification letter from 
Marathon-Ashland which appears in the Appendix on page 281.
---------------------------------------------------------------------------
    Senator Levin. Thank you. And you don't know?
    Mr. Pillari. Well, your question was on MTBE. On oxygenates 
in general, we have said we prefer a results-based regulation 
such that we would have the option to use oxygenates, 
particularly ethanol, where it makes the most sense.
    Senator Levin. Which, I think, in plain English means that 
you would therefore prefer the elimination of the requirement, 
leaving it optional.
    Mr. Pillari. Correct.
    Senator Levin. Now, when I asked you before, did you lobby 
for the elimination of the oxygenates/tax breaks for same, you 
said not to the best of your knowledge.
    Mr. Pillari. I'm sorry, sir. I misunderstood the question. 
I thought you were asking me specifically about MTBE.
    Senator Levin. No. I was very precise. It was oxygenates.
    Mr. Pillari. Well, then I misspoke. I heard the question 
incorrectly. We would prefer to have the option to use 
oxygenates rather than have it mandated.
    Senator Levin. OK. Then is it fair to say that you have 
lobbied for the elimination of that requirement?
    Mr. Pillari. Yes.
    Senator Levin. Therefore, you have, in fact, done one of 
the things, at least, that is in that document, because that 
document says that in order to reduce supply, No. 3, that you 
will lobby for the elimination of oxygenates/tax breaks for 
same, and you now acknowledge that you have done that. 
Previously you said you didn't do any of these things, you 
didn't adopt any of these recommendations. Now you acknowledge 
you have, in fact, done one of the three things that were 
recommended.
    Mr. Pillari. What I would say, sir, is that the desire to 
have an option to use oxygenates so that we can use ethanol 
where it makes the most sense actually increases the gasoline 
pool, and that decision is about increasing the production of 
gasoline and the clean aspects of gasoline. It has nothing to 
do with this report.
    Senator Levin. Let me just go back to this. I want to get 
this really clearly for the record. Have you lobbied for the 
elimination of oxygenates?
    Mr. Pillari. We have lobbied to make oxygenates optional 
for a results-based formula.
    Senator Levin. So it is fair to say that you have lobbied 
to eliminate oxygenates as a mandate?
    Mr. Pillari. Correct.
    Senator Levin. And you are saying that is different from 
what that recommends?
    Mr. Pillari. Yes, it is.
    Senator Levin. OK. We also have a memo from Texaco--that is 
now part of Shell that we will discuss a little bit later--
stating that the elimination of the oxygen mandate would be a 
good way to tighten supply in California. Is that accurate? Let 
me ask you that right now since we are on this subject.
    Mr. Routs. Is that the memo that was produced in the 
Aguilar case, sir?
    Senator Levin. Yes.
    Mr. Routs. First of all, Shell was not involved in the 
situation 10 years ago.
    Senator Levin. Let me ask Texaco then, if you don't know 
the answer to that. Did Texaco state that the elimination of 
the oxygen mandate would be a good way to tighten supply in 
California?
    Mr. Routs. This is the first time I have seen this internal 
memo in Texaco the way you produced it. The reference to Shell 
in the memo is--I mean, I'm not aware of anything, and we 
haven't been able to trace anything in this short time period, 
sir.
    Senator Levin. Let me then ask----
    Mr. Routs. Let me put it this way: It's my belief in the 
situation that we're seeing today that importing into 
California--importing CARB gasoline into California wouldn't 
have been the cheaper option. I think they were dreaming in 
what they were doing at the time.
    Senator Levin. OK. Well, we are going to come back to that 
document.
    Now, the fourth option that was presented to the executives 
at BP was to eliminate exemptions for small refiners. Was 
that----
    Mr. Pillari. Well, that was rejected.
    Senator Levin. Right. So you didn't take any steps in that. 
Now, increase product demand, this is product short (1) on page 
281.\1\ The first option, lower prices. I know you didn't 
implement that. The next way to increase product demand is to 
convince swing cities on Gulf Coast supply to require 
reformulation that is not readily available from the Gulf 
Coast, in other words, to pull RFG from the Midwest to those 
other cities, even though they may not need it. So here you 
have the consideration by BP of promoting government 
regulation, promoting the use of RFG, which is a boutique fuel, 
to reduce supply in the Midwest.
---------------------------------------------------------------------------
    \1\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    Now, here is what EPA says about this. This is not just me. 
It is the EPA. In its report on boutique fuels, it says that, 
``Some refiners have promoted boutique fuels in order to create 
tight markets for those fuels.'' That is an EPA finding. Yet we 
have Lord Browne, who is the head of BP, saying that boutique 
fuels cause price spikes. So EPA has found that some refiners 
have actually promoted boutique fuels to create the tight 
markets for those fuels, and I think the head of your company--
is he still the head of it--Lord Browne?
    Mr. Pillari. Yes, he is.
    Senator Levin. Says that boutique fuels cause price spikes, 
or help cause price spikes. Now, I want to jump to product 
short (2), which is page 282,\1\ and this is, again, options 
presented to your executives to reduce supply.
---------------------------------------------------------------------------
    \1\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    The first category on this page for reducing supply is to 
``export products from the Midwest.''
    Second, to ``move product into southern Ontario.'' I 
presume by that you mean to just take product from the Midwest 
and export it to Canada to make supplies tight in the Midwest.
    Third item, ``use Xylene line or others to move product 
south or out of the area.''
    Next category is options called ``fill import logistics'' 
which would make it difficult to import products into the 
Midwest, and the first option in this category is to ``ship 
crude substitutes and/or intermediates/blendstocks on product 
lines.'' That sounds like a plan to use products--to use the 
pipelines for products other than gasoline so that the 
pipelines won't be available to carry gasoline to the Midwest. 
Have you ever followed that strategy at BP?
    Mr. Pillari. All of these that you have just mentioned have 
been rejected and never implemented.
    Senator Levin. The next option is ``don't incent pipeline 
conversions to products,'' threat of swing or seasonal 
production to deter. That sounds complicated, but I think the 
option that was presented there to the BP executives is that BP 
would threaten to increase its own production and thereby 
depress prices if other companies seek to create more pipeline 
capacity into the Midwest. That threat you say was presented 
and then it was rejected.
    The next strategy, to incent--``incentivize,'' I presume 
that means--``Koch not to ship into Chicago.'' Koch is a major 
supplier of reformulated gasoline in Chicago, and this strategy 
is to get Koch not to ship into Chicago.
    You weren't at the meeting, but perhaps you can help us out 
with this. What kind of incentives could BP use had they 
adopted that strategy to get Koch not to ship into Chicago? Do 
you know?
    Mr. Pillari. I have no idea, sir.
    Senator Levin. OK. The next option is to lobby for 
elimination of drag-reducing agents for environmental reasons, 
and this is No. 8 on page 282.\1\ Now, those are chemicals that 
are put into pipelines to make the product in the pipeline move 
more easily and more quickly, and by using DRAs, pipelines can 
ship gasoline faster and at less cost than if DRAs are not 
used.
    This suggestion is that you should lobby to eliminate the 
use of DRAs, slowing the delivery of gasoline into the Midwest, 
and to use the argument that DRAs are not good environmentally.
    Did you, in fact, lobby for the elimination of DRAs?
    Mr. Pillari. No, sir. To my knowledge, we did not since all 
of these options were rejected.
    Senator Levin. Thank you. Did any of the companies here 
lobby for the elimination of DRAs, do you know? Mr. Carter.
    Mr. Carter. No, Mr. Chairman.
    Senator Levin. Mr. Heminger.
    Mr. Heminger. No, Mr. Chairman.
    Mr. Routs. No, Mr. Chairman.
    Mr. Reeves. No. We have increased the use.
    Senator Levin. The next category on this chart is ``change 
behavior of shippers to support niche uplift,'' which we assume 
means to raise prices in this area. These proposals were to 
increase the cost of transporting product to the Midwest, and 
one way would be to support market-based tariffs which would 
presumably lead to increased costs for transporting product to 
the Midwest, and the other way would be to simply raise 
tariffs.
    Has BP supported higher tariffs on products going to the 
Midwest?
    Mr. Pillari. No, sir.
    Senator Levin. Thank you.
    And the last option is ``reduce product inventory in the 
niche'' or in the area. And you say that you did not act to do 
that?
    Mr. Pillari. No, all of this was rejected, sir.
    Senator Levin. Thank you.
    Now, on June 28, 2001, in a Chicago Tribune article, Sir 
John Browne, who is your CEO, talks about price volatility in 
the United States. This is Exhibit 14.\1\ Mr. Browne is quoted 
as saying that the shortage of refining capacity is not causing 
the price spikes. Do you agree with that?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 14 which appears in the Appendix on page 266.
---------------------------------------------------------------------------
    Mr. Pillari. Sir, what he was referring to was a briefing 
that I had given him about the problems with the Explorer 
pipelines, the CITGO fire problems. So the context of this 
discussion would have been is it a basic refining problem or 
are there logistics interruptions.
    Senator Levin. And, in his judgment, is there a shortage of 
refining capacity?
    Mr. Pillari. Well, I think what he was saying is we--and he 
means BP--does not need any more refineries in the United 
States.
    Senator Levin. All right. He says that the problem is 
``that products can't flow easily to where shortages develop.'' 
It seems pretty clear that shortages--that short supplies are 
intended by companies--that you intend to have a tight supply. 
And we just went through a lengthy presentation of top 
officials about how to achieve that goal. We were told that 
those particular methods were not used. But the presumption 
here is that the people who made that presentation were aiming 
to achieve that goal of tightening supply for BP. I mean that, 
it seems to me, has got to be indisputable. They may at this 
meeting have rejected or not used those methods, although we 
have a difference over the one issue involving lobbying to 
eliminate the oxygenate requirement. Nonetheless, the goal of a 
tight supply in a market was the purpose of looking at all of 
those options. Is that correct, Mr. Pillari, that that was the 
purpose of considering those options?
    Mr. Pillari. Sir, I would be speculating on what they did 
since I wasn't there----
    Senator Levin. Not what they did. What the purpose of the 
presentation was.
    Mr. Pillari. I would be speculating on the purpose of the 
presentation. The request that they were given was to take a 
look at the integration of all the facilities in this area and 
develop some scenarios so that management could then decide the 
way forward.
    Senator Levin. All right. Would you agree with me that 
those suggestions are outrageous?
    Mr. Pillari. Yes, I would.
    Senator Levin. If these are outrageous recommendations, 
didn't anyone call these folks on the carpet?
    Mr. Pillari. Yes. It's my understanding that the BULs did, 
which is why the business unit leaders would never have taken 
it forward. I mean, these were rejected immediately. The people 
were counseled on the inappropriateness of it, and it never 
went any farther than that.
    Senator Levin. And did the senior person who was overseeing 
that presentation ever say to the people making the 
presentation this is wrong, it should not be presented to our 
executives?
    Mr. Pillari. I don't know exactly what they had said, but 
since it never came forward and since I know that they were 
counseled, I would assume that something like those words were 
said.
    Senator Levin. OK. Let us know for the record, would you?
    Mr. Pillari. I will.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 29, letter from Ross J. Pillari, dated May 16, 
2002, which appears in the Appendix on page 285.
---------------------------------------------------------------------------
    Senator Levin. Find out.
    Mr. Carter, the Majority staff report contains a document 
from February 1996, and that is on page 225.\2\ It is a series 
of E-mails between Mobil officials discussing how to block the 
proposed startup of the Powerine refinery or to at least 
prevent its output from reaching the market. Apparently, 
according to the E-mail, Mobil had successfully kept the 
Powerine product from reaching the market the previous year, 
and the way they did that was they bought all the Powerine 
product and then Mobil marketed it.
---------------------------------------------------------------------------
    \2\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    In one of these E-mails, one Mobil official said the 
following: ``Needless to say''--and this is Exhibit 15,\3\ by 
the way, now on page 228. ``Needless to say, we would all like 
to see Powerine stay down. Full court press is warranted in 
this case and I know Brian and Chuck are working this hard.''
---------------------------------------------------------------------------
    \3\ See Exhibit No. 15 which appears in the Appendix on page 26700.
---------------------------------------------------------------------------
    What do you think is meant by ``full court press'' to keep 
Powerine down, to keep their production down?
    Mr. Carter. Mr. Chairman, Powerine was a refinery in 
California that had chosen not to make the investment required 
by California regulators to produce and sell gasoline that was 
in compliance with the regulations there, to clean up the air 
in California. And they had petitioned the California Air 
Resources Board, the regulatory authority, to be allowed to 
sell gasoline that was not in compliance with the regulations 
of California. And we opposed that.
    We had made a unilateral decision to upgrade our own 
refinery. We had spent millions and millions of dollars to 
produce gasoline that was in compliance with the air 
regulations of California. Having another refinery be able to 
sell environmentally unfriendly gasoline and not make the 
investments to upgrade their refinery seemed to us to present a 
playing field that wasn't level, and we did, as we have a right 
to do, oppose their selling of this gasoline. And that's what I 
understand to be meant there.
    Senator Levin. So you didn't buy their product. You bought 
the product before they in any way changed it or affected it?
    Mr. Carter. That's correct, sir.
    Senator Levin. Powerine was selling RFG below the cost of 
MTBE, and you bought it and marketed it at a higher price. Is 
that what you understand that E-mail to be saying?
    Mr. Carter. I don't understand exactly what they did the 
year before. They did say they bought Powerine's output and 
marketed it through Mobil. I'm not sure what price they charged 
for it.
    Senator Levin. You are not aware of the fact that they had 
bought that at a higher price, your company bought it at a 
higher price and then marketed it?
    Mr. Carter. I'm not sure I understand you, sir. We bought 
it at a higher price and then marketed it?
    Senator Levin. That is correct, and you marketed it instead 
of allowing them to market it.
    Mr. Carter. I'm aware that we marketed it, yes. I'm not 
aware of what price we paid.
    Senator Levin. So what you are saying is that you were 
trying to protect the environment? You weren't trying to 
protect your own company?
    Mr. Carter. In the case of Powerine producing gasoline that 
wasn't in compliance with the regulations of the California Air 
Resources Board, we thought it was unfair, that it was an 
unlevel playing field, and they should have to make the same 
investments that we made and comply with the regulations.
    Senator Levin. And how would buying all their production 
achieve that?
    Mr. Carter. I believe that was in the prior year, sir, 
before----
    Senator Levin. But you were proposing to do the same thing. 
It says, ``might be worth buying out their production and 
marketing. . . . Last year when they were dumping RFG at below 
cost of MTBE, we purchased all their avails and marketed 
ourselves which I believe was a major reason that the RFG 
premium last year went from [1 cent per gallon] in January to 
[3 to 5 cents per gallon] thru to their shutdown.'' In other 
words, the price of RFG went up 3 to 5 cents because you shut 
them down the year before. Isn't that what that E-mail says?
    Mr. Carter. I believe, if I can get the question right----
    Senator Levin. Page 228.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 15 which appears in the Appendix on page 267.
---------------------------------------------------------------------------
    Mr. Carter. If in the case they started the refinery up and 
produced non-compliant gasoline, was it an option for us to buy 
it and resell it, and that was the second option. The first 
option was to oppose that they produce non-compliant gasoline 
to protect our investment and to make the playing field as 
level as we thought we could. A second option was to buy the 
gasoline in that case. Again, I believe this was in the Aguilar 
case. This has been thoroughly investigated. It went to the 
California Supreme Court, and our company was not found to be 
in violation of any regulations or laws.
    Senator Levin. That is not the question here whether or not 
you violated a law by doing this. The question is whether or 
not that was a way of maintaining the control over the supply 
of a product. That is what we are talking about here today. And 
the way you did that was that, according to this E-mail that is 
on page 228, it ``might be worth buying out their production 
and marketing ourselves, especially if they start to market 
below our incremental cost of production.''
    It doesn't say anything here, by the way, about environment 
but, nonetheless, this is what the E-mail says. ``Last year 
when they were dumping RFG at below cost of MTBE, we purchased 
all their avails and marketed ourselves which I believe was a 
major reason that the RFG premium last year went from [1 cent 
per gallon] to [3 to 5 cents per gallon] thru to their 
shutdown.'' So you benefited economically when there was 3- to 
5-cent premium for RFG gas in California, and after you 
purchased all of their production so that they couldn't 
undercut your price, you benefited by having a higher price for 
all of your output. Isn't that what happened? Isn't that what 
that says, that E-mail?
    Mr. Carter. We were protecting our investment. We thought 
that was the best way to level the playing field.
    Senator Levin. And then it says, ``. . . if they do start 
up, I'd seriously consider this tactic.'' Did you?
    Mr. Carter. I don't believe they started up, sir.
    Senator Levin. OK. Senator Collins.
    Senator Collins. Thank you.
    I want to follow up on an issue that the Chairman has 
raised about the industry's lobbying efforts on MTBE and the 
oxygenate requirement in general, because I think the record is 
confused right now as to motivation of the various industry 
representatives here today in lobbying on these issues.
    In Maine, the MTBE additive has caused some serious 
groundwater contamination, and, thus, in our State the 
legislature, and the governor, supported by the entire 
congressional delegation, have called for a phase-out of MTBE. 
The implication, however, in the BP-Amoco exhibit that Senator 
Levin used is that the oil companies lobbied to remove the 
oxygenate requirement because it would reduce the supply of 
gasoline and presumably drive up prices.
    All of you in response to Senator Levin's question have 
commented on your various lobbying efforts regarding the 
oxygenate requirement. So I want to ask you directly for the 
record: What was your motivation in lobbying for the removal of 
the requirement for MTBE in particular or the oxygenate 
requirement in general? And I realize, Mr. Heminger, that you 
gave a slightly different answer than your colleagues in this 
area.
    Mr. Carter.
    Mr. Carter. Thank you, Senator. As I previously said, we 
thought that phasing out of MTBE or phasing down of MTBE was a 
good idea. We had used some MTBE prior to the Clean Air Act 
Amendments, but it was a very small amount. The Clean Air 
Amendments that require the oxygenate, in effect, because of 
the supply of oxygenates, basically dictated that we use MTBE 
and we thought it should be phased out. So for that reason, we 
thought that elimination of the oxygenate mandate was a good 
idea.
    Senator Collins. But was your motivation to also try to 
tighten to supply and drive up prices?
    Mr. Carter. No, Senator.
    Senator Collins. OK. Thank you. Mr. Heminger.
    Mr. Heminger. Yes, Senator. When we looked at MTBE, we, 
too, understand the problems it has with groundwater, and we 
did not lobby to tighten the supply. In fact, we supported 
ethanol as a replacement for the MTBE. We have a very small 
manufacturing capacity of MTBE, but we did support the new 
proposal to increase the amount of ethanol.
    Senator Collins. Mr. Pillari.
    Mr. Pillari. Yes, our position on oxygenates is not related 
to a supply decision. Our position on oxygenates is related to 
our desire to have clean fuels and to have them be results-
based and to have the option to use oxygenates when it's the 
most efficient, economic way to make clean fuels.
    Senator Collins. Mr. Reeves.
    Mr. Reeves. Yes, Senator, we have actively proposed and 
supported the phase-out of MTBE, primarily because our 
customers and regulators around us prefer not to have it in the 
fuel. In 1990, when the oxygenate mandate became a part of the 
Clean Air Act, we actually did design in the use of MTBE as we 
expanded our refining capacity in California to meet the new 
requirements of California fuel.
    We continue to support the Governor in California to remove 
MTBE, are somewhat disappointed that he extended that ban 
delay, delayed it an additional year, and we would continue to 
support it. It really is not targeted at a volumetric issue. 
It's because the customers and regulators prefer to have it 
out.
    Senator Collins. Mr. Routs.
    Mr. Routs. We have supported it because customers and 
regulators have asked us to remove MTBE. We have also very 
actively, through API, supported the growth of ethanol in the 
country to address just the issue that you're talking about, to 
make sure that the total volume sold is stable.
    Senator Collins. Mr. Reeves, in your testimony you talked 
about the seasonal transition between summer and winter 
gasoline, and most of you identify the changeover to summer 
fuels as one of the reasons for causing an increase in prices. 
You also blame the start of the summer driving season.
    I guess my reaction to that is you know that is going to 
happen each year. You know that consumers are going to drive 
more during summer months. You know that you are going to have 
to make this seasonal transition between winter fuels and 
summer fuels. So you also know from experience that there can 
be glitches such as refinery fires or a pipeline breakdown. So 
why don't you plan better? I mean, it seems to me that you 
could take steps to deal with this issue and, thus, remove one 
of the price spikes that are so harmful to our economy and so 
burdensome to consumers. Mr. Reeves.
    Mr. Reeves. Thank you, Senator. Perhaps it is a good idea 
to get a mental picture of what's actually happening as 
inventories are drawn down and the transition between one grade 
to another occurs. I think as other people have mentioned, 
something like 97 or 98 percent of the fuel that is delivered 
out to the retail stations actually goes through terminals, not 
delivered directly from the refinery. And when you go to a 
terminal, there is a diesel tank and a jet fuel tank and 
probably three tanks for various grades of gasoline. And what 
happens is you have to draw those gasoline tanks down out at 
the terminal level and then replenish it with the new 
specification fuel for whatever seasons you're moving into. So 
there really is no capacity in the pipeline terminals out.
    Now, you could argue that we could choose to invest, to 
expand put in more tanks and carry more inventory. I think 
generally in the concept of inventory, while I think it's true 
inventory can help dampen volatility, I happen to believe that 
if you have to invest and carry a lot of inventory, the average 
price would actually increase, and our incentives are to keep 
as low working capital as we possibly can. So I guess that 
would explain our motivation, Senator.
    Senator Collins. Well, that does bring me to my next 
question. Every 10-cent increase in gasoline prices results in 
approximately $10 billion in revenues to oil companies over the 
course of a year. So if you have a spike of even short 
duration, it results in considerable profits to the oil 
companies. And yet I am hearing today that one of the reasons 
for price hikes and for price volatility is a lack of capacity, 
a lack of refining capacity, not enough pipelines.
    Given those kinds of profits, why aren't investments being 
made? If I look, three of the companies that are here today 
were in the top 50 on the Fortune 500 list released in April. 
Clearly there are profits available that could solve some of 
these infrastructure problems that have been cited repeatedly 
as the causes of these glitches that produce these very onerous 
price spikes.
    So why aren't additional investments being made to keep 
your refineries in better condition and to build additional 
storage tanks? Mr. Carter, we will start with you and go down 
the line.
    Mr. Carter. That's an excellent question, Senator, and, in 
fact, we have made considerable investments to upgrade our 
capacity and to be able to produce more of these boutique 
gasolines.
    If we take the Midwest, for example, in the year 2000 we 
started up our investment to make RFG with ethanol at our 
Joliet refinery, and we never operated that unit before. It was 
brand new. And we had some difficulty when we first came out of 
turnaround. We learned to use it better, and the next year we 
made even more gasoline there that met the requirements there.
    In addition to that, we learned to make components that can 
be blended to make RFG with ethanol at our Baton Rouge 
refinery, and we found new barges to ship that material up the 
Mississippi River to the Midwest. I think this was one of the 
advantages of the merger between Exxon and Mobil. That probably 
wouldn't have happened short of the merger.
    So we've taken a lot of steps. That's just one example.
    Senator Collins. Mr. Heminger.
    Mr. Heminger. Thank you, Senator, and as Senator Bunning 
stated, for 4\1/2\ years now, we have attempted to build a new 
pipeline and invest in a pipeline that would take product from 
the Catlettsburg refinery in Kentucky up to Columbus.
    In addition to that, I'll show a picture here of Creal 
Springs. This is the endpoint of the new Centennial pipeline 
which has the capacity to move 200,000 barrels a day into 
southern Illinois. This is just a picture which illustrates the 
2.2-million-barrel tank farm that we have built, and that 
system is now operating and has the ability to bring that to 
the Midwest.
    And, last, I stated our refinery in Garyville, Louisiana, 
invested $300 million to build a new coker which provides 
enough fuel for another 60,000 cars per day. So we have 
invested heavily.
    Senator Collins. Mr. Pillari.
    Mr. Pillari. Yes, Senator. We've invested in our Toledo and 
Whiting refineries to be able to make more RFG product in the 
last 2 years, and we have maintained our terminaling system as 
it has been.
    I would say in coming back to the fundamentals of this that 
one of the things that has to happen with investing in 
terminals or inventory is it has to be a good economic decision 
for the long run, not just for 3 or 4 days. And I think in our 
company's case, we are more of a buyer on the marketplace than 
maybe some others. We buy almost 40 percent of our product from 
other suppliers.
    Senator Collins. Mr. Reeves.
    Mr. Reeves. Thank you. I think it's fair to say that over 
the last decade or so, the vast majority of our investments in 
the refining and marketing business have been to do two things: 
Improve the reliability and meet the environmental standards on 
refining, and to grow our retail business. That's it 
essentially--and they're roughly equal.
    I think you've heard a lot of testimony in the opening 
comments about the returns on the refining investment--the 
refining and marketing business in the United States which have 
historically been very low. The industry does not attract a lot 
of discretionary capital, and, therefore, we just have chosen 
to invest in the things that we need to do to run reliably and 
make sure that we get the value out of the assets that we 
already own.
    And if I could just correct the record, Senator Levin asked 
me earlier on a question which we passed by quickly, did we 
ever buy or sell--buy capacity and then shut it down. And I 
said no. During the Gulf merger in 1985, there were some 
refineries that came with that merger. One was in Philadelphia 
that ultimately did shut down. It was one of those that you 
heard of. So we didn't buy it to shut it down, but it was shut 
down. And then we have sold--we did sell our Port Arthur, 
Texas, refinery to Clark back in the early 1990's, just to 
correct the record.
    Senator Collins. Mr. Reeves, I want to follow up on that 
point then. Why would you shut down a refinery when there is a 
shortage of refining capacity?
    Mr. Reeves. Well, certainly at the time Philadelphia was 
shut down, that wasn't the case.\1\ It was in the middle of the 
1980's. There was plenty of surplus refining capacity, and it 
was uneconomic to run.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 30, May 14, 2002 clarification letter from 
ChevronTexaco which appears in the Appendix on page 287.
---------------------------------------------------------------------------
    Senator Collins. Mr. Routs, my original question.
    Mr. Routs. Senator, in the 1990's, we invested about a 
billion and a half in our refineries for clean fuels and CARB 
fuels. We are looking forward to investing over the next 5 to 7 
years another billion dollars in low-sulfur gasoline, low-
sulfur diesel, the consent decree that we have done with the 
EPA on the emission side of the business. We started up last 
year a $300 million coker in Deer Park in Houston that is 
delivering more product to the market. And we're investing a 
lot of money and human capital in getting the reliability of 
our refineries and systems up, because in the end, getting our 
refineries to run properly is going to create more volume for 
the market. We've had in the past some trouble doing that, and 
right now we're investing 200 man-years in order to train 
people properly to get the most out of those places, and that 
will help the consumer.
    On the pipeline side, we've heavily supported the expansion 
of the Explorer pipeline that is now in the process of getting 
expanded by about 100,000 barrels. That will bring more volume 
into Chicago. And we're actually in construction of the Two 
Rivers pipeline which will bring more volume from the mid-
continent into the Ohio region. So there is a fair bit of 
investment going on as we speak, and that should help the end 
consumer in the years to come.
    Senator Collins. Mr. Chairman, since two--well, now one of 
our colleagues has not had a chance to question yet and the 
hour is late, I am just going to make one final comment in the 
hopes of letting Senator Bunning question before we break for 
lunch, and that is that consumers are not the cause of refinery 
glitches, whether it is a fire or--nor are they to blame for 
industry supply miscalculations, nor are they to blame for 
infrastructure shortcomings.
    It concerns me that every year, as predictable as Memorial 
Day, are price spikes; we just know that is going to happen. 
And it seems to me that the industry could do more to try to 
even out the pricing and prevent those spikes. And I still 
don't feel like I have gotten a good answer to why these 
investments have not been made before now, why they are not 
being made more aggressively, and that is what leads people to 
conclude, perhaps completely unfairly, that the industry is 
manipulating supplies or wants tight suppliers or wants 
shortages in order to drive up prices and, thus, profits.
    So I think at the least that you need to give us a better 
understanding of what you are doing to learn from past 
experience and prevent these disruptions that are so burdensome 
to our economy and to the average consumer.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Collins. 
Senator Bunning.
    Senator Bunning. Let me start off by saying nothing lights 
up my phone more in my local office, in my Washington office, 
when we see a 10- or a 15- or, for that matter, a 20-cent-per-
gallon increase today or tomorrow, and then over a period of 
time it gradually reduces down maybe about to where it was, and 
then all of a sudden we have another increase of 15 cents a 
gallon, like we did 2 weeks ago. Nothing more infuriates the 
consumer because they do not understand the complications that 
go into it.
    The question I want to ask, can you explain how zone 
pricing works for each of your companies? The Subcommittee 
report points out that some retailers here in Washington, DC, 
felt that they were not able to compete with other stations 
just across the river in Virginia, for instance, because of the 
zone they were in. How do you respond to this? Is it the zoning 
price that causes the great big fluctuations or is it something 
else?
    We will start with the ExxonMobil people.
    Mr. Carter. Thank you, Senator.
    The way we establish zones is we go into the marketplace, 
and we look at competition. And where we have a group of 
dealers that face similar competition, we set up a price zone 
for them so we can price to them, at a level which allows them 
to compete with their local competition, and we do that all 
over the country. We have been doing it for at least 30 years, 
my entire career.
    Senator Bunning. Let me explain. I can go over in Virginia 
and buy gas 25 cents less for unleaded regular than if I buy it 
in Washington, DC. Is that taxes or what is it? What causes 
that?
    Mr. Carter. I'm not familiar with the taxes in Washington, 
DC. I would be happy to get back to you with that. I can tell 
you that it is extraordinarily difficult to build a service 
station in Washington, DC. We would love to build more stations 
here. The last time we tried to build a new-to-industry station 
here, we spent over a million dollars to buy a piece of 
property on the expectation we would be able to get a permit, 
that the community would welcome another service station. In 
fact, after a number of years, we could not get a permit, and 
we had to sell that piece of property at a significant loss.
    So there are fewer stations in Washington, DC, because of 
permitting----
    Senator Bunning. I know that land costs are high, but----
    Mr. Carter [continuing]. And the land costs.
    Senator Bunning. Are they trying to recoup the land costs 
from the price of the gasoline, do you think?
    Mr. Carter. We, and our dealers, try to recoup our cost, 
and the dealer is ultimately--there are no company-operated 
stations in Washington----
    Senator Bunning. So it is dealer operated.
    Mr. Carter. Right, it's the dealer that does the pricing.
    Mr. Heminger. Senator, Marathon Ashland Petroleum does not 
market here in Virginia or Washington, DC.
    Senator Bunning. OK, but you have a zone pricing.
    Mr. Heminger. But for zone pricing, within our Marathon-
brand stations, we have zone pricing, and each station is set 
up on its own price grid, and therefore a zone. And they are 
priced individually against the grid or against the competition 
on that zone. So I would say each one of those grids is 
competitive against its own other market competitors.
    Senator Bunning. No matter how much the cost of the product 
that you are sending into that zone?
    Mr. Heminger. The cost of the product is a big part of how 
we decide to set the price on a daily basis.
    Senator Bunning. What we are getting at is the Midwest, 
obviously, because of the huge spikes in the prices that 
occurred in the Midwest in the past couple of years. That is 
what I want to know. I know you are located right in the middle 
of the Midwest, did the Midwest structure differ from where you 
sell out of the Midwest?
    Mr. Heminger. Within the Midwest, I see the Midwest, as 
other parts of the country, but specifically the Midwest, as 
being one of the most fiercest, competitive areas in the 
marketplace. Every day we look at our prices. And we have a 
very small number of customers that are on zone pricing, the 
balance are through our Speedway stores, which are direct-
operated stations. Every day we look at those, and our strategy 
has always been, as we shared with the staff, is to be the 
lowest price on the street. And every day as you----
    Senator Bunning. That is hard to do because there's 
independents who probably buy a product from you and someone 
else who will take a lesser of a margin on that same gallon of 
gasoline that drives the price down. I use convenience stores 
and other independents. I do not know where they are getting 
their product, but obviously the wholesale price of that 
gasoline that they are buying, they are getting a less markup 
on because they are underselling your Speedway stations in my 
area.
    Mr. Heminger. Well, Senator, we attempt to match the lowest 
price on the street, and therein goes the volume that we sell 
on a daily basis. If we do not match the lowest price on the 
street, and we are a very big supplier to the balance of the 
independents in the marketplace, you are absolutely correct, 
but if we don't match the lowest price on the street, just a 
penny, therein goes our sales. So we watch that every day to 
ensure that we are competitive on the street.
    Senator Bunning. Let me ask you something different because 
it is really--BP has a station in Highland Heights, Kentucky. 
It is the lowest priced gasoline in my whole area, but BP also 
has a station right across from my office in Northern Kentucky 
that is one of the highest priced gasoline in my area--as much 
as 20 cents more a gallon. Now how do I explain that to 
somebody who calls me and says, ``What are you doing about the 
price of BP's gasoline over here in Fort Wright, Kentucky, when 
I can go over in Highland Heights, Kentucky, and buy it for 20 
cents a gallon cheaper?''
    Mr. Pillari. Well, first of all, I'm pleased that you have 
noticed us. I hope you are a customer.
    Senator Bunning. I wouldn't know your two stations.
    Mr. Pillari. I have never been to those stations, but in 
that area we are basically jobber and dealer. So those 
locations in that area would buy product from us and then set 
their own retail price, and each dealer or jobber would 
determine how they want to set that price. Some of them prefer 
a low-volume, high-price strategy to get the cash they need to 
run their business. Others will prefer a lower price and try to 
get a higher volume to get the cash to meet their economic 
needs. And so you can see big swings within the market based on 
how each individual----
    Senator Bunning. Even in your own stations.
    Mr. Pillari. Yes.
    Senator Bunning. Even with your BP markets.
    Mr. Pillari. Yes, absolutely.
    Senator Bunning. Mr. Reeves.
    Mr. Reeves. Thank you.
    Of course, we don't operate in the Midwest, so I will give 
you a broader answer than just the Midwest.
    Senator Bunning. All right, zone pricing.
    Mr. Reeves. Zone pricing. I'll go back to the original 
question, thanks.
    I always think of zone pricing, and I was reminded actually 
this morning, when I paid my hotel bill, zone pricing sounds 
mysterious, but it's really meeting local, relevant 
competition, and that's why hotel bills are different in 
Washington, DC, or across the river in Virginia or in Kansas 
City or elsewhere. It's the dynamic of meeting competition, and 
that's our basic philosophy.
    Zone pricing is just that. It is figuring out what's a 
relevant area of competition, and who do you want to compete 
against and why, and figuring out where to set your price 
relative to those, so that you can get the volume that you need 
and the balance between volume, and price, and margin is what 
generates the cash to run the business. And it sounds 
mysterious, and it sounds complicated, but it is actually as 
simple as meeting local competition.
    Senator Bunning. It is hard to explain to the average 
consumer----
    Mr. Reeves. Very hard. I've been trying to do it for a lot 
of years.
    Senator Bunning. And that is who we are trying to explain 
it to every day, why there is a 15--today, we were buying 
gasoline at 94 cents for regular unleaded at one time just like 
4 months ago, and now it is at $1.44 for regular unleaded in 
the same area. So that's a 50-cent-per-gallon increase, and boy 
that will bring the consumer right to your door.
    Mr. Routs. Basically, the same story. It's all determined 
and set by the competition in the neighborhood. I must say 
cases like you mentioned of across the river and across the 
street we will look at because it is not a very healthy 
circumstance when one side of the road has one price and the 
other side of the road has another price. Then you start 
looking at things like is there a median in the street, and are 
people going to take that detour to actually go to the lower 
price range? So all of that is being balanced in order to 
arrive at the right situation in the end.
    Senator Bunning. I know how the price of gasolines compare 
over the last 30 years, and even longer. We are getting a 
bargain, actually, here in the United States. If you travel 
anywhere, our prices per gallon are much cheaper than they are, 
for instance, in Europe and other places. But the Midwest seems 
to chronically be short of product. Please explain why that is.
    Mr. Heminger. Senator Bunning, as I testified, the Midwest 
imports approximately a million barrels per day of gasoline and 
diesel fuel above and beyond what is manufactured in the 
Midwest, and when you go back and look at the amount of product 
that is coming in from the Gulf Coast, there were two major 
pipelines, an Explorer pipeline and TEPPCO pipeline, which had 
the ability to ship about 750,000 barrels a day into the 
Midwest at peak. We just started up, as I stated, the 
Centennial pipeline, which will have the ability to bring 
another 200,000 barrels a day.
    Since the Midwest only refines approximately 75 percent of 
its demand, it's important, and the only way to really bring 
it, we bring a little bit from the East Coast, from the harbor 
market, but the majority of it comes from the Gulf Coast. The 
Gulf Coast is the flywheel supply to the United States. And we 
have attempted here to lay this new pipeline that is going to 
go from Catlettsburg, a 240,000-barrel-a-day refinery, into 
Ohio to take some of the pressure off of the Midwest. And as I 
stated earlier, we're still 4\1/2\ years into the project to 
try to get a permit.
    Senator Bunning. A regulatory quagmire, I understand that.
    Mr. Heminger. Yes.
    Senator Bunning. We will try to get you out of that, but 
the point being that there is 75 percent only being produced in 
the Midwest that is being used. That is correct.
    You talk about capacity and refineries. Are any of your 
companies thinking about building new refineries, since it has 
been well over 20-plus years that we have built new refineries 
in the United States, any of you?
    Mr. Reeves. No.
    Mr. Routs. We are not.
    Mr. Pillari. No, sir.
    Mr. Heminger. No, sir.
    Senator Bunning. And the reason is that it is not 
environmentally possible, it is not economical? What is the 
reason?
    Mr. Routs. I think it's been said before the refining 
business over the last 10 years has had returns of an average 
of about 5 percent.
    Senator Bunning. So it is cheaper to bring it in.
    Mr. Routs. That's right.
    Senator Bunning. Just buy it and put our dependency on 
foreign crude and foreign gasoline at a higher--we are going to 
be over 60 percent very shortly.
    Mr. Routs. If you will allow me, Senator, we had a refinery 
in Wood River in the mid-continent, and we decided to sell that 
to Tosco at the time because of the very low returns that 
refinery had. So that's the kind of a view we had on the 
refining industry at the time.
    Senator Bunning. Thank you very much, Mr. Chairman.
    Senator Levin. Thank you, Senator Bunning.
    I think we are going to, if it is all right with our 
witnesses, I think what we will do is work right through the 
lunch hour. We may be able to finish by 1:30, depending on 
whether colleagues come back or not. Is that agreeable with all 
of you?
    Mr. Pillari. That is fine.
    Senator Levin. I want to go back to the ExxonMobil E-mail 
that is on Page 228. It is Exhibit 15.\1\ Mr. Carter, this is 
where--back to Powerine, where it says, ``Needless to say, we 
would all like to see Powerine stay down. Full court press is 
warranted in this case and I know Brian and Chuck are working 
this hard.''
---------------------------------------------------------------------------
    \1\ See Exhibit No. 15 which appears in the Appendix on page 267.
---------------------------------------------------------------------------
    Can you tell us what that ``full court press'' entailed?
    Mr. Carter. Yes, Senator. My understanding is that that 
meant that we were going to oppose their petition before the 
regulatory body in California to allow them to manufacture and 
sell in California gasoline that didn't meet the air 
requirements.
    Senator Levin. Is that all that was done?
    Mr. Carter. To my knowledge, that's correct, sir.
    Senator Levin. Mr. Pillari, on Page 219,\2\ I want to refer 
you to a document from 1996. This document came from ARCO, 
which BP Amoco acquired in 2000. It is a presentation to senior 
ARCO managers, and it says the following:
---------------------------------------------------------------------------
    \2\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    ``From time to time, APC,'' which is ARCO, ``may need to 
endure brush fires to discipline the market, exchange and trade 
selectively to preserve market discipline.''
    Can you explain to us what you think ARCO meant by 
``disciplining the market'' or ``preserving market 
discipline.''
    Mr. Pillari. Sir, I don't know what they meant. This was 
quite a long time ago before we were involved.
    Senator Levin. Have you ever heard the term ``preserve 
market discipline''? Have you ever used the term or heard it?
    Mr. Pillari. No, sir.
    Senator Levin. This is another example where it is not just 
sort of market factors which are controlling, this is another 
example of companies taking very specific actions to impact 
that market--in this case, exchange and trade.
    Now I want to talk to you about this memo on Page 273.\2\ 
This is a document from the Marathon files, dated October 1, 
1998, and it appears that Marathon was pleased that Hurricane 
George came through and knocked out a refinery. Here is what 
the document says:
    ``As OPEC and other exporters' efforts to rein in output 
began bearing fruit, nature stepped in to lend the oil 
producers a helping hand in the form of Hurricane George, which 
caused some major refinery closures, threatened off-shore oil 
production and imports, and generally leant some bullishness to 
the oil futures markets. However, this storm-induced optimism 
is likely to prove temporary, leading to some pullback in 
prices prior to the heavier worldwide demands for crude in late 
fall and early winter.''
    Mr. Heminger, it is quite an amazing document, actually, 
that you would view the hurricane as nature providing oil 
producers a helping hand. What do you have to say about that 
memo?
    Mr. Heminger. Mr. Chairman, first of all, I apologize for 
any inference whatsoever that is taken from this document or 
anything taken out of context in this document that states that 
my company would find pleasure in any natural disaster. That is 
totally an incorrect interpretation.
    What that document is, is on a monthly basis we basically 
recite the EIA, OPIS, other industry magazines, other industry 
reports about what is going on in the crude oil market and what 
we expect the future price is going to be. This merely recites 
what was stated at that point in time for the cause of the 
increase in crude oil prices. But we have employees in the Gulf 
of Mexico working on a LOOP platform, we have employees at our 
parent company working on production platforms and a number of 
employees working in the marine business that would be off of 
the Gulf of Mexico. We certainly would never want anything to 
happen to anyone.
    Senator Levin. Well, first of all, I think you will agree I 
read the whole paragraph. I did not take words out of context; 
is that not correct?
    Mr. Heminger. That's correct, Mr. Chairman.
    Senator Levin. And, second, I want to get to the heart of 
the matter, which is that reining in output, reducing supply 
helped oil producers; is that correct?
    Mr. Heminger. What that document is discussing is crude oil 
prices only. And when it talks about they had to shut down 
platforms, in a hurricane disaster and safety procedures, you 
have to shut in the platforms, and many times we shut in 
pipelines that are bringing off-shore crude oil into the 
marketplace.
    Senator Levin. How does that help producers? How does 
closing, major refinery closures, it says here, help oil 
producers?
    Mr. Heminger. Closing a major refinery, Senator, never 
helps a producer.
    Senator Levin. Let me read it to you again, putting aside 
the reference to Hurricane George for a minute.
    ``As OPEC and other exporters' efforts to rein in output,'' 
reduce output, ``began bearing fruit, nature stepped in to lend 
the oil producers a helping hand, in the form of Hurricane 
George, which caused some major refinery closures.''
    Now, putting aside the fact that it was Hurricane George 
which did that, the closing of major refinery closures is 
referred to in that document as lending oil producers a helping 
hand.
    Mr. Heminger. I cannot--I did not write the document, first 
of all, but closing a major refiner or refinery would never 
help a producer because that would take additional demand off 
of the marketplace.
    And what that report back at that time was discussing was 
the global crude oil market. And as you are aware, OPEC's back-
and-forth stance on whether they're going to produce more or 
produce less, that was specifically speaking to reports from 
the EIA and from other industry reports talking about the 
global crude oil market.
    Senator Levin. Do you know who wrote this document?
    Mr. Heminger. I'm aware, yes, sir.
    Senator Levin. Who is it?
    Mr. Heminger. A gentleman in our Economics Department.
    Senator Levin. Have you talked to the person and said, ``My 
God, what are you saying here? You are saying exactly what 
Senator Levin is saying, which is that reducing supply can help 
us here. Controlling supply, having a tight supply is good for 
oil producers. That is what Senator Levin is saying, and my 
gosh you put it all there right in the first paragraph''?
    Did you talk to this man about this?
    Mr. Heminger. I have not spoken to this man yet, no.
    Senator Levin. I am sure you will after this hearing.
    Mr. Heminger. Yes, sir.
    Senator Levin. Now let's go to the first few words. ``As 
OPEC and other exporters' efforts to rein in output began 
bearing fruit.'' That is bitter fruit for most consumers. When 
OPEC reins in output, it is bitter fruit for the consumers of 
America. We fight that, and yet here is your economist saying 
that when OPEC and other exporters rein in output, it bears 
fruit.
    How does he--explain those words.
    Mr. Heminger. First of all, reining in production, from a 
producer's standpoint, has no benefit whatsoever to the 
downstream part of our business. So I never like to see 
increased crude oil prices.
    Senator Levin. It says here it ``lends oil producers a 
helping hand.'' ``Nature stepped in.''
    Putting aside the reference, the crude reference out of 
Hurricane George, OK, put that aside, just the fact that OPEC 
is reining in output is bearing fruit, that is a positive 
reference. Bearing fruit means it is good. Your economist says 
that is good. You are saying it is not. Your document says it 
is. Why? It lends oil producers a helping hand, and it talks 
about closing major refineries. That is a plus.
    It is evidence of exactly what the report's conclusion here 
is, it seems to me, but I want to just again give you a chance, 
just on the OPEC issue, reining in output is referred to as 
bearing fruit, and I just want to be sure you are saying, from 
your perspective, that is wrong.
    Mr. Heminger. From my perspective, that is discussing about 
a crude oil producer, not a refiner and a marketer.
    Senator Levin. Your company is a refiner and marketer, is 
it not?
    Mr. Heminger. Yes, Mr. Chairman.
    Senator Levin. ``And this storm-induced optimism is likely 
to be temporary.'' The good news is like to be temporary; isn't 
that what this is saying?
    Mr. Heminger. Any time there is a natural disaster and we 
have to take our employees out of the Gulf of Mexico or close 
down a refinery is generally very temporary, and it's never 
good.
    Senator Levin. The staff report, now turning to California, 
found that ``a number of refiners sought to limit the amount of 
supply in order to get higher margins. And to reduce supply, 
the refiners sought to increase exports, limit imports, 
eliminate the oxygenate mandate and prevent additional refinery 
capacity from operating.''
    I just want to repeat it. This is what the staff report 
finds, and it has got the evidence set forth right there, 
bountifully.
    ``A number of refiners sought to limit the amount of supply 
in order to get higher margins.'' How do you reduce supplies? 
Refiners sought to increase exports from California, limit 
imports to California, eliminate the oxygenate mandate and 
prevent additional refinery capacity from operating.
    I want to just look at a couple of memos here now on 
limiting imports into California. First, on Page 218, and it is 
Exhibit 18.\1\ This is a Texaco memo, and the Texaco 
representative is reporting a conversation that he had with a 
representative from Shell regarding Texaco's plan for 
manufacturing gasoline under new standards that were brought 
about to take effect in the fear that Texaco would import 
gasoline. So that is the fear. This is 1992. Now the Texaco 
official reports that the Shell representative said the 
following:
---------------------------------------------------------------------------
    \1\ See Exhibit No. 18 which appears in the Appendix on page 271.
---------------------------------------------------------------------------
    ``Shell and the other oil companies are extremely concerned 
about Texaco's silence--'' Let me read that again.
    ``Shell and the other oil companies are extremely concerned 
about Texaco's silence and the lack of activity concerning our 
plans toward CARB Phase 2 compliance.'' The Shell 
representative called Texaco a ``wild card'' and said, ``We are 
nervous about it.'' The Texaco official said that an ARCO plant 
manager expressed the same concerns at a refinery managers 
meeting in April.
    I am going to address this to you, Mr. Routs, because you 
now speak for not just Shell, as I understand it, but for part 
of the old Texaco; is that correct?
    Mr. Routs. Indeed. We went into a joint venture with Texaco 
in 1998 and bought them out in 2002.
    Senator Levin. The document here, the memo, talks about 
Texaco's silence. What silence would that be referring to?
    Mr. Routs. Not having been involved in these discussions, 
Senator Levin, I have no idea. I have to assume that the 
industry was announcing what they were going to do about this 
whole thing, in terms of capital investment, and that Texaco 
hadn't announced, but again that is a speculation, but that's 
what happens in other parts of the world.
    Senator Levin. The memo refers to Texaco as a ``wild 
card.'' Do you know what that means? Are the other companies 
known or----
    Mr. Routs. It's not the kind of language that I would allow 
in my company today, Senator.
    Senator Levin. OK. Is it standard practice within your 
company to ask other refiners about their plans for refining 
gasoline?
    Mr. Routs. It is not.
    Senator Levin. That would be borderline collusion, wouldn't 
it?
    Mr. Routs. That would be absolutely forbidden, and our 
lawyers----
    Senator Levin. Because it might be collusion.
    Mr. Routs. Our lawyers would take action. We think it's 
anticompetitive, yes.
    Senator Levin. OK. Now the Shell representative here 
apparently said of Texaco imports, ``Shell will seek a tax on 
the importation of RFG.''
    Do you know anything about that effort, Mr. Routs?
    Mr. Routs. I don't know anything about the effort, Senator.
    Senator Levin. It looks like a direct threat to Texaco. 
That would surely be an anticompetitive action, would it not?
    Mr. Routs. Believe me that I find it incredible that if a 
conversation like this has taken place in the past, that it is 
absolutely not acceptable in our norms and ethics of today and 
at the time, for that matter.
    Senator Levin. Let me just interrupt for one second. We 
decided, I hope, with everybody's consent, although you weren't 
here to give it to me, that we would work right through the 
lunch hour. And so you can, any time you are ready, if you have 
additional questions, I can just stop and pick up----
    Senator Voinovich. You are going to continue?
    Senator Levin. I am going to continue for some time.
    Senator Voinovich. This is Governmental Affairs, and we are 
involved in looking at the entire operation of the government 
and how it operates. If I recall correctly, when I met with a 
representative from BP in my office, he indicated to me that 
they didn't need more refineries here in the United States, and 
also there was an indication that the boutique gasoline 
problem, our various RFG formulas, were not that big a problem.
    I heard this morning that these various numbers of 
gasoline, over 91--you used to have 6 and now you have 90--is a 
problem, that looking at that situation and changing it would 
help ease the spikes that we are seeing.
    The other thing that I am concerned about is that if we 
only have limited refinery capacity and if one of them goes 
down, again, we see prices spike. I would like to eliminate all 
of the causes that you have put on the table that cause spikes. 
Now we can't do much about the issue of crude oil, and that is 
a problem that we have had, and we are going to continue to 
have for a long time. I think it is going to get a whole lot 
worse before it gets better, but that is something that we are 
going to have to spend some time with.
    But the issue of refineries, I would like to hear from all 
of you how do we get another refinery built here? I think we 
need more refineries. The first question is do we need more 
refineries? I want to hear from each one of you, do we need 
more refineries?
    Mr. Carter. Senator, my company doesn't need any more 
refineries. We have done a really excellent job of expanding 
the ones we have. They are large refineries. They are highly 
efficient. Under previous regulations, we have been able to 
expand those and have added considerably to our capacity over 
the years.
    This incremental growth of refining capacity, however, is 
threatened by current New Source Review regulations. They are 
difficult to interpret. They are being interpreted 
retroactively. The DOE and EPA are studying those. We have 
submitted a report to them with our recommendations. I would be 
happy to get you a copy of that report, but in our view, that 
is the largest threat out there to increasing refinery 
capacity.
    Senator Voinovich. So, as far as your company is concerned, 
you have the facilities and, with clarification of New Source 
Review, you think you'd be OK in terms of your refinery; is 
that right?
    Mr. Carter. With that exception, and also in my testimony, 
I mentioned the new sulfur regulations, potential phase-out of 
MTBE, the need to coordinate these changes in gasoline 
regulations so that we have the time to make the investments, 
and they don't gang up on us. The NPC has done a study of that. 
They have raised some doubts whether the industry will be in 
position to meet all of the new software requirements, as well 
as MTBE phase-out. So I think those should be coordinated as 
well, sir.
    Senator Voinovich. So we have to coordinate the MBTE phase-
out, and you are going forward with the sulfur regulation, but 
you think you are going to have a problem in complying with it, 
as Congress has mandated; is that correct?
    Mr. Carter. The NPC found that. I, personally, have a lot 
of confidence in my company, but when the NPC looked at the 
entire industry, they raised some doubts about the industry's 
ability.
    Senator Voinovich. How about the sulfur implementation?
    Mr. Carter. All of these together.
    Senator Voinovich. Mr. Heminger.
    Mr. Heminger. Yes, Senator, we have invested heavily in our 
refineries. In fact, I stated we just invested $300 million to 
upgrade our plant in Garyville, and we are going to have to 
invest between $600 and $700 million just to meet the low-
sulfur regs for gasoline and diesel by 2006 to 2008 time frame. 
So we are going to continue to invest, but that is investment 
just to keep today's capacity where it is. If you take between 
$600 and $700 million of investment, with basically no return 
off of that investment because I look at that as ``stay in 
business'' capital, I would say it is going to hurt us to 
continue to invest in new refineries.
    To go back to your other question, would we invest in a new 
refinery? We certainly would give strong consideration to that. 
I believe, though, it needs to be on the same pipeline or the 
same corridor of the pipeline and the infrastructures that we 
have available in the country today. But as I have also stated 
how difficult it has been to get a permit to do a very small 
pipeline, we find it many multiples more difficult to be able 
to try to increase refining output.
    Senator Voinovich. Mr. Pillari.
    Mr. Pillari. Thank you, Senator.
    We are investing heavily in our core refineries, those that 
we believe have the best long-term future. As you know, we have 
been selling refineries. All of them are still operating in the 
marketplace, but we have been selling them because we believe 
that the economics of the business support an alternate 
purchase rather than an investment in a new refinery.
    Senator Voinovich. Is all of the crude oil that comes into 
this country refined here or is some of it refined when we 
bring it in? Is all of it refined in the United States? How 
much?
    Mr. Pillari. All of the crude oil that we bring into the 
country?
    Senator Voinovich. Yes.
    Mr. Pillari. Everything we bring into the country is 
refined here.
    Senator Voinovich. It is refined in the United States?
    Mr. Pillari. Yes.
    Senator Voinovich. Why don't you bring in refined oil?
    Mr. Pillari. We also bring in refined oil products.
    Senator Voinovich. So you have options. BP has options. You 
can either have somebody refine it here or you bring in oil 
that is refined.
    Mr. Pillari. Correct.
    Senator Voinovich. Why doesn't that take care of the 
problem when a refinery breaks down, if you can just bring it 
in from someplace else?
    Mr. Pillari. Well, it takes a little while to get it here, 
and I think there are two things about it. First off, when 
something unusual happens, if it is significant, like the fire 
at the Citgo refinery last year, something that major that 
takes a lot of product out of the marketplace, it takes a 
little while, particularly in the Midwest, for the product to 
come in through the Gulf Coast or through New York or somewhere 
to get up there. So there are logistics issues for getting up 
there, and at the same time, you are also then dealing in the 
spot market, which is reacting to the marketplace.
    Senator Voinovich. Does BP think we need more refineries in 
the United States?
    Mr. Pillari. We think we don't need more refineries.
    Senator Voinovich. I know that because you got rid of one 
in Lima, and thank God a company picked it up and it is 
refining. I don't know what we would have done if they had shut 
that place down.
    Mr. Reeves.
    Mr. Reeves. Similar to earlier answers, Senator, the vast 
majority of our capital over the last certainly 6 or 8 years 
has gone into meeting environmental performance requirements, 
and very much of that driven in California. That is where the 
majority of our refining capacity lies.
    Also, looking at California, I find it inconceivable that 
in California's climate today a new refinery could be built. We 
also have a large refinery in Mississippi, which is under 
construction right now to meet the new clean fuel standards. 
There will be some minor expansion of capacity there, but 
certainly nothing major.
    The answer to the second question, which is do we need more 
refining capacity, ultimately, demand is going to outstrip the 
capacity of the refining industry in the United States over the 
next 20 years. The question is how do you meet that? Is it 
going to be imports? Is it going to be constructed? Generally, 
today there is adequate refining capacity in the world to 
import products to meet U.S. demand, and barring any unforeseen 
circumstances, I would guess that is how it is going to evolve.
    Senator Voinovich. No new refineries. Mr. Routs.
    Mr. Routs. No new refineries. Actually, we are going the 
other way. The refinery coverage is about 70 percent of our 
branded sales. We have sold over the last couple of years two 
refineries. They are still operating. But this is a business, 
as I said earlier, that has very low returns, and where we have 
to spend billions of dollars in order to meet the requirements 
of clean fuels and the requirements of emissions. And don't 
take me wrong, I think those things are necessary to protect 
the environment, but in the end, it's not a business that makes 
a lot of money. So what we are looking at actually is to, 
through a global trading system, to bring more gasoline into 
the country.
    Now you asked a question why doesn't it happen all of the 
time? Time requirements are one, but the other one also is 
arbitrage. Gasoline might just be more expensive in Europe, and 
prices have to come in this country, in terms--for gasoline to 
move from Europe to the United States.
    So all of those things have to adjust and get balanced 
before a cargo gets sent this way.
    Senator Voinovich. So, basically, all of you are saying 
that none of you are going to build any new refineries. In 
fact, many of you are selling them because the rate of return 
on them is not that good, those are environmental problems of 
going forward with them, and you've got a problem with the ones 
you have right now because you don't know where you stand on 
New Source Review; is that about it?
    But what it basically says is, if a major refinery goes 
down in the United States, the people in the United States, 
depending on where it is, can experience what we did 2 years 
ago in the Midwest; is that right? And if we import it here, we 
are going to pay more for it because of where it is coming 
from. So that is a question that we ought to discuss, Mr. 
Chairman, as to what can we do to create an environment where 
companies are willing to build more refineries here in this 
country.
    My last question adresses the problem of reformulated gas, 
the various degrees of reformulated gas that we have.
    What is the answer? Is it a problem or isn't it a problem?
    Mr. Reeves. Well, I'll take a shot at it, Senator.
    It is a problem for the distribution system. To date, it 
has been a problem that can be overcome, but generally creates 
or at least is a contributing factor to some of the price 
volatility. I think it's important to remember that those 
boutique fuels were created as our legislative, and 
environmental, and regulatory communities, and the business 
communities tried to seek a balance. They weren't created with 
ill will, they were created to match local environmental 
conditions and then place requirements on the people that 
manufacture fuels that are sold there.
    So I think the boutique fuel issue, looking ahead of us, is 
going to be very difficult to overcome because it almost either 
requires everybody to come up to the highest possible standard, 
which can place some costs on people that don't currently 
reflect those costs in their prices, or it asks people to lower 
their environmental performance expectations in certain 
markets, to lower them to the average, and I don't see that as 
a very easy thing to change.
    Senator Voinovich. Is there anybody from the industry that 
is looking at these 90 different RFGs to find out if there is 
an easier way of skinning the cat, and getting the job done and 
respecting the environment? Are they?
    Mr. Heminger. Senator, I know the National Petroleum 
Refining Association and the American Petroleum Institute have 
been working on that question.
    Mr. Routs. As the chair of the Downstream Committee of the 
API, we have been pushing very strongly to get the number of 
gasolines reduced, and we have had a proposal in, and actually 
in the new energy bill some of those proposals are going to be 
worked. So we think there is a solution in sight. It is just a 
matter of arriving at the right balance between what we can put 
in our distribution system and what is acceptable to the 
environment.
    Senator Voinovich. So your suggestion is that we ought to 
see if there is a way that we can smooth it out a bit and get 
rid of some of the jagged edges. But the public has to 
understand that if you are doing this kind of gasoline, that 
they are going to have to pay more for it at the pump.
    I remember well, as governor of Ohio, we had the issue of 
our reformulated gas in Cincinnati, and the choice was we go 
RFG or we go to emissions testing. I opted for emissions 
testing because I knew that if we went to the reformulated 
gasoline, it would cost more money for our people, and we could 
comply with the law in a cheaper way by doing the emissions 
testing.
    I think that one of the things that the public has to 
understand is that the environmental considerations have had a 
dramatic impact on your businesses and that, as you point out 
Mr. Reeves, in many instances they are proper requirements, but 
the fact of the matter is that you are going to have to pay for 
it.
    There is a public perception that the oil companies are 
making money hand over fist. I would like to know from you, Mr. 
Heminger, what has happened to your stock price in the last 
several years. Are you making out like a bandit because of 
these spikes at the pump?
    Mr. Heminger. Well, our stock price is really reflected in 
both parents, Marathon and Ashland, and I would say that, no, 
our stock price has been relatively flat over the last number 
of years.
    Senator Voinovich. What do you mean by flat?
    Mr. Heminger. We have not seen any sustainable increase in 
rates of return. Therefore, we have not seen any growth or any 
increased value in the market capitalization of our stocks.
    Senator Voinovich. There was a brief period there where the 
stock prices went up, and then they came down again, correct?
    Mr. Pillari, you are worldwide, BP?
    Mr. Pillari. Correct. Our share price has been almost as 
volatile as gasoline prices in the last 5 or 6 years. I think 
today we are probably sitting somewhere in the low fifties. We 
have dropped $3 or $4 just in the last month or so, and we have 
been as low as the forties. So we've seen quite a bit of 
volatility.
    Senator Voinovich. Mr. Reeves.
    Mr. Reeves. That would be the same for us. We're right now 
in the mid eighties, up as high as the mid to high nineties and 
to the low seventies over the course of the last 2\1/2\ years.
    Mr. Routs. Royal Dutch shares, same thing happened in the 
mid sixties. We are right now trading around fifty.
    Senator Voinovich. Mr. Carter.
    Mr. Carter. Same answer. Our stock today, I mean, it 
fluctuates as well, but if you look at it today versus 2 or 3 
years ago, it is lower.
    Senator Voinovich. Mr. Chairman, I have no other questions 
at this time.
    Senator Levin. Thank you, Senator Voinovich.
    Let me ask, first, Mr. Carter a question about a document 
on Page 214.\1\ It is a document that discusses limiting 
imports into California, and it is a strategy discussion by 
officials from Exxon who were looking at the West Coast supply 
picture.
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    \1\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
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    And then on the last page of that memo, which is Page 214, 
there are several general strategy considerations, and I want 
to just make reference to one of them. In the first bullet, 
there is a proposal that Exxon, ``Should not do deals that 
support others importing barrels to the West Coast.'' What kind 
of deals would that bullet be referring to?
    Mr. Carter. Mr. Chairman, I am not absolutely familiar with 
the memo. I can tell you about our practices on the West Coast. 
Many times we have manufactured California-grade gasoline in 
our refinery at Baytown, Texas, and we have shipped it all the 
way around, up the West Coast, into California at considerable 
expense, and in many cases we have lost money on that gasoline.
    As the report indicates, the California and West Coast 
marketplace is isolated. It's sometimes long of product, it's 
sometimes short of product. In short periods, we have often 
manufactured the gasoline on the West Coast, the East Coast or 
Gulf Coast and moved it all the way around.
    I take this memo to refer to those times when the supply is 
long. That is the only thing I can assume that it's referring 
to.
    Senator Levin. Now, there is also a ChevronTexaco memo, 
which is Exhibit 19,\2\ and this----
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    \2\ See Exhibit No. 19 which appears in the Appendix on page 272.
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    Mr. Reeves. I'm sorry, Senator, what page would that be?
    Senator Levin. This is Exhibit 19. That is on Page 202.
    Mr. Reeves. Thank you.
    Senator Levin. This is a study which says the following:
    ``Exports becoming a more important factor in balancing 
light product supply and demand.''
    So this memo starts or that reference highlights the use of 
exports of gasoline to keep supplies tight. And then it goes on 
to make another important statement. It says the following:
    ``Market is dominated by limited number of large, committed 
refiner/marketers whose individual actions can have significant 
market impact.''
    Now that is pretty much what our conclusion is in the 
report, so I am going to read it again.
    ``Market is dominated by limited number of large, committed 
refiner/marketers whose individual actions can have significant 
market impact.''
    That's what a highly concentrated market is all about. I'm 
just wondering whether or not, let's see, this would be you, 
Mr. Reeves, do you agree with that statement from your 
document?
    Mr. Reeves. Well, actually I've been with the Chevron 
organization long enough that I was actually part of the study 
team that put this together.
    Senator Levin. Better yet.
    Mr. Reeves. So I can reply to it.
    Senator Levin. Do you agree with what you wrote?
    Mr. Reeves. I do, yes. I guess I'd parse it into two 
pieces; one is the large committed refiner/marketer, and it is 
true that is a reflection of the West Coast competitive 
structure, and probably the most important word there is 
``committed.'' Given the volatility of the West Coast refining 
and marketing business, it's my belief, when you look back over 
at history, that small companies who don't have the financial 
wherewithal to see it through the ups and the downs, have 
elected not to remain in that business, and so that is the 
reflection of the large and committed and why it is 
significant.
    Individual actions, I think you've seen that actually play 
out. This is a document I think from 1993 or somewhere back 
then when we were actually long on product, but even then you 
could see that if there were significant incidents and 
disruptions in the marketplace, that there was a lot of 
volatility in the price. So, yes, I would certainly stand by 
what we wrote then.
    Senator Levin. Is the market in California dominated by a 
few large refiners that can have a significant market impact?
    Mr. Reeves. Well, the refining capacity has not really 
materially changed over the last, oh, 9 to 10 years. The 
ownership has been moving around quite a bit, mostly as a 
result of the mergers and the required FTC divestments. It is 
characterized by larger refiner marketers, large integrated oil 
companies, and now an emerging group, companies like Valero-
UDS, who are now actually the largest refiners in the United 
States or close to it.
    Senator Levin. Going back to the statement, is it true that 
the market is dominated still by a limited number of large, 
committed refiner/marketers, and these now are the key words 
``whose individual actions can have significant market 
impact''? Is that true?
    Mr. Reeves. I think I've already agreed with that 
statement, Senator.
    Senator Levin. You have? I didn't hear a clear agreement 
with it.
    Mr. Reeves. It was, yes.
    Senator Levin. Thank you. Now, relative to an ARCO 
presentation, this is Exhibit 17,\1\ Page 223, and this 
advocates exporting gasoline in a number of places.
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    \1\ See Exhibit No. 17 which appears in the Appendix on page 269.
---------------------------------------------------------------------------
    On Page 223, Exhibit 17b, if you look up at the upper right 
hand, under ``Take Action,'' it says, ``Export to keep the 
market tight.''
    So let me ask, is that still the policy of ARCO?
    Mr. Pillari. Well, since we have owned ARCO, we have not 
been exporting product. We are a net buyer of product in the 
market, and so we are quite short.
    Senator Levin. And so ARCO did not follow that?
    Mr. Pillari. I don't know what ARCO did back then. I think 
this was, what, the mid-nineties or something?
    Senator Levin. This document, I believe, is 1996.
    Anyway, you don't know whether that action was taken, 
whenever the date of the document is?
    Mr. Pillari. No, I don't, but today we are a net buyer.
    Senator Levin. Now let me ask ExxonMobil, has ExxonMobil 
exported gasoline from California to maintain high refining 
markets?
    Mr. Carter. No, Mr. Chairman.
    Senator Levin. I mean, high refining margins.
    Mr. Carter. The California-grade gasoline we manufacture is 
sold in California.
    Senator Levin. All right. Let me ask Shell, has Shell 
exported gasoline from California to maintain high refining 
margins?
    Mr. Routs. No, we have not, Senator.
    Senator Levin. Thank you.
    If you take a look at Exhibit 20,\1\ this is a Texaco 
document from the Aguilar case. This is a 1996 memo, and it is 
on Page 238.
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    \1\ See Exhibit No. 20 which appears in the Appendix on page 273.
---------------------------------------------------------------------------
    Texaco's ``position is to fight the proposed specification 
changes because it will increase fuel costs and not deliver 
commensurate benefits to consumers.'' That sounds good.
    Then the next paragraph says the following:
    ``Incremental improvements to refinery margins from 
reducing supplies can be achieved in a number of ways. One 
way--'' I want to point out here this is what this report is 
all about is increasing refinery margins from reducing 
supplies. This memo says it can be achieved in a number of 
ways. ``One way would be to promote the more restrictive 
mandated specification changes to reduce supply of product; 
another would be for refiners to voluntarily reduce refinery 
production, without incurring added costs or suffering 
attrition [admittedly unreasonably idealistic, but the best 
option.]''
    Now the goal then, as stated in this memo, is to reduce the 
supply of gas in order to increase refining margins; is that 
correct?
    Mr. Routs. I can't comment on it, Senator. I don't know 
what the goal was at the time that this memo was being put 
together.
    Senator Levin. OK. Texaco has taken a position of opposing 
one particular plan for new specifications for fuel. This memo 
is contemplating changing that position in order to tighten 
supply; is that correct? That is what the memo was doing, 
saying maybe we ought to change our position about whether we 
support or oppose a particular plan for new specifications in 
order to tighten supply.
    Am I reading it correctly, to begin with?
    Mr. Routs. I agree with you that you can read that memo 
that way, Senator.
    Senator Levin. Now, in the BP memo that we discussed 
earlier, BP seemed to be opposing oxygenate requirements or at 
least was considering it, in order to tighten supply, because 
without the oxygenate more gasoline is needed. So it appears as 
though, whether or not companies support or oppose fuel 
specifications could depend on whether or not those fuel 
specifications increase or decrease the supply of gasoline. 
That is what it appears from these memos.
    Now another proposal in this memo, which is on Page 238, is 
to ``voluntarily reduce refinery production.'' That just means 
shutting down a refinery in order to reduce supply; is that 
right? Did Texaco do that?
    Mr. Routs. I can't answer that question on behalf of 
Texaco, sir.
    Senator Levin. Let me just ask Shell. Has Shell ever done 
that?
    Mr. Routs. Could you repeat the question?
    Senator Levin. Yes. I think you may have answered this 
before, this issue that is coming up now. Has Shell ever 
reduced refinery production or shut a refinery just to reduce 
supply?
    Mr. Routs. As I said earlier, the main reason why we have 
sold or shut capacity is because it was no longer economic to 
run.
    Senator Levin. All right. I want to go back to what Senator 
Voinovich was asking about also, which is whether or not the 
United States needs more refineries. And the answer, I believe, 
from each of our witnesses was that your company doesn't need 
more refineries. Is that correct?
    Mr. Routs. That's right.
    Senator Levin. With the one exception, I think, of 
someone----
    Mr. Heminger. I said we would consider an investment in 
refining.
    Senator Levin. You would consider. The other companies, I 
believe, said that you have adequate refinery capacity. Is that 
correct?
    Mr. Reeves. That's right.
    Mr. Carter. We don't need another refinery. I did not say 
we would not add refining capacity, and I talked about the New 
Source Review requirements and things like that.
    Senator Levin. OK. That is correct. You don't need another 
refinery. So the only company that is considering an additional 
refinery then would be Marathon. Is that correct?
    Mr. Heminger. We would consider that, yes, sir.
    Senator Levin. All right. Now let me ask you this question: 
Putting aside your own company's situation relative to the need 
for additional refineries, is the United States now short of 
refineries? Mr. Carter.
    Mr. Carter. Well, my company is not short. We run our 
refineries----
    Senator Levin. In your judgment, is our country short?
    Mr. Carter. No, sir.
    Senator Levin. In your judgment, is the United States short 
of refineries, Mr. Heminger?
    Mr. Heminger. I would say we are short of refining capacity 
because we're importing refined products today.
    Senator Levin. All right. So you believe our capacity right 
now is too low?
    Mr. Heminger. Mr. Chairman, when you look at the rates that 
we're running all the refineries today, we are running them 
full out for the majority of the year. And if we're importing--
in fact, the question came up a while back on Venezuela. We're 
importing a significant amount of refined product from South 
America and from Europe, so it's clear to our company that more 
capacity could be used in this country.
    Senator Levin. OK. Mr. Pillari.
    Mr. Pillari. Given the imports coming in, I would say we 
are finely balanced, just a tad bit short.
    Senator Levin. OK. Mr. Reeves.
    Mr. Reeves. A similar answer. I think we clearly are 
importing products, and it is--at least, I think returns are 
telling us that is the most economic solution right now. If 
demand continues to grow--and that is an unknown--out over 
another couple of decades, I think the situation would have to 
be looked at differently.
    Senator Levin. OK.
    Mr. Routs. Imports will cover our needs. It's more economic 
for us at this point.
    Senator Levin. I think from at least most of your answers, 
it is clear at least that there is not--in terms of trying to 
look at the cause for price spikes, you can't point to the 
shortage of refineries since most of you say there is no 
shortage of refineries. Most of you say there is no shortage of 
refining capacity. Sometimes that is given as the reason for 
price spikes. But I don't think we can use that excuse. I don't 
think that particular justification or rationale washes, given 
at least the bulk of your answers here.
    I want to talk just a minute about concentration in 
Michigan. The Department of Energy's Energy Information----
    Senator Voinovich. Mr. Chairman, excuse me just a minute.
    Senator Levin. Please.
    Senator Voinovich. It is my understanding that when we have 
had refinery fires and shutdowns, prices have been impacted.
    Senator Levin. That is correct. There is a disruption in 
supply.
    Senator Voinovich. There is a disruption in supply, and 
that refineries do have an impact on these spikes.
    Senator Levin. On spikes where there has been a disruption 
in supply, but our recent spikes are not. The issue also is 
inventory, not just refining capacity. They maintain 3 days of 
excess inventory, which means they keep the supply very tight. 
The report says that gives, in a highly concentrated area, the 
ability of a few companies then to have an impact on price 
without fear of significant competition. That is the result of 
maintaining a very tight supply. That is the finding of the 
report.
    Senator Voinovich. The issue is the competition.
    Senator Levin. That is correct.
    Senator Voinovich. And whether or not the competition is 
there in terms of the refineries, and is it cheaper to raise 
the price than to import refined oil in from some other place.
    Senator Levin. The issue is lack of competition. That is 
what our focus has been in the highly concentrated areas, and 
the fact that there is inadequate competition and what effect 
that has on price.
    Senator Voinovich. But the bottom line is that we have been 
told that the return on investment in building refineries is 
not that good, and that is why they are getting rid of them and 
they are selling them off. Also, they have a problem with 
regulations in terms of building them.
    Senator Levin. They can argue the return on capital, that 
is something they may wish to argue, although if you look at 
all the other industries and businesses, it is somewhere in the 
middle. But, nonetheless, they can make the argument, but it 
can't be, under their testimony, that the lack of refineries 
causes price spikes, because they just said we do have enough 
refineries. And presumably they don't support price spikes. At 
least that is what we have been told this morning.
    Senator Voinovich. Well, I would like them to respond to 
that.
    Senator Levin. That would be fine. Are refineries--the 
shortage of refineries the cause of price spikes? Mr. Carter.
    Mr. Carter. That was not my testimony, Mr. Chairman.
    Senator Levin. Thank you. Mr. Heminger.
    Mr. Heminger. That was not my testimony.
    Senator Levin. Mr. Pillari.
    Mr. Pillari. No, sir.
    Senator Levin. Mr. Reeves.
    Mr. Reeves. No, I believe it is the regional imbalance that 
causes the spikes, and then markets require some time to 
equilibrate. Ultimately they go down. So it is the time lag to 
resupply.
    Senator Levin. OK. Mr. Routs.
    Mr. Routs. I agree with Mr. Reeves. I think we have an 
ample refining capacity, though not necessarily in the right 
place.
    Senator Levin. OK. And, of course, a separate issue here is 
inventory and the way that is kept very low with a 3-day 
supply, and when inventory goes down because of the disruption 
or whatever, at that point you have got a problem. But that is 
a decision to maintain a low inventory level, which the oil 
companies have maintained.
    The EIA, the Energy Information Administration, says that 
in my State of Michigan four firms--Marathon, BP, ExxonMobil, 
and Shell--provide about two-thirds of the gasoline sold within 
Michigan. And it is my understanding that the EIA is measuring 
which companies are either manufacturing gasoline within the 
State or bringing it into the State from elsewhere. So we are 
not talking here retail sales. We are talking about those 
companies which are manufacturing in the State or bringing it 
into the State.
    So the EIA says that this reflects a tight oligopoly in 
this market. That is not me. That is the Department of Energy 
which says there is a tight oligopoly in the Michigan market 
and in other States in the Midwest and California and other 
States.
    Do you disagree with this characterization? First let me 
ask Exxon.
    Mr. Carter. Well, sir, as I testified, we looked at the 
Midwest, not at individual States. Individual States are not 
generally refining markets.
    If you go back to January 1, 1997, prior to all the mergers 
that have been discussed here, there were 27 gasoline-producing 
refineries in the Midwest owned by 19 companies. If you come 
forward to today, there are still 25 refineries owned by 18 
companies, so only one less company.
    If you use the Herfindahl Index or whatever people use--my 
economists do that--the Midwest is by that classification ``not 
concentrated'' in 1997 and it retains that classification 
today.
    Senator Levin. Not heavily concentrated?
    Mr. Carter. ``Not concentrated,'' is the FTC wording.
    Senator Levin. OK.
    Mr. Carter. That's in my written report, Mr. Chairman.
    Senator Levin. OK. Thank you. Mr. Heminger.
    Mr. Heminger. Mr. Chairman, we believe that the Midwest is 
one of the most fiercest competitive marketplaces, and I stated 
that in my testimony. And, in fact, when we look at the Midwest 
and the State of Michigan, we supply 2 billion gallons more 
product, so we believe we have acted very responsibly in being 
able to supply the market.
    Senator Levin. OK. Thank you. Mr. Pillari.
    Mr. Pillari. We only make about 60 percent of what we sell 
in the Midwest. We have refineries in Toledo and Chicago, and 
the rest we buy on the open market.
    Mr. Reeves. I'm not qualified to comment on the Midwest.
    Senator Levin. Thank you. Mr. Routs.
    Mr. Routs. We have no refineries in the Midwest.
    Senator Levin. Do you generally agree that high 
concentration leads to higher prices? Mr. Carter.
    Mr. Carter. I couldn't disagree with that, sir.
    Senator Levin. Mr. Heminger.
    Mr. Heminger. I disagree with that.
    Senator Levin. OK. Mr. Pillari.
    Mr. Pillari. I don't think it's automatic.
    Senator Levin. Mr. Reeves.
    Mr. Reeves. I would disagree with that as per my testimony.
    Senator Levin. Mr. Routs.
    Mr. Routs. I don't think it's automatic either.
    Senator Levin. Would you generally agree the more 
competition, the better, in terms of consumers?
    Mr. Carter. I think competition is good for consumers, yes.
    Mr. Heminger. I agree.
    Mr. Pillari. Yes, sir.
    Mr. Reeves. I would.
    Mr. Routs. As a consumer, yes, sir.
    Senator Levin. Let me give you the concentration numbers, 
that same HHI Index which was referred to, for the United 
States gasoline wholesale market in 1994. There was moderate 
concentration in 22 States. That went up to 28 in the year 
2000, and there was high concentration in 1994 in 5 States, and 
that went up to 9 States.
    So 37 States, according to that same index which you quote, 
the HHI Index, 37 of those States are either highly or 
moderately concentrated, and that is an increase from 27 States 
just 6 years before.
    Now, those are the HHI numbers that we have in terms of 
concentration. The other index which is used shows a doubling 
of the States that are in high concentration areas. So by 
either index, there has been a significant increase in 
concentration between 1994 and the year 2000.
    Let me just ask Marathon a question here. I want to talk to 
you about a practice that we witnessed in Michigan and Ohio, 
something that I call Speedway bumps--not speed bumps but 
Speedway bumps. And I call them that because it is quite 
apparent in Michigan and Ohio that Speedway takes the lead in 
bumping up the price of gasoline dramatically on Wednesdays or 
Thursdays by a dime or more, and then letting it slowly fall 
over the weekend. And then once Speedway does that, it is 
apparent that the other brands follow, some to a greater 
degree--Shell, for example--some to a lesser degree--Mobil, for 
example. And you can see that in those two figures.
    This is the last price spike, by the way, that we are 
looking at. There, again, no relationship to the price of 
crude, but you can see the difference in rack and retail 
prices, wholesale and retail prices in Michigan from January to 
August 2001.\1\ The other one shows Michigan retail prices by 
brand for the month of April 2001.\2\ You can actually see 
those Speedway bumps on that right-hand chart and on the left-
hand chart. We have enlarged it on the right-hand chart. Up for 
the weekend, then down; up for the weekend, then down; up for 
the weekend, then down, and so forth.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 11 which appears in the Appendix on page 260.
    \2\ See Exhibit No. 12 which appears in the Appendix on page 261.
---------------------------------------------------------------------------
    Mr. Heminger, let me ask you about that pricing policy. 
First of all, do you agree that you appear to be the price 
leader in Michigan, that other companies, other retailers 
follow your lead?
    Mr. Heminger. Mr. Chairman, our pricing policy is every 
day, as I had in my testimony. We look at our cost, we look at 
our sales, and we look at how the competitors are pricing, and 
we elect, as I stated, to always match the lowest price on the 
street.
    And then there comes a time when our costs have increased 
that we elect to raise our retail price to try to recover some 
of our costs.
    Senator Levin. Would you agree with me, though, that when 
you look at the history of pricing and who is a price leader, 
who follows whom, that in Michigan you appear to be the price 
leader, that others follow your price? Would you agree with 
that?
    Mr. Heminger. Mr. Chairman, every day we attempt to be--to 
match the lowest price on the street, and there are times--you 
stated it in your question Wednesday or Thursday. I hope that 
we are not that predictable. In fact, we look at our prices 
every day, and we make decisions based on the cost of that 
given day and time.
    Senator Levin. Well, you can see Wednesdays or Thursdays on 
that chart. Those are peaks, little mountains. It doesn't get 
to Everest until a little later, but there are some peaks, 
valley, peak, valley, peak, valley, peak, valley, on Wednesday 
and Thursday. You are just saying that is a coincidence?
    Mr. Heminger. No, sir. I said that every day we look at our 
price. There are times--in fact, many times, Wednesday or 
Thursday is when we will elect or we historically have elected, 
better said, to increase our price. It is not every week. And 
when you look at the charts and you really look over the period 
of time of the spring and summer of 2001, in comparing that 
back to the crude oil price, and as Senator Voinovich just 
stated, it wasn't a cause of refineries or it wasn't a cause of 
crude oil prices in that time frame. It was because of two big 
fires, one with the Tosco refinery, another one in Lamont, 
which is southern Chicago, and the prior year it was because of 
two pipeline failures, is what caused those spikes in the 
summer months.
    Senator Levin. I want to talk to you about parallel pricing 
just for a minute. I want to put the Illinois chart up, if we 
can get it, for June 2001.\3\ Now, this shows how companies 
maintain a price relationship to each other, and this is true 
in many areas. The same company typically will be at this 
level; the next company, a penny or a fraction of a penny above 
it; another company, a penny or a fraction above that, and so 
forth. So you've got like four or five fingers moving down, up 
or down together, rarely crossing each other. It is called 
parallel pricing. It is not illegal under current antitrust 
law. But it sure is no coincidence, either. It may not be 
illegal, but it is not a coincidence.
---------------------------------------------------------------------------
    \3\ See Exhibit No. 9 which appears in the Appendix on page 258.
---------------------------------------------------------------------------
    In a foot race, if all the competitors of equal speed came 
across the finish line in the same order race after race after 
race, some would think that something was fishy.
    Now, when major brands in a market region change their 
prices at the same time, stay in the same relationship, moving 
in the same direction and by the same amount, do you not agree 
that the consumer out there is going to believe and, I will 
add, reasonably believe that there is a conscious decision to 
maintain a relationship price-wise between those brands? Would 
you not agree with that, Mr. Carter? What is a consumer to 
think when he sees that parallel pricing, that ribbon with the 
four companies in the same relationship to each other?
    Mr. Carter. Mr. Chairman, I notice my company is missing 
from the chart so I don't know from that what my relationship 
was. We look at our prices every day. We look at the individual 
zones where our dealers operate. And we try to provide them 
with a price that allows them to compete in their zone.
    If you take Washington, DC, the gasoline we are supplying 
here today was put in a pipeline in the Gulf Coast 30 days ago. 
If our price is extraordinarily low, we are going to run out 
before the next amount of gasoline gets here. If our price is 
extraordinarily high, then we are not going to sell anything. 
And since this is the end of the Plantation pipeline, we won't 
know what to do with the gasoline when it gets here.
    So it's a very careful balancing act to keep our supply in 
balance and to compete with our competitors. As several of the 
Senators said, it's a very visible marketplace; everybody can 
see our prices every day right out on the street without even 
getting out of their cars.
    Senator Levin. OK. Do you want to comment on that, Mr. 
Heminger?
    Mr. Heminger. Mr. Chairman, as this chart illustrates, 
Speedway is always the lowest price on the street on this 
chart, and that has been our strategy, and we hope that our 
customers look at us as being a value pricer at the street.
    Senator Levin. OK.
    Mr. Pillari. Sir, if you take a look at this data, it shows 
that our company was trying to determine where the consumer 
would put us in their buying decision, and in some cases our 
price was up quite a bit higher. And if you look at the end of 
the period, you would see we were quite down in the middle of 
the pack. So it doesn't seem to be as consistent as a set 
approach.
    Senator Levin. Is parallel pricing illegal?
    Mr. Pillari. Not to my knowledge, no, sir.
    Senator Levin. Do you have any problem with making it a 
presumption that when companies go down or up together and stay 
in the same price relationship with each other, that that 
should be evidence that there is something at work which should 
not be at work? In other words, is there any problem with 
making that a presumption of illegality that is rebuttable by 
the industry that you can see?
    Mr. Pillari. I'm not sure I understand the presumption 
you're asking me to----
    Senator Levin. Parallel pricing, under the current law, 
which is what that is--where companies stay basically in the 
same relationship, going up and down together--is not illegal 
under current law. Would you have a problem with making it 
presumptively illegal subject to rebuttal?
    Mr. Pillari. I'll be honest, sir. I don't know what 
``presumptively illegal'' means.
    Senator Levin. OK. Thank you. Mr. Reeves.
    Mr. Reeves. To answer your question, I would object, and I 
happen to think that the reflection of a reasonably stable 
relationship of prices is actually an indication that the 
market is working exactly as it should.
    Senator Levin. Even when the companies stay in the same----
    Mr. Reeves. Yes, sir.
    Senator Levin [continuing]. Relationship to each other?
    Mr. Reeves. And the reason I say that is our pricing is the 
cumulative effect and response of millions of consumers' 
decisions, and they choose which brand they care to shop at. 
They choose for what reasons they choose to shop at a 
particular company. And the fact that market prices are going 
up and going down and that individual companies are in relative 
position, not changing quite often, is, in fact, an indication 
to me that the market is working. So a presumption of guilt 
would be completely inappropriate in my view.
    Senator Levin. Is there any reluctance on your part to say 
that your company engages in parallel pricing?
    Mr. Reeves. I don't know the correct definition of parallel 
pricing. I only know as it's been described here, and I've just 
said that I think that's a perfectly good reflection of an 
active and healthy and competitive market.
    Senator Levin. So you don't know what parallel pricing 
means?
    Mr. Reeves. I don't know.
    Senator Levin. Thank you. Mr. Routs.
    Mr. Routs. This to me is an example of a highly competitive 
market where people react to each other or react to each of the 
pricings. We measure on a daily basis the volumes that go 
through our stations. If the price is high, we see that the 
volumes come down immediately. It's very competitive.
    Senator Levin. And if companies stay in the same 
relationship to each other price-wise, up and down, does that 
trouble you?
    Mr. Routs. No, it doesn't trouble me, sir.
    Senator Levin. OK. Does it trouble you, Mr. Carter?
    Mr. Carter. Mr. Chairman, as I stated, I think this 
marketplace is highly competitive. I went through how we price 
and so forth. In my testimony I indicated that gasoline prices 
last year were about $1.50 a gallon, down significantly across 
time. I understand CNN reported this morning that gasoline 
prices today are $1.39. In 1999 dollars, I guess that's around 
$1.30, the lowest prices it's been in a month.
    I checked into my hotel room last night, and I found this 
there. I had a bottle of water. A liter of water, about a 
quart, is $6. If I convert that to per gallon, that's $24 a 
gallon for water, which comes out of the ground. They don't 
have to refine it. They don't have to meet all these 
regulations. And while the marketplace is volatile and I'm 
concerned about the volatility, I think the absolute price out 
there is pretty good for consumers.
    Senator Levin. Well, first of all, I think I'd change 
hotels. But putting that aside---- [Laughter.]
    I think if you saw the price of bottled water go up and 
down together every day, every week, with the same brands 
staying in the same relationship to each other, I think you 
would think that something is fishy, too. But my question is: 
Would it trouble you if brands stay in the same price 
relationship to each other up and down and up and down? Mr. 
Heminger.
    Mr. Heminger. Mr. Chairman, as I say, our strategy is every 
day to give that value price. We're talking about a global 
commodity, and if we didn't have NYMEX and if we didn't have 
the Chicago Exchange, maybe all of those prices wouldn't be 
transparent. But they are, and all that is traded, and all that 
reflects costs every day. And we have to take into account how 
we price our gasoline, and if we want to be the value leader on 
the street, as this chart illustrates, we really have to pay 
attention to where our consumers are buying.
    Senator Levin. OK. Thank you. Would it trouble you if four 
or five brands stayed in the same price relationship with each 
other up and down, Mr. Pillari?
    Mr. Pillari. Sir, I believe the consumers set the price 
relationship based on their view of the value of each brand, 
and so it will be where the consumers allow it to be. So, no, 
it doesn't trouble me.
    Senator Levin. It doesn't trouble you at all. OK.
    Mr. Reeves, I think you have answered the question already. 
Mr. Routs.
    Mr. Routs. It doesn't trouble me in the sense that I think 
that is indeed what the market drives us to do.
    Senator Levin. It drives you to engage in parallel pricing?
    Mr. Routs. That's not what I said.
    Senator Levin. What does the market drive you to do?
    Mr. Routs. The market drives us to be very competitive and 
to stay close to our competitors in terms of pricing.
    Senator Levin. OK. Let me ask about zone pricing. It is a 
very specific question. Are a large number of your zones 
single-dealer zones? Mr. Carter.
    Mr. Carter. No, Mr. Chairman.
    Senator Levin. Do you know about what percentage of the 
zones are single-dealer? Would it be less than 10 percent?
    Mr. Carter. I don't know the exact number. I expect that 
it's less than 10 percent.
    Senator Levin. OK. Mr. Heminger.
    Mr. Heminger. Mr. Chairman, they are all single-dealer 
zones.
    Senator Levin. Every zone has just one gas station?
    Mr. Heminger. Yes, sir.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 27, May 13, 2001 clarification letter from 
Marathon-Ashland, which appears in the Appendix on page 281.
---------------------------------------------------------------------------
    Senator Levin. OK. Mr. Pillari.
    Mr. Pillari. As far as I know, the only single-station 
zones we would have would be out in the rural areas, and that 
would be relatively small.
    Senator Levin. OK. Mr. Reeves.
    Mr. Reeves. It would be a very small percentage of ours.
    Senator Levin. Mr. Routs.
    Mr. Routs. Fifty-three percent, I am just informed, of our 
areas are single-dealer.
    Senator Levin. OK. On the lessee dealers, is it generally 
correct that lessee dealers do not negotiate the price of the 
product that you provide to them, that it is set by the company 
and that they are obligated under the lease to pay whatever 
they are charged by the company? Is that generally true?
    Mr. Carter. Well, Mr. Chairman, there are two caveats to 
that. There are laws that prescribe how we price to our 
dealers, UCC, I believe. I'm not an attorney, but I get a lot 
of advice from them. And, second, our dealers feel very free to 
let us know when they think their price is not a price that 
allows them to compete. I don't agree that that's negotiation, 
but certainly they feel free to express their views and we take 
it into account.
    Senator Levin. But by the lease, are they obligated to pay 
the price that you charge?
    Mr. Carter. That's correct, Mr. Chairman.
    Senator Levin. Mr. Heminger.
    Mr. Heminger. Yes, Mr. Chairman, by the lease they're 
obligated to pay the price, and we have very few lessee 
dealers.
    Senator Levin. OK. Mr. Pillari.
    Mr. Pillari. We have very few also, but, yes, they're 
obligated to comply with the brand. They can only sell our 
brand through branded dispensers.
    Senator Levin. Well, that wasn't my question, though. Are 
they obligated to pay the price that you charge?
    Mr. Pillari. Yes.
    Senator Levin. Mr. Reeves.
    Mr. Reeves. That would be the case for us as well.
    Senator Levin. Mr. Routs.
    Mr. Routs. As far as I'm aware, that's the case, sir.
    Senator Levin. And do you recommend retail prices to your 
branded stations?
    Mr. Carter. We do not today, Mr. Chairman. There was a time 
when one of our predecessor companies would tell the dealers 
what the recommended price was. They would also in the same 
communication tell them that they were free to set it as they 
chose.\2\
---------------------------------------------------------------------------
    \2\ See Exhibit No. 28, May 17, 2002, clarification letter from 
ExxonMobil, which appears in the Appendix on page 282.
---------------------------------------------------------------------------
    Senator Levin. OK.
    Mr. Heminger. Not to our branded stations, Mr. Chairman.
    Senator Levin. Not to your lessees?
    Mr. Heminger. We do not recommend the retail price to our 
lessees or lessee dealers.
    Senator Levin. OK. Mr. Pillari.
    Mr. Pillari. It's against policy.
    Senator Levin. It is? Thank you. Mr. Reeves.
    Mr. Reeves. We do not encourage that, no. We don't give 
them a recommended price.
    Senator Levin. OK. Mr. Routs.
    Mr. Routs. We don't tell our dealers what to charge.
    Senator Levin. No, that is not my question, though. Do you 
give them a recommended price for their retail?
    Mr. Routs. We have discussions with them about the pricing 
in the zone, but they can still make their own decisions after 
that.
    Senator Levin. You discuss with them, but do you publish a 
recommended price to your dealers----
    Mr. Routs. We don't.
    Senator Levin [continuing]. Or do you give them in writing 
a recommended price?
    Mr. Routs. We don't, sir.
    Senator Levin. OK. So, orally, what you discuss with them 
you don't consider to be a recommendation?
    Mr. Routs. No, we don't consider it a recommendation, and, 
again, they don't have to act upon the discussion.
    Senator Levin. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    First, Mr. Chairman, let me thank you for allowing me to 
participate. I think this is a superb report, and I would only 
say that I think you and I both know that this litany of anti-
competitive practices that you found and that I found in my 
inquiry in Oregon--it really extended to the West Coast--these 
anti-competitive practices have been documented again and 
again. But the fact is that these problems are growing, and the 
reason that they are growing is that the law under which they 
could be stopped is full of loopholes. And what we have found 
is that unless people are engaged in some textbook case of 
collusion, which these companies are far too intelligent to do, 
it is very hard to bring a successful action to protect the 
consumer. And that is why I am especially interested, Mr. 
Chairman, in exploring this idea that you and I have talked 
about in the past, and that is, when there are anti-competitive 
practices that as of today are not per se illegal and you have 
a concentrated market, that you create a presumption that this 
is raising an anti-competitive issue unless information is 
proven to the contrary. And I am going to address that more 
fully on Thursday when I testify, but I appreciate the chance 
to work with you on it.
    I think for purposes of this afternoon I want to start with 
you, Mr. Pillari. At an April 25, 2001, hearing before the 
Commerce Committee, Mr. Malone, who is your Western regional 
president, refused to make any commitment to stop exporting 
Alaskan oil to Asia. And as you know, we have seen E-mail that 
essentially says, hey, this is a no-brainer to export oil from 
Alaska to Asia at a discount because you can stick it to people 
on the West Coast of the United States, in Oregon, Washington, 
and California, in order to make up the difference.
    Now, the company, of course, has said that this person 
didn't speak for the company, and I understand all of that.
    What I would like to do this afternoon is get a sense about 
your current policy and commitments that you are willing to 
make to the public. My understanding is you are not exporting 
Alaskan oil outside the United States today, but I would like 
to ask you to commit today that BP is not going to export 
Alaskan oil overseas, period. Can you make that commitment this 
afternoon?
    Mr. Pillari. Sir, let me respond by saying we're a net 
buyer of Alaskan crude oil. We have to buy a significant amount 
of our needs. So as a net buyer, exporting has not been an 
issue for us.
    Senator Wyden. But that is not my question. My question is, 
because we have obtained E-mail from your company, sir, saying 
it is a no-brainer. Now, again, these are not my words or the 
words of some consumer advocate. These are the words of people 
in your company, calling it a no-brainer to export oil from 
Alaska to Asia. So what I would like to know is whether you all 
are willing to make a commitment. Mr. Malone was not. Mr. 
Malone basically said, ``We're going to export oil any time 
it's in our economic interest. We're not doing it today, but 
whenever it's in our economic interest, we are going to export 
oil overseas.''
    So what I would like to hear from you is not about your 
situation today with you as a buyer or this or that. I would 
like to hear categorically whether you will commit not to 
export oil from Alaska overseas.
    Mr. Pillari. As I said, we're a net buyer. What I would say 
about the future is it can't be predicted. I don't know what 
will happen in the future and I would not commit to limit my 
commercial flexibility.
    Senator Wyden. Well, that was my understanding. I 
appreciate your candor, and of course, that is, in my view, why 
this whole notion of making this country energy independent, 
something I strongly support, is directly undercut when an oil 
company executive says, ``Look, I'm not going to commit to 
anything. If it's in our economic interest, of course we're 
going to export.'' And that is why so many people on the West 
Coast of the United States are unhappy about that particular 
policy. Frankly, I mean, we have a whole host of anti-
competitive practices that we are facing. We have had juries 
handing out awards for redlining for millions of dollars, 
redlining our markets. I am going to talk about that on 
Thursday, but I will tell you it is very disappointing to my 
constituents and people all up and down the West Coast, that 
you will not commit, at a time when the oil companies are 
saying, ``We've got to be energy independent, got to make this 
country strong and energy secure.'' You again have restated 
what I thought was the position, and that is that you will not 
commit to banning the exports of Alaskan oil.
    Let me ask then the panel, if I might, about their views, 
and put it in the context of the situation with respect to the 
Arctic National Wildlife Refuge, ANWR. My sense is with the way 
your companies have been merging, ExxonMobil, BP Arco, 
ChevronTexaco, spinning off assets right and left in the past 
few years, any of your companies could end up with leases and 
drilling rights in the Arctic Refuge. So what I would like to 
do is just go down the row and see if each one of you would 
pledge this afternoon not to export any oil you get from the 
Arctic Refuge if it ends up being opened up to drilling?
    Why don't we just go right down the row.
    Mr. Carter. Well, we are a major exploration company. We 
explore all over the world. We produce a lot of oil and gas. To 
my knowledge, we haven't been spinning off assets since we 
merged except as required by the FTC. We do favor additional 
exploration. If I recall--I'm not an upstreamer, but if I 
recall correctly, we opposed the export of Alaskan crude, and 
as you know, the law required it to stay in the United States 
at one time. To the best of my knowledge, it does stay here. I 
have no authority to commit us on what would happen if ANWR--
but I can tell you what our practices have been.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 28, May 17, 2002, clarification letter from 
ExxonMobil, which appears in the Appendix on page 282.
---------------------------------------------------------------------------
    Senator Wyden. I would just like to get an answer because 
you all are the leaders in the field, to hear a pledge not to 
export any oil you get from the Arctic Refuge if it is opened 
to drilling. It is a simple question. I mean it is a chance for 
you to make a strong statement about energy independence, and 
if anything, the arctic issue makes it even more stark. I mean 
everything about this arctic debate has been about let's get 
that oil and make us energy independent. Now, if you all will 
not pledge to keep this oil here, if anything, it is going to 
make us more energy dependent because we will be drilling in 
Alaska, selling it to Asia at a discount, and sticking it to 
people on the West Coast of the United States.
    So I am just going to go right down the row and the 
question is just that simple.
    Mr. Heminger. Yes. Senator, my company, we're just 
refining, marketing and transportation. We have no equity 
production, so I can't comment.
    Senator Wyden. OK.
    Mr. Pillari. Sir, I would not change my earlier view.
    Mr. Reeves. Senator, to my knowledge, we don't produce much 
if any crude oil out of Alaska. I would say the answer to your 
question was, I don't have the authority to make the decision, 
but if I did, I would say that it would be irresponsible for 
any company, certainly our company, to try to accurately 
predict what we would do in commercial circumstances, 5, 10, or 
20 years out.
    Mr. Routs. I cannot comment. I represent Shell's 
downstream, and have very little to do with the upstream at 
this point.
    Senator Levin. Senator Wyden, we suggested that we would 
try to stop at 1:30, and they have been here a long time.
    Senator Wyden. Mr. Chairman, you have been kind to me, and 
I will look forward to Thursday.
    Senator Levin. Thank you.
    Let me close first of all by thanking our witnesses. It has 
been a long hearing, and you have been cooperative in your 
production of testimony and materials. We again appreciate that 
as a Subcommittee.
    Just one word about our responsibility and yours. You 
represent large and successful corporations, and it is to be 
expected that you are going to act in ways to maximize your 
profits. That is what you are in business to do. The government 
has a responsibility, on the other hand, to the public as a 
whole. And government's job is to make sure that the markets 
stay competitive and that anti-competitive practices be 
prevented, and that the consumers of this country get a fair 
shake.
    Our analysis of the oil industry is that it is highly 
concentrated in a number of markets in the United States, and 
that in these highly-concentrated markets, major oil companies 
take actions that limit supply in order to keep prices higher, 
and because of insufficient competition in those highly-
concentrated markets, they can succeed more readily in keeping 
prices up.
    The number of mergers in the last few years is dramatic. 
When you have Chevron merging with Texaco and BP with Amoco, 
and whoever would have thought that Exxon would merge with 
Mobil, but it happened. And as the industry has gotten more 
concentrated, the lifeblood of this country, gasoline, is in 
the hands of fewer and fewer players, and that means that if 
those players can effectively control supply in order to have a 
significant impact on price, a healthy economy is in jeopardy, 
and that is not what the American public wants.
    The question is what can we do about this, and I think 
there are at least a number of steps that we ought to take or 
consider taking. First, the Federal Trade Commission should be 
more cautious about approving mergers. The current situation is 
bad enough in terms of concentration in the oil industry. Any 
additional mergers should be subject to strict scrutiny, and 
the presumption should be that any merger that the oil industry 
is proposing should be not only scrutinized carefully, but the 
burden of proof, it seems to me, should clearly be on the 
people who are proposing those mergers and should be against 
the merger occurring. The presumption should be against any 
further mergers.
    Moreover the Federal Trade Commission needs to make sure 
that when it requires assets to be divested as part of a merger 
approval, the divested assets are viable as a competitive 
factor. There is concern that while the FTC has ordered certain 
divestitures in approving mergers, those divestitures haven't 
been to a sufficiently viable entity, so that they end up being 
a competitive force over time. I would recommend that the FTC 
study the mergers in the oil industry over the last 5 years to 
determine what the results of the ordered divestitures have 
been, to find out, in other words, whether the FTC was 
successful in achieving the desired level of competition that 
they thought that they were going to achieve. Those are 
responsibilities of the FTC.
    Second. I think we ought to at least consider changing the 
law with respect to the issue of parallel pricing. Right now 
parallel pricing is legal. To bring an antitrust case with 
respect to parallel pricing requires additional proof, proof 
that there was some agreement or collusion or conspiracy. But 
parallel pricing can be an anti-competitive act, and the courts 
have said that any plaintiff bringing an antitrust suit with 
respect to parallel pricing, cannot under current law get to a 
jury without some showing of agreement or collusion. It seems 
to me with respect to this issue that we should consider 
allowing parallel pricing cases to go to a jury if there is 
sufficient evidence of parallel pricing alone to make that 
rebuttable presumption, but nonetheless sufficient evidence to 
get to the jury.
    Oil companies, through their legal counsel try to avert or 
try to avoid overt collusion. But the reality is that with 
exchange agreements, the use of common consultants, public 
postings of prices, and common statistical resources and 
analysts, the market can, in the words of one oil company, ``be 
disciplined.'' And it can be disciplined in areas of 
significant or heavy concentration without overt collusion.
    Now, with all the evidence that the plaintiffs in the 
Aguilar case had assembled to demonstrate anti-competitive 
behavior in California, the courts threw out a case and granted 
a motion for summary judgment because of the absence of overt 
conspiracy. But I think that new circumstances ought to at 
least have us look at possible changes in current law so that 
again we would allow proof of the fact of parallel pricing to 
be enough to withstand a motion for summary judgment and to get 
a case to the jury.
    Finally, I think Congress should consider the possibility 
of requiring the oil companies to maintain a certain level of 
inventory of gasoline in order to avoid price spikes and price 
fluctuations. Four countries in Europe have such a requirement: 
France, Switzerland, Germany, and the United Kingdom. And we 
ought to at least look at that possibility as an appropriate 
approach for the United States so that supply is not so tight 
as it is in these highly concentrated areas. The oil companies 
have reduced their inventory levels dramatically over the past 
few years, so that now we have only 3 days worth of emergency 
supply at the Nation's current consumption rate. The tight 
balance between supply and demand and the low inventories, when 
combined with market concentration, have contributed to the 
recent price spikes and gas price volatility. It may be time to 
require a cushion of gasoline supply.
    On Thursday we will hear, in addition to Senator Wyden, 
from three State Attorneys General, who have been investigating 
the practices of oil companies for the last few years, as well 
as from a number of oil experts who can respond to the issues 
that were raised here today and in the Majority Staff's report.
    The hearing will begin at 9:30 on Thursday. It will not be 
held in this room. It will be held in room 342 of the Dirksen 
Building, which is the Governmental Affairs Committee hearing 
room.
    Again, I want to thank our witnesses for volunteering to 
come forward, for the cooperation of their companies, and for 
their testimony here today. It will be made part of the record 
in its entirety as drafted and presented to the Committee, and 
of course your oral comments here will be helpful to the 
Subcommittee.
    We will stand adjourned.
    [Whereupon, at 1:42 p.m., the Subcommittee was adjourned.]

 
                  GAS PRICES: HOW ARE THEY REALLY SET?

                              ----------                              


                         THURSDAY, MAY 2, 2002

                                       U.S. Senate,
                Permanent Subcommittee on Investigations,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:36 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, Lieberman, and Collins.
    Staff Present: Linda J. Gustitus, Chief of Staff for 
Senator Levin, Senator Levin; Mary D. Robertson, Chief Clerk; 
Laura Stuber, Counsel; Dan Berkovitz, Counsel; Edna Falk 
Curtin, Detailee/General Accounting Office; Cliff Tomaszewski, 
Detailee/Department of Energy; Kathleen Long (Senator Levin); 
Kim Corthell, Minority Staff Director; Eileen Fisher, 
Investigator to the Minority; David Mount, Detailee/Secret 
Service; Hilary Keilp (Intern); Joyce Rechtschaffen, Staff 
Director, Government Affairs Committee; Laurie Rubenstein and 
David Berick (Senator Lieberman).

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Good morning, everybody. Today the Permanent 
Subcommittee on Investigations will hold its second of two 
hearings on the reasons for dramatic fluctuations and recent 
increases in the price of gasoline. On Monday of this week, the 
Subcommittee released the report of the Majority staff 
following a 10-month investigation. One of the basic 
conclusions of the report deals with the effects of increased 
concentration in the oil industry on the wholesale supply 
market.
    Due to a series of refinery closures and mergers within the 
oil industry, the wholesale supply market is now more 
concentrated than ever. According to information provided by 
the Department of Energy's Energy Information Administration, 
the wholesale supply market is moderately to highly 
concentrated in a total of 37 States. By another accepted 
measure of concentration, 28 States are considered tight 
oligopolies.
    In general, more competition means lower prices for 
consumers, and lack of competition leads to higher prices. The 
oil industry is no exception to these general rules.
    In areas of high concentration, where a few refiners 
control most of the retail sales, by keeping supplies tight 
refiners can raise the price of gasoline without great fear of 
competition. One way to maintain a tight supply is by keeping 
only a minimal amount of gasoline in inventory. One effect of 
doing that is that any supply disruption will cause a shortage 
of gasoline because there is no reserve capacity to bring to 
market.
    This invariably leads to price increases, and because 
gasoline is such an essential commodity in our lives today, 
most Americans have no choice but to pay more and more when 
prices rise.
    Keeping supplies tight and inventories low in highly 
concentrated areas makes it possible for companies to spike 
prices without great fear of competition. Since all the 
companies maintain minimal inventories, no company need fear a 
competitor will gain market share by keeping their prices low 
because they would quickly run out of gas.
    James Carter, Regional Director, U.S., for ExxonMobil, 
testified to that on Tuesday. He said, ``If our price is 
extraordinarily low, we are going to run out before the next 
amount of gasoline gets here.'' So the few companies in these 
areas raise and lower prices together and in the same price 
relationship to each other, a practice called ``parallel 
pricing.''
    One of the key findings in the staff report is that in a 
number of highly concentrated markets, oil companies are not 
just passive actors who respond to whatever the supply and 
demand situation is at a given moment; but, rather, they are 
active players, seeking to shape and structure the market in 
such a way so as to make the refining business more profitable.
    The investigation found a number of documents, which we 
discussed Tuesday, indicating that oil companies seek to 
tighten supply in highly concentrated markets to increase 
prices. While the oil company executives who testified on 
Tuesday said either that their companies didn't adopt the 
options set forth in their memo to limit supply, or that they 
didn't have any knowledge of the activities discussed in 
another memo, or that actions described in a third memo were 
against corporate policy, the evidence presented in the 
Majority staff report demonstrated many instances when refiners 
acted to limit supply to raise prices.
    Most of the oil companies that testified on Tuesday do not 
believe we need additional refineries in the United States. 
These companies believe that a shortage of refineries has not 
been a cause of any of the recent price spikes.
    Now, although the price of crude and government regulatory 
actions obviously have a large effect on wholesale and retail 
prices in this country, or in the case of regulatory actions, 
surely contribute to the cost of gasoline, the staff 
investigation looked at actions taken by the oil companies, 
within their control, downstream from the crude oil production 
process.
    Today we will hear from a number of distinguished public 
officials and economists about this subject. First we will hear 
testimony from Senator Ron Wyden. Senator Wyden has been 
working on the issue of gasoline prices and industry 
concentration for many years.
    Following Senator Wyden, we will hear from a panel of 
Attorneys General. Attorney General Jennifer Granholm is here 
today from my home State of Michigan. Attorney General Granholm 
has been very active on a number of consumer issues, including 
gasoline pricing in Michigan. She successfully forced gasoline 
stations that gouged the public after the tragic events of 
September 11 of last year to return some of their ill-gotten 
gains.
    Attorney General Richard Blumenthal from Connecticut is 
also on our panel today. Attorney General Blumenthal has been 
very active in gasoline pricing issues. Over a number of years, 
he has aggressively advocated for a competitive gasoline 
marketplace on behalf of Connecticut motorists.
    I am also pleased that Thomas Greene, Assistant Attorney 
General from California, will be here to represent the 
California Attorney General's views. As our Majority staff 
report shows, the effects of high concentration and vertical 
integration in the refining and marketing industries are 
acutely seen and felt by consumers in the State of California.
    A few years ago, the California Attorney General issued a 
report on gasoline pricing in that State. That report addressed 
many of the issues that we have been looking at. We are looking 
forward to Mr. Greene's testimony.
    On the third panel today, we will hear from four 
economists. All four of these panelists have studied one aspect 
or another of the petroleum industry. We are grateful for their 
presence, and we look forward to hearing from them as well.
    Senator Collins.

              OPENING STATEMENT OF SENATOR COLLINS

    Senator Collins. Thank you, Mr. Chairman.
    First, let me commend you and your staff for your in-depth 
investigation into this very important issue of how gasoline 
prices are set and the causes of high gasoline prices and price 
spikes. Volatile prices are a major source of concern to 
Americans, particularly lower-income families and small 
businesses. Given how vital oil and gasoline are to every 
aspect of our economy, gasoline prices play an important role 
in our country's ability to recover from the recession.
    On Tuesday, we heard testimony from executives of several 
of the Nation's largest oil companies who explained the 
industry's practices in distributing and establishing prices 
for gasoline. I was particularly interested to hear what the 
witnesses had to say about the impact on supply of the seasonal 
transition between winter and summer gasoline, a time of year 
when price spikes are common.
    The perennial glitches that occur during this seasonal 
transition are contributing factors to price spikes in some 
areas of the country. The oil industry argues that the 
stringent transition calendar that the EPA has put in place is 
at fault. I must say, based on my review, I do not understand 
why, after years of experience in the oil business and several 
years of dealing with the various Federal and State 
environmental regulations on gasoline, the industry has not 
been able to plan more effectively for these transitions to 
avoid price spikes. After all, summer always is going to follow 
spring, and the summer driving season is going to begin every 
year around Memorial Day.
    In addition, I remain concerned that the oil companies have 
not made the necessary investments in infrastructure and to 
maintain U.S. refineries. Refinery breakdowns were a major 
cause of gasoline price spikes in the Midwest, especially in 
the spring of 2000. While the oil companies clearly are 
profitable, they testified that they had made investments in 
refineries of only a few million dollars, mainly so that they 
could stay in compliance with environmental regulations. With 
refineries operating at near 100 percent capacity, any glitches 
usually lead to limited supplies and higher costs to 
consumers--costs to the tune of $1 billion in revenue annually 
for the industry for every penny increase at the pump.
    I also share Senator Levin's concern about the impact that 
industry mergers in recent years have had on competition. That 
has led to greatly increased concentration in the industry, and 
a basic rule of economics is more competition produces more 
choice for consumers and lower prices. We seem to be going in 
the opposite direction in the oil industry.
    For that reason, I am particularly interested in hearing 
the testimonies from the three States' Attorneys General. They 
will discuss their investigations into competition within the 
gasoline industry in their home States.
    I also look forward to hearing the statements from several 
economists and oil industry analysts who have studied the 
effects of mergers and the resulting increased concentration 
levels in the industry. This raises questions about the 
effectiveness of the FTC's review of mergers during the Clinton 
Administration.
    I also look forward to hearing their opinion on the 
industry's contention that U.S. refinery capacity is sufficient 
for our needs. I just don't see how that can be with the 
refineries operating at nearly 100 percent capacity. It seems 
to me that leaves no room for error.
    Consumers in Maine and across the Nation are justifiably 
confused and frustrated by the recent high gas prices and price 
fluctuations. I again want to thank Senator Levin for shining a 
spotlight on this important issue and for exploring what can be 
done to protect American consumers.
    Senator Levin. Thank you again, Senator Collins, and thank 
you again for your support and the support and assistance of 
your staff in this matter.
    Now the Chairman of our full Committee, Senator Lieberman.

             OPENING STATEMENT OF SENATOR LIEBERMAN

    Senator Lieberman. Thank you, Senator Levin. I am glad to 
be here for this second hearing on gas prices, and once again I 
would like to, in my capacity as Chairman of the Senate 
Governmental Affairs Committee, thank you and Senator Collins 
and your staffs for the extraordinary work that you have all 
done that led to a very substantive and informative hearing a 
few days ago. And I am sure the same will be true today.
    I want to thank our colleague, Senator Wyden, who has been 
a real leader on behalf of consumers in this and so many other 
areas over the years and to welcome particularly a couple of 
generals who are here today, I say as a former Attorney 
General, General Granholm of Michigan and my own Attorney 
General, Dick Blumenthal, from Connecticut, along with the 
senior Assistant Attorney General Greene from California. I 
know that they have very important testimony to offer.
    This Permanent Subcommittee on Investigations report on 
gasoline pricing raises some very serious questions. Is the oil 
industry as competitive as it ought to be? And is government 
doing everything it can, we can, to safeguard consumers?
    I want to go back in history a bit. The government broke up 
Standard Oil 91 years ago, ending one of the most egregious 
distortions of free and fair markets in our history. There is a 
wonderful quote from a book by Thomas Lawson called ``Frenzied 
Finance,'' which was published in 1905. I believe that it may 
have been given as a present to Senator Thurmond's parents on 
his birth.
    Anyway, I quote from it: ``Standard Oil has, from its birth 
to present writing, been responsible for more hell than any 
other trust or financial thing since the world began. Because 
of it, the people have sustained incalculable losses and have 
suffered untold miseries.''
    Well, obviously, the oil market is much more free and more 
fair today than it was back then. But today, as this 
Subcommittee's investigation has shown, we are still faced with 
mergers and marketing practices that may well be constraining 
the marketplace rather than lubricating the gears of 
competition.
    The possibility of market manipulation in oil and gas is 
particularly troubling because, as we know, higher gas prices 
hit middle- and low-income workers and families the hardest. 
They are regressive. For the American who earns $30,000 per 
year, for instance, and has to drive 30 miles back and forth to 
work each day, the price at the pump can mean the difference 
between making ends meet and being unable to pay all the bills.
    That is why we should be disturbed by the PSI 
investigation's finding that gas prices in America are so 
volatile not because of a responsive market, but because of a 
market that is unhealthy. And its illness can be seen through 
two sets of symptoms: Concentration in the wholesale markets on 
the one hand and restrictive practices in the retail markets, 
such as zone pricing and redlining, on the other.
    In testimony to the House Judiciary Committee 2 years ago, 
Attorney General Blumenthal called zone pricing ``invisible and 
insidious.'' In fact, there are big signs outside every station 
with the price of gas, but consumers are actually kept 
completely in the dark when it comes to the workings of zone-
pricing schemes.
    One major oil company operating in Connecticut, our 
geographically small State--we have just eight counties--had 46 
different zones just in our State. That is astonishing. How can 
the market work as effectively as possible when wholesalers 
offer different distributors, who have no choice but to accept 
them, dozens of different prices for the very same product?
    I did some work on this when I was Attorney General during 
the 1980's. General Blumenthal has done very strong and 
effective work. And I must say I agree with his assessment that 
zone pricing is both invisible and insidious.
    Based on the Permanent Subcommittee's investigation, it 
does appear that oil companies could be charging more in some 
areas to squeeze as much as they possibly can out of retailers 
and consumers wherever and whenever they think they can get 
away with it. If gasoline dealers had more freedom to shop 
around, we would probably be seeing a much fairer and more 
fluid market in which prices were kept down by the natural 
pressures of supply and demand and not artificially inflated.
    To date, the Federal Government has not sent a clear signal 
on the legality of either zone pricing or redlining. Last year, 
the Federal Trade Commission closed an investigation into 
Western States' gasoline pricing after determining that there 
was insufficient evidence to show that any of the Western 
States refiners' practices caused higher wholesale or retail 
prices for gas. But in a concurring statement, Commissioner 
Mozelle Thompson expressed his concern about some of the 
redlining practices being employed, and he concluded, ``The 
Commission has vigilantly protected the competitiveness of the 
Nation's energy sector for years through its enforcement 
actions. I, therefore, am confident that should the Commission 
find evidence in any future investigation that site-specific 
redlining results in anti-competitive effects without 
generating countervailing consumer benefits, it''--the 
Commission--``would challenge the practice.''
    With all respect, I am not confident that such effects 
could be discovered because of the lack of information revealed 
by big oil companies about their pricing policies. And 
government cannot challenge what it doesn't know. Fair and 
competitive markets are the foundation of a strong free 
economy, but the current level of information about how the oil 
industry really operates isn't enough for oversight agencies to 
ensure that these markets are fair and competitive. That needs 
to change, and quickly. And Attorney General Blumenthal has, I 
think, a very constructive proposal to bring that about.
    So, Mr. Chairman, I thank you again. I look forward to 
hearing this morning's testimony, and I am eager to make sense 
of these practices, and maybe even to figure out how we can 
save consumers a few cents a gallon at the same time. Thank you 
very much.
    Senator Levin. Thank you very much, Senator Lieberman.
    With respect to your zone-pricing point, one of the 
witnesses on Tuesday said that every single gas station is a 
separate zone.
    Senator Lieberman. That is quite a statement.
    Senator Levin. Quite a bit of testimony.
    Let me now introduce our first witness this morning, our 
friend and colleague, the senior Senator from Oregon, Ron 
Wyden. Senator Wyden, as I mentioned, has worked for years on 
the issue of gas prices and their volatility in Oregon and on 
the West Coast. We are pleased to have you before our 
Subcommittee this morning for your views on the subject.
    As you know, pursuant to Rule VI, all of the witnesses 
before this Subcommittee are required to be sworn, and so I 
would ask you to stand and be sworn in at this time. Do you 
swear that the testimony you will give before the Subcommittee 
will be the truth, the whole truth, and nothing but the truth, 
so help you, God?
    Senator Wyden. I do, Mr. Chairman.
    Senator Levin. Thank you. Please proceed.

 TESTIMONY OF HON. RON WYDEN,\1\ A U.S. SENATOR FROM THE STATE 
                           OF OREGON

    Senator Wyden. Thank you, Mr. Chairman, and let me begin by 
saying, watching you, Mr. Chairman, and your colleagues 
question the oil company executives a couple of days ago was 
like watching a teach-in on how to do oversight right. And I 
just want to commend you and the staff for a superb job both 
with the report and with the hearing that was held several days 
ago.
---------------------------------------------------------------------------
    \1\ The prepared statement of Senator Wyden appears in the Appendix 
on page 175.
---------------------------------------------------------------------------
    Senator Levin. Thank you very much.
    Senator Wyden. As you know, I have been investigating the 
oil price issue for several years, and I have brought with me 
this morning just a portion of the pile of government reports, 
including my own, that have detailed oil company anti-
competitive practices over the years. The findings of the 
Subcommittee closely track what each of those investigations 
have shown, and that is, anti-competitive practices are rampant 
in the gasoline markets.
    Now, essentially in these reports is everything: That oil 
companies redlined; they sought to keep independent wholesalers 
from competing in markets by refusing to let independent 
dealers buy better-priced gas from the local jobber; they zone-
priced; they charged different prices for the same gas at their 
own branded stores and adjacent neighborhoods, pricing it as 
high as the market would bear. They kept the market for 
themselves. They kept down refineries that could have increased 
supply and introduced competition. And they stuck it to the 
consumer on the export issue. The big oil companies, BP 
specifically in their internal E-mail, called it a no-brainer 
to export gas and oil to Asia at rock-bottom prices and just 
make up the difference by sticking it to people on the West 
Coast of the United States.
    It seems to me that cumulatively these practices just strip 
the competitive gears out of the gasoline market and hammer the 
consumer. And what is especially ominous is when you look at 
these reports and study the controlling law in this area, there 
isn't a whole lot that can be done right now to turn this 
situation around.
    So I wanted to come this morning and say I think there is 
really one question for the Congress at this point: Is it going 
to be business as usual with these reports just becoming an 
annual dust-collecting exercise? Or is the Congress going to 
move to rein in market manipulation and require meaningful 
consumer protection reforms?
    And I think--and this is what I am going to outline this 
morning, Mr. Chairman--moving to these reforms is critical now.
    I was in a small town in Oregon Saturday last, a small town 
on the Oregon coast called Brookings. The situation there is so 
bad that they are trying to form a nonprofit organization so 
that they can buy gas at a wholesale price because they are 
getting killed with retail prices. You have senior citizens, in 
my view, in Maine and Oregon and in small towns across this 
country basically trying to figure out how to do this kind of 
thing because the competition is being drained out of the 
gasoline markets.
    So here is my sense of what would constitute real reform, 
Mr. Chairman. First, I think the controlling statute in this 
area needs to be changed and broadened. The current law states 
that there must be one of three kinds of outright collusion 
taking place to stop these anti-competitive practices. One, 
there has got to be a contract or an agreement between 
companies to fix prices. Two, there has got to be a combination 
or a formal alliance of companies fixing prices. Or, three, 
there has got to be a conspiracy, which is basically like a 
bunch of people getting together for dinner and saying, Well, 
Bob, what do you think the price of unleaded should be?
    Now, we all know the old saw that the certainties in life 
are death and taxes. There is another one. You're not going to 
find smart oil companies holing up in a room colluding in that 
kind of way to set prices. They are just too savvy and the 
problem is subtle. Supplies are being manipulated and 
competition is being restricted in broad daylight.
    For example, the FTC found that redlining was used to 
discourage competition and raise prices while providing no 
benefit to the consumer. But because the Commission found no 
evidence that the refiners met either of those three tests for 
collusion, redlining could just go forward unabated.
    I believe it's time to make these anti-competitive 
practices illegal once and for all. So I would propose that, in 
addition to collusion, the statute be broadened to bar anti-
competitive practices by a single company where the market is 
concentrated, where you have four or fewer players controlling 
a significant majority of the market. This would raise the bar 
to expect better business practices from the oil companies.
    When a company tries to squeeze an independent jobber out 
of a market by telling branded stores what gas they can and 
can't buy, the law wouldn't have a loophole anymore. So I think 
that would be change No. 1, making a change in the controlling 
statute to broaden out beyond that three-part test with respect 
to collusion.
    But I would propose changes in a second area, specifically 
changes to the law that authorizes the Federal Trade Commission 
and governs its oversight of markets. Under the FTC Act, I 
believe the Federal Government should consider establishing 
consumer watch zones in these concentrated markets. At 
Tuesday's hearing, ChevronTexaco's North American President 
David Reeves admitted that the West Coast gasoline market is 
dominated by a limited number of refinery marketers who, acting 
alone, can evade the laws of supply and demand. There's no need 
for oil company executives to get together in a smoke-filled 
room to collude on price when they've got the individual power 
to manipulate markets in that kind of fashion. And I believe 
that when you have a market that is highly concentrated, you 
ought to go beyond the question of whether there's collusion 
between competitors. And in these consumer watch zones, when 
oil companies employ anti-competitive practices like redlining 
or zone pricing, I believe the burden of proof should shift 
onto them to prove that those practices are not harming 
consumers. So that would be the second change that I would 
advocate, Mr. Chairman, as to the FTC statute in these 
concentrated markets, when you find practices like redlining 
and zone pricing, the burden of proof should shift to the 
companies to demonstrate that it is not harming the consumer.
    My sense was, Mr. Chairman, you were suggesting almost the 
same sort of thing with respect to parallel pricing, and I 
support those kinds of efforts as well.
    In the same way, the whole litany of anti-competitive 
practices should be considered an area that is substantively 
questionable until proven otherwise. That would include 
redlining, exporting at a discount, pressuring independents, 
all of the practices that manipulate supply or limit 
competition. The second set of changes I believe would go a 
long way towards helping American consumers.
    I would also empower the Federal Trade Commission to take 
more immediate action when you have those problems in a 
concentrated market. Under the FTC Act, I would like to see the 
agency have the ability to issue cease and desist orders to 
companies that participate in the anti-competitive practices so 
as to provide the consumers protection. It seems to me the 
Federal Government should not be powerless to regulate anti-
competitive practices that can raise gas prices for the 
consumer.
    In addition, I would use this watch zone concept, this 
question of how you proceed in concentrated markets to serve as 
an early warning signal with respect to the antitrust statutes. 
If a proposed merger of oil companies would create a consumer 
watch zone, again, with four or fewer players controlling 70 
percent of the market, I would say that kind of merger should 
require a closer level of scrutiny. A higher standard of 
evidence--of review would demand evidence before the merger 
would be allowed to proceed, again, to protect the consumer.
    Americans shouldn't have to wait for what amounts to an oil 
oligopoly to start gouging the consumer to get some protection 
from high prices.
    The Federal Trade Commission has already said that 
Americans shouldn't have to suffer because of bad decisions 
made by regulators years ago. The agency recently instituted a 
new policy of looking back at previously approved oil company 
mergers to see if there are any lingering anti-competitive 
problems. If the agency finds such problems, they're going back 
in to fix them. Why not make a change so as to do the 
appropriate amount of investigating on the front end before you 
let another anti-consumer merger kick in and, in my view, stop 
the anti-competitive practices before they start?
    Let me be clear on this point, Mr. Chairman and colleagues. 
When I suggest changes to the laws that govern oil companies 
and oil markets, I want to propose that those changes only be 
made in the case of concentrated markets where a predisposition 
to consumer abuse has been documented. Legislation along those 
lines would ultimately take the country in a more constructive 
direction. I don't think the country would be taken in a more 
constructive direction by some of the proposals that we heard 
in the last few days, such as weakening the Clean Air Act. We 
even heard Tuesday that the Clean Air permitting process, known 
as New Source Review, needs to be streamlined; it's been a 
deterrent, according to the companies, to increase capacity in 
the country. But I think there is something wrong with that 
picture when Mr. Reeves from ChevronTexaco testifies they have 
made significant expansions at their Mississippi refinery. He 
also states it'll be one of the first refineries in the Nation 
capable of producing both low-sulfur gas and highway diesel 
fuel outside of California. The project will be completed in 
advance of national deadlines for these requirements.
    So it seems to me by their own words, the words that you 
heard Tuesday, Mr. Chairman, the oil industry's claim that the 
Clean Air Act requirements are deterring refineries from 
increasing their output doesn't exactly match up with what's 
happening in the real world at ChevronTexaco's refinery.
    There's also something wrong with this picture when we hear 
repeatedly that no new refineries have been built in decades 
and that the Clean Air Act is at fault. Yet when asked whether 
the United States needs additional refineries, all of the 
executives at Tuesday's hearing said no. The real reason has 
more to do with return on investment, in my view, than anything 
to do with the Clean Air Act.
    There isn't going to be any more competition under the 
industry's proposals to streamline the Clean Air permitting. 
What I tried to offer today was a proposal to open up the free 
enterprise system in the gasoline business, and I think that 
ought to be a base by which the Congress proceeds rather than 
an approach that would advocate dirtier air and reward the same 
oil companies who perpetuated the gasoline supply crunch in the 
first place. These are the companies that deliberately worked 
to keep down refineries. You and I have talked specifically 
about Powerine in California, but these are the kinds of 
examples that are in these reports, Mr. Chairman.
    I want to commend you and your staff again on a very 
thorough report. It documents a litany of anti-competitive 
practices the oil companies use to manipulate supply and price 
in gasoline markets, and close by coming back to that question 
that I think is central to this debate.
    Mr. Chairman, we could pile these reports over the next 10 
years up to the ceiling, and yours is superb and the work that 
you've done and Senator Collins and Senator Lieberman is 
excellent. I think the question now is: Are we going to do more 
than stack up the reports? I think that it is time now to get 
beyond the statute today that makes it virtually impossible to 
protect the consumer. These companies are not going to go into 
a back room, have a big supper, and say, ``Joe, what do you 
want the price of gas to be?'' They're just not going to do it. 
But that's virtually what you have to prove in order to bring 
an action to protect the consumer.
    I think we can do better on a bipartisan basis. In my 
State, Senator Smith shares many of the same views that I do. 
Senator Collins has a long record of consumer advocacy in this 
area. There is not going to be anything partisan about doing 
this job right, in my view, and I thank you and your staff, Mr. 
Chairman. You have given me a lot of time in recent months to 
work on an area I feel strongly about, and I'm very 
appreciative.
    Senator Levin. Well, thank you, Senator Wyden, for your 
testimony and for your long, energetic, persistent effort to 
protect consumers in this area. As we have discussed, a number 
of reforms are needed in the law to tighten up the law. I would 
only add to that very general point that the Federal Trade 
Commission does have power under existing law which it has not 
exercised to try to prevent some of the mega-mergers which have 
occurred and some of the lack of competition which has 
resulted. But I very much appreciate your very specific 
testimony. That is very helpful to this Subcommittee, and I 
would ask my colleagues if they have any questions. Senator 
Collins.
    Senator Collins. No, thank you, Mr. Chairman.
    Senator Levin. Senator Lieberman.
    Senator Lieberman. No, Mr. Chairman.
    Senator Levin. Thank you again.
    Senator Wyden. Thank you.
    Senator Levin. I would now like to introduce our second 
panel of witnesses. Welcome to this Subcommittee. Richard 
Blumenthal, Attorney General for the State of Connecticut; 
Jennifer Granholm, Attorney General from my home State of 
Michigan; and Tom Greene, the senior Assistant Attorney General 
for the State of California. This is a very distinguished, a 
very knowledgeable panel. We look forward to hearing your views 
on gasoline volatility and your experiences in your respective 
States and what we can do about it.
    Pursuant to Rule VI, as I have indicated, all witnesses who 
testify before the Subcommittee are required to be sworn, and 
so I would ask each of you to stand at this time and raise your 
right hand. Do you swear that the testimony that you will give 
this morning before this Subcommittee will be the truth, the 
whole truth, and nothing but the truth, so help you, God?
    Mr. Blumenthal. I do.
    Ms. Granholm. I do.
    Mr. Greene. I do.
    Senator Levin. Thank you. I think we will start with 
Attorney General Blumenthal.

TESTIMONY OF RICHARD BLUMENTHAL,\1\ ATTORNEY GENERAL, STATE OF 
               CONNECTICUT, HARTFORD, CONNECTICUT

    Mr. Blumenthal. Thank you, Mr. Chairman, and I would like 
to second a number of the remarks that have been made about the 
quality of the staff report that has been done. I know that 
very frequently we compliment the staff on the work they do, 
but this report really is extraordinarily insightful, 
penetrating, and revealing about the practices of this 
industry, and I think it will provide real ammunition for 
effective reform, and I want to thank you, Senator, and Senator 
Lieberman and Senator Collins for your excellent work in this 
area and for making sure that this report will be as useful and 
productive as I hope it will be.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Blumenthal appears in the 
Appendix on page 179.
---------------------------------------------------------------------------
    Price spikes have become almost a national norm at this 
point in gasoline pricing, and, unfortunately, they affect very 
deeply not only American consumers, particularly those of low 
and moderate means, but also our economy. And as you have 
remarked, Mr. Chairman, they have probably stifled our recovery 
and perhaps precipitated the recession that we are now seeking 
to undo. So there are implications to these kinds of price 
abuses beyond the simple consumer protection issues. They 
affect all of us, and their effects are tremendously far-
reaching and fundamental.
    Market concentration has enabled the industry to manipulate 
prices, to take advantage of low supplies and even disruptions 
that may be the result of temperature, refinery fires, pipeline 
problems, and so forth. The industry has exploited those 
problems for its own benefit, and the Subcommittee report very 
dramatically documents that conduct. It also indicates that 
there has been conduct verging on the illegal, if not an 
outright violation of the antitrust laws. A number of the 
discussions and memos that are evidenced in the report show 
that there is a need for further investigation and enforcement. 
And one of the reasons that we have such high degrees of 
concentration is indeed the lack of effective enforcement. It 
has been a bipartisan failure on the part of the FTC, on the 
part of Federal enforcers, and the proposal that I am making 
today really is the result of that lack of effective 
enforcement that has brought us to such high degrees of market 
concentration.
    I am proposing a moratorium on all major mergers and 
acquisitions within this industry, whether at the wholesale or 
retail or other levels, a moratorium that would enable the 
Congress to fashion more effective remedies, and not only to 
empower but also to require Federal enforcers to do a better 
job. And I believe that a moratorium of this kind may be 
regarded as a kind of last resort. It ought to be for at least 
1 year. It would affect only major mergers and acquisitions and 
so provide an exception, for example, if there were failing 
companies or if their market share were less than a certain HHI 
degree or number. But I believe that the record now more than 
justifies that kind of halt to any further major mergers and 
acquisitions in this industry.
    The second proposal that I believe is well merited would 
involve the kind of change that Senator Wyden and you have 
mentioned, Senator Levin, that would make admissible evidence 
of parallel pricing, the kind of conscious parallelism that in 
a market so highly concentrated as this one certainly ought to 
be regarded as evidence of an antitrust violation. I believe 
that the proposal that he has just made would also apply to 
concentrated markets that have a predilection or a 
predisposition toward abuse, those changes in the standard 
itself are worth consideration as well. But I think at a 
minimum there ought to be admissibility for common pricing 
patterns or conscious parallelism under our antitrust laws 
where there are highly concentrated markets, and that would 
certainly apply to this industry. And perhaps in some 
instances, with a sufficient threshold showing, it ought to be 
a per se violation. Obviously there are arguments pro and con 
to that kind of proposal, but I believe it's worthy of 
consideration.
    And then to promote more effective enforcement at the State 
as well as Federal level, I think there needs to be better 
information. Quite simply, there should be under the Energy 
Information Administration a central data bank that is 
accessible and more complete in real time so that it is truly 
useful to Federal antitrust enforcers and to State enforcement 
officials, such as those before you today and our colleagues 
around the country who have our own antitrust and consumer 
protection responsibilities.
    Right now, we have to spend tens and sometimes hundreds of 
thousands of dollars doing the kind of work that California did 
in its study, that Connecticut has sought to do over the last 
10 years while I have been Attorney General simply to make a 
case, wholly apart from the use of subpoenas and other 
investigatory tools. Basic information is simply not as 
available and accessible as it should be.
    Finally, I propose again and urge very strongly a ban on 
zone pricing. I recognize that you have heard testimony from 
the industry that would seek to justify it on a competitive 
basis. In my view, zone pricing really is not a competitive 
measure. In fact, it is anti-competitive. And I have cited in 
my testimony pricing conduct that has been documented in our 
local media. The Stamford Advocate, for example, has reported 
price differentials in a very close proximity of 7 to 12 cents. 
It now happens that a truck can be delivering the same gasoline 
that is exactly the same product to the same city, indeed 
sometimes the same street, out of the same truck, and often to 
the same owner of two different stations located within blocks 
of each other; and simply because of these artificial, 
geographic, discriminatory means and distinctions, the prices 
will be different substantially to the consumer. The industry 
relies on computer programs and secret calculations as to how 
much profit the consumer will bear, not what competition will 
enable or provide.
    And so I believe that the Robinson-Patman Act and the 
Petroleum Marketing Practices Act ought to be amended to 
specifically prohibit the single-source requirement, which is 
at the root of this abuse, or specifically, discrimination 
based on location of stations, discrimination in pricing, and 
close the loopholes that now exist in those two statutes.
    I recognize, finally, that conservation has a role to play. 
All of the members of this panel have commented very eloquently 
on the importance of conservation, fuel efficiency, and mass 
transportation, other measures that can help us to save and 
conserve as well as to eliminate the abuses that artificial 
shortages and low inventories have created.
    I again thank this Subcommittee for this opportunity to 
comment on an area that I think has come of age. It certainly 
is an issue whose time has come. These practices for the most 
part are invidious and insidious. They are often invisible to 
consumers, but their effects are real and dire. And I offer my 
continuing help in addressing them. Thank you.
    Senator Levin. Thank you very much, Mr. Blumenthal. 
Attorney General Granholm.

 TESTIMONY OF JENNIFER M. GRANHOLM,\1\ ATTORNEY GENERAL, STATE 
                 OF MICHIGAN, LANSING, MICHIGAN

    Ms. Granholm. Thank you very much, Mr. Chairman. It's great 
to be invited here to talk about such an important subject. I 
very much appreciate the opportunity.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Granholm appears in the Appendix 
on page 187.
---------------------------------------------------------------------------
    I'm the Attorney General of Michigan, and for nearly 3 
years, my office has been involved in the review of gas 
pricing, as well as in independent actions from our office to 
curb excesses. We joined with the FTC in looking at their 
investigation following the spikes in the year 2000. In the 
wake of the terrorist attacks, of course, many of us saw prices 
go through the roof, and in Michigan, it was between $2 and $5 
per gallon, and our office filed notices of intended action 
against 46 gas stations who jacked up those prices and did get 
refunds. Thank you for mentioning that.
    In my role as legal counsel for our Michigan Public Service 
Commission, which is the body that regulates utilities, my 
office intervened in a FERC matter regarding the Wolverine 
pipeline and its lack of competition with respect to access to 
the pipeline and with respect to rates, which was so well 
documented in your report.
    So I would like to propose a couple of things. First of 
all, I think that General Blumenthal has made some excellent 
points. I agree on the issue of a moratorium--a moratorium 
particularly with respect to wholesale mergers. I was 
interested to hear Senator Wyden's comments about four 
suppliers controlling 70 percent of the market as being sort of 
a threshold. If you look at the HHI index, in Michigan we 
approached that almost tipping point. We are almost at 1,800 on 
that tipping point. And one more merger would push us over the 
top.
    Now, if you use that index as a means sort of across the 
board of saying when do we apply a moratorium, when do we 
believe there's too much concentration--and that's, of course, 
the threshold that the FTC and the DOJ use, anyway--I think 
that is a great way to start, at least where we might be able 
to apply the existing criteria and know that we've got to take 
another look before there's any more concentration of a market. 
So I agree fully with the moratorium idea.
    A couple of other things that I think are relevant, and I 
know that they were discussed before. First of all, I know 
Senator Collins was speaking particularly about the industry 
capacity levels being at almost 100 percent. And, of course, 
when that is the case, before, when they were much more fluid 
and you could shoot gas to an area where there was a 
disruption, there was an ability for the market to self-correct 
in a much more ready fashion. The inventory levels, the 
reformulated gas problems--and in Michigan, we don't have a 
reformulated gas requirement, but certainly the availability of 
supply from other States is more limited when other States have 
got different requirements. And when you combine that with this 
inventory level problem, that's, of course, exacerbating the 
spike problems. And in Michigan, we've had the Wolverine 
pipeline, which is our main pipeline, break down, huge gas 
spikes as a result of inability to access quick supplies.
    Now, the notion about that, though, that the market could 
self-correct and that the industry can take advantage of the 
arbitrage possibilities that previously existed when the prices 
were high in one area, and the other area with lower prices 
could shoot gas over and see the sort of equilibrium arise, 
they are much more limited, of course, when there is a 
concentration of market power in one area. And so in Michigan, 
I just want to address this issue of--because we have seen 
amazing price differentials from one adjacent area to the next, 
where you would think that the ability to take advantage of the 
arbitrage capability would really create a much more level 
pricing scenario, and they have not.
    We've seen as much of a 10-cent difference from the Chicago 
market to the West Michigan market, and the reason is--I mean, 
even a 2-cent differential would cause gas to shoot from one 
place to another. But a 10-cent difference, you'd really have 
to say: What is going on here? Who's taking advantage of 
something? And it's because in West Michigan--because we have 
had a merger, first of all, of Marathon and Ashland Petroleum. 
That occurred in 1998. And then the two of them merged with 
Ultramar Diamond Shamrock.
    Now, the resulting merger means that five companies in 
Michigan control 80 percent of the market, and in West 
Michigan, this concentration is particularly egregious because 
really the Marathon Wolverine pipeline--the Wolverine pipeline 
is owned by a number of these very same companies, and they 
control access to the tanks at the pipeline. So not only do you 
have a concentration of supply, but you have a concentration of 
the means of distribution and the tank--access to the tanks as 
well.
    As a result, we have seen--and the reason for this big 
disparity that I mentioned between Chicago and West Michigan is 
because people have difficulty accessing the terminals when the 
terminals are owned by one entity, which in this case is 
Marathon Ashland Petroleum. They were not allowing others to 
have access, which is why our office intervened with FERC to 
allow an independent wholesaler to have access to the 
terminals. But the result of these mergers was to limit access, 
and that is another area that I think this Subcommittee can 
look at. So it's not just the concentration and the ability to 
control capacity, but it's also the ability to control 
distribution and access to these terminals that we have seen 
the increases--where the increases have been so disturbing.
    Merger mania within the industry, in the last 5 years--I 
know you have documented this. This wave of mergers has 
obviously reduced competition enormously. But because Marathon 
Ashland Petroleum in our State alone has 28 percent of the 
terminal capacity market, and the next one down is British 
Petroleum Amoco, which merged, which has 14 percent, so the No. 
1 person has more than twice what the next one has. And there's 
five who control the market. Exxon is the next one. Equilon and 
Citgo, and they have nearly 80 percent of the petroleum 
terminal capacity in Michigan.
    So I know that when you've got that concentration and you 
have an inability of independent jobbers to access the 
terminals or to access the pipeline or to access capacity, you 
have these independents having an inability to compete, and 
often they are not just competing with the retail 
establishments like Speedway, which is owned by Marathon, but 
they are also competing because they are purchasing their 
supply from the owners of Speedway. So their supplier is 
competing with the other retailers. You've got no ability for 
greater independence in the market when the entity from whom 
the independents are buying from is the same entity that's 
supplying their competition, the retailers, the other 
retailers. It's all coming from one place and, therefore, the 
competition is just not there.
    Consequently, in your report, which was very interesting, 
on the graph that you showed on page 361 and 362,\1\ has, of 
course, all of these spike fluctuations in Michigan. But this 
one down here shows who leads the fluctuation. And in this 
case, it is Speedway stations that are always leading the price 
up or down, it's Speedway that is doing it. Speedway, of 
course, is the one that is owned and controlled by the largest 
capacity operator.
---------------------------------------------------------------------------
    \1\ See Permanent Subcommittee on Investigations' Majority Staff 
Report, Gas Prices: How Are They Really Set, which is reprinted in the 
Appendix on page 322.
---------------------------------------------------------------------------
    So the concern, of course, that one entity is being able to 
not just control the market but control the prices is of great 
significance, and the independent folks have to compete and 
often lose money when the big players are lowering their 
prices. I think you have Justine Hastings who's testifying 
later today, and she will tell you, I'm sure--because she's 
written this--that the independent station is the only type of 
station that can purchase gasoline from any refiner and 
independently set its retail markup and, thus, increase 
competition at the wholesale and retail level. But if you 
reduce their ability to compete, obviously, then you have much 
higher prices.
    My suggestion, respectfully, to the Subcommittee in the 
wake of the great report that you have done, is to dovetail on 
General Blumenthal's request for a moratorium. Again, in 
Michigan, I would suggest that it would go to wholesale 
suppliers because there may be some very small retailers that 
are being acquired that may be independent gas stations, that 
may not affect the market as much, but wholesale, absolutely, 
terminal owners, etc.
    I would like to see also that there be adequate resources 
for merger review at the FTC and the DOJ so that they can 
really focus in on this. I'm not sure that they've got the 
ability to assess in the way they ought every merger that is 
being proposed, and I'd like to see that occur as well. Not 
every merger, of course, is a bad thing, but with the resource 
constraints and the overwhelming number of mergers in the past 
few years, I think that there are a number of anti-competitive 
mergers slipping through the cracks.
    And then I also believe that there should be a review of 
whether the transportation and the access to terminals' 
bottlenecks preclude normal market forces from responding to 
the higher prices as well. I dovetail, too, as well on what 
General Blumenthal said with respect to having access to 
information from the Energy Information Administration. It 
would be very good, particularly for States that don't have 
their fingers in the pie as much, to be able to have access to 
that information to know whether they can bring an action.
    So, again, I want to thank you very much for the 
opportunity to testify and talk a little bit about what has 
happened in Michigan because of the concentration of market 
power. And I truly do hope you're able to achieve some great 
results, too.
    Senator Levin. Thank you, General--``Jennifer,'' I almost 
said.
    Ms. Granholm. That's OK.
    Senator Levin. General Granholm, thank you so much for the 
testimony. Mr. Greene.

 TESTIMONY OF TOM GREENE,\1\ SENIOR ASSISTANT ATTORNEY GENERAL 
 FOR ANTITRUST, CALIFORNIA DEPARTMENT OF JUSTICE, SACRAMENTO, 
                           CALIFORNIA

    Mr. Greene. Thank you, Mr. Chairman and Members, and 
certainly thank you on behalf of Attorney General Bill Lockyer 
of California, who could not be here this morning.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Greene appears in the Appendix on 
page 198.
---------------------------------------------------------------------------
    I think that the panel has already spoken eloquently to the 
key problems here. Let me just tick off the major points from 
my perspective.
    The first is that inventories, that key safety margin 
between enough supplies and shortage, have razor-thin margins. 
We are now at a point in which inventories are measured in days 
rather than weeks or months. The implication of that is that 
even a minor refinery outage, a minor fire, can throw markets 
into complete disarray. Our experience in 1999 in California, 
and more recently consumer experience in the Midwest, is that a 
5- to 10-percent reduction in supply can kick the spot price up 
50 to 100 percent. So this is a market in which volatility is 
increasingly a normal aspect of the marketplace.
    I think this has a number of critical implications. The 
first from my perspective is the necessity for aggressive, 
affirmative antitrust enforcement. That's what I do on a day-
to-day basis. I would certainly echo Attorney General 
Granholm's perspective that resources are critical to this 
process. I was personally involved in the ExxonMobil 
transaction in which, at least from a California perspective, a 
major refinery was spun off. So we did what we refer to in the 
business as a zero delta deal, which is--from the perspective 
of our markets, the competitive situation did not change.
    But in that particular transaction, we received and 
analyzed over 10,000 boxes of material. When you deal with 
these kinds of transactions, you're talking about huge amounts 
of material that must be analyzed and reviewed. So I think both 
State resources and Federal resources must be adequate.
    We are increasingly familiar with the importance of retail 
in the competitive picture for this industry. We think of the 
oil industry as going from Kuwait to Kansas to California. They 
are enormously large corporations, among the largest in the 
world. But one of the things that has happened, largely because 
of the existence of new computer technology, the ability to 
communicate by satellite link on a daily basis between 
individual retail stations to the home office and to a very 
small group of consultants, actually, that help set the retail 
price, what is increasingly happening is a process which is 
called ``retail-back pricing''--that is, prices are set based 
on what's happening in the marketplace at the local corner. 
It's not a question of prices being set by the price of crude 
with a markup. It is what the market makes possible in a local 
situation.
    That is affected in a very dramatic way by what's already 
been spoken to, and that is, zone pricing. In a situation in 
which we have retail-back pricing, the lack of independence in 
those zones means that prices will not fall. There will be much 
less competition than we would otherwise expect.
    One of the implications of that, at least one of the things 
that we believe we've observed in California markets, is what 
we refer to as ``a rockets and feathers pricing pattern''--that 
is, when there is a refinery outage, prices rocket up, but they 
do not fall at a similar speed. They rocket up and then feather 
back down. We believe one of the reasons for that, indeed 
perhaps the major reason, is a limited amount of retail 
competition. There aren't effective competitive forces at 
retail at the local level to push those prices down as quickly 
as they rose.
    As a professional prosecutor in this area, let me speak to 
what I think may be important limits to current antitrust 
jurisprudence in this arena, and this has been touched on 
earlier. Largely unbeknownst to the public at large, there has 
been a major sea change--starting with the Federal courts which 
is now working its way into the State courts as well--
increasing substantially the burden of proof for prosecutors in 
showing that there has been an agreement within the meaning of 
the antitrust laws. A generation ago, actually, 10 years ago, 
approximately, the Ninth Circuit decided, In Re Petroleum 
Products Antitrust Litigation, that allowed us to use 
substantially circumstantial evidence to prove up the existence 
of a conspiracy.
    Far more recently, actually, last year, the California 
Supreme Court in its Aguilar decision looked at facts that were 
very similar, frankly, when you really examined the two cases, 
and determined that there was insufficient evidence to 
determine the existence of a conspiracy.
    When you are dealing with highly concentrated, oligopolized 
industries, communications of a very limited sort can have 
enormous implications in terms of providing and facilitating 
coordination between ever more concentrated players in this 
marketplace.
    There may be some other implications which I would 
certainly like to surface for the Subcommittee. Because of 
California's insularity due to its physical location and its 
unique fuel blend, we are beginning to look seriously at the 
possibility of creating a State physical hedge, a strategic 
inventory of fuel which would allow us to begin to move fuels 
into the marketplace if there are small perturbations in the 
supplies from the refineries as a way of addressing these very 
volatile price spikes. Whether that makes sense on a national 
basis, we would certainly leave it to the Subcommittee and its 
expert consultants. However, I would certainly commend to the 
Subcommittee the consultant reports that I've supplied with my 
testimony.
    There is another competitive issue which you need to be 
aware of. This affects us very directly in California, but 
insofar as reformulated gasoline becomes much more a part of 
the national picture, the existence of certain key patents, may 
become critical. Unocal sat in on the regulatory meetings, knew 
what was the arc of development of our fuel blend. At the end 
of the process, it was discovered both by the other major oil 
companies and by regulators, to the chagrin of all, that Unocal 
had patented the key blending technology. So our clean fuels 
are now possibly subject to patent challenge.
    This has gone through a whole series of pieces of 
litigation, and the usual patent is itself being specifically 
re-examined by the U.S. Patent Office.
    As gasoline becomes much more technical in terms of meeting 
specific clean air goals, patent policy may become very 
important here. In California, as I said, one of the reasons 
that we think people are more reluctant than not to come into 
our market is because of ambiguities created by the Unocal 
patent and whether people will be exposed to patent litigation, 
licensing litigation, in the event that they bring fuels into 
our market.
    Let me mention two other supply points. There is in our 
market a key oxygenate, methyl tertiary butyl ether, MTBE. This 
constitutes roughly 11 percent of our supplies. We are in the 
process, because of clean water problems associated with MTBE, 
of removing MTBE from our gasoline blends while still meeting 
our clean air obligations. Indeed, as the Subcommittee is 
presumably aware, California sets the most stringent clean air 
requirements in the United States.
    We believe that there is no fundamental chemical or 
environmental reason why we need to include oxygenates in our 
fuel. Governor Davis has written to President Bush seeking a 
waiver so that we can meet clean air requirements. We're 
willing to meet any of the air standards, but we would like to 
meet that without the necessity of oxygenates. This could very 
well give us more flexibility to create a blend which would 
both meet clean air standards and not result in an 
extraordinary reduction in supplies. In this regard, the 11 
percent portion of our fuel stocks that MTBE represents would 
also be the equivalent of one major refinery in California. 
And, again, if we're in a situation in which a 5 or more 
percent perturbation in supplies could have a very outsized 
effect on price, this is a very big deal for us.
    Finally, I would certainly echo the points made earlier 
about conservation. California consumers are among the 
thriftiest in the Nation. We rank 44th in per capita gasoline 
consumption. That said, we think there are still enormous 
opportunities for reducing the need for gasoline both by 
increased support for rapid transit, and we think, without re-
arguing all the questions about fuel economy standards, that 
there are still enormous opportunities in the transportation 
sector itself.
    And with those points made, I'd certainly be prepared to 
answer questions from the Subcommittee. Thank you.
    Senator Levin. Thank you very much, Mr. Greene. Thank you 
all.
    One of our key findings is that in areas of high 
concentration, where fewer refiners control most of the retail 
sales, by keeping supplies tight refiners can raise the price 
of gasoline without great fear of competition. And since all 
the companies maintain minimal inventories, no company need 
fear that a competitor would gain market share by keeping their 
prices low, because that competitor would quickly run out of 
gas.
    We walked through with the industry representatives on 
Tuesday a number of documents that we believe demonstrated that 
effort to tighten supply. And I want to go through a few of 
those with you.
    One of the most troubling was a 1999 memo from BP which 
went through a laundry list of truly outrageous methods for 
keeping supplies of gas tight in the Midwest. The witness 
agreed that the proposals were outrageous, said BP rejected 
them, and, ``counseled'' the persons who prepared them.
    But that doesn't take away from a very key fact that the 
goal of the BP effort was to increase prices in the Midwest by 
1 to 3 cents by restricting supply.
    The top executives in BP were working to achieve that goal. 
Whether they rejected the particular methods or not is one 
issue but the goal they did not reject. Their goal was to 
increase prices by restricting supply, and they felt they could 
increase prices just by those means by 1 to 3 cents a gallon. 
And, again, 1 penny a gallon is $1 billion a year for the 
industry.
    Another memo from Marathon talked about OPEC's efforts, and 
here reading the words in this memo, OPEC's efforts to rein in 
output as ``bearing fruit.'' For our consumers in America, it 
is bitter fruit. But listen to what this Marathon memo says. 
``As OPEC and other exporters' efforts to rein in output began 
bearing fruit, nature stepped in to lend the oil producers a 
helping hand in the form of Hurricane Georges, which caused 
some major refinery closures, threatened offshore oil 
production and imports, and generally lent some bullishness to 
the oil futures market.'' And they acknowledge that was an 
incredibly awful way to describe a result of a hurricane. But 
that's the way it was viewed.
    And then we had a memo from a Texaco official talking about 
how Shell had told him that everyone was nervous because Texaco 
wasn't saying what it was going to do about importing CARB into 
California. The memo says that Shell threatened Texaco that if 
they did import CARB fuel into California, then Shell would 
lobby for a tax on that import.
    So now the Shell official--who now owns that portion of 
Texaco, by the way--disavowed that conduct, said it would not 
be tolerated in the company today. But that was the conduct: 
You do this, we're going to go and try to get a tax on your 
import.
    A Chevron memo, one the oil company did not disavow, said 
the following: ``Market is dominated by limited number of large 
committed refiner/marketers whose individual actions can have 
significant market impact.'' So this is just some of a lot of 
evidence of showing that they are aware of the fact that by 
limiting supply in a highly concentrated market, that they can 
basically succeed to raise prices.
    Now, I have two questions. One, does that surprise you, 
what I just read? And, second, would you forward to this 
Subcommittee any material that is not in that report, if you 
have had a chance to read it, which also shows in your States 
the evidence of the oil companies' restricting supply because 
of the ability in that situation, particularly in concentrated 
markets, to have a direct impact on price? So let me start with 
you, if I could, General Blumenthal.
    Mr. Blumenthal. Thank you, Senator. To answer your second 
question first, I would be happy to forward any documents now 
in our possession or that we acquire in the future that show, 
as these very powerfully do, an intent or a desire to exploit 
tight supplies for purposes of raising prices and ultimately 
raising profits, and prices, as Senator Collins and the report 
indicated, have a very direct and immediate impact on profits 
because every 10-cent increase in prices produces on an annual 
basis $10 billion in additional revenues.
    Of course, all of these documents were merely for the 
purposes of brainstorming, I'm sure, as the industry has 
indicated. I am actually, to be very serious, not so sure that 
they were simply to consider illegal action and then reject 
them, as the industry has also said. I think they are very 
solid evidence that call for changes in the burden of proof, in 
evidentiary standards, that make these kinds of cases easier to 
detect, investigate, and prove.
    There are two areas that need improvement: One, as Attorney 
General Granholm has very well said, more resources so that 
prosecutors have the wherewithal to prosecute these cases; and 
the other is the standards of proof and evidence that enable 
them to deal with the much more sophisticated, technologically 
advanced means of communication. We don't have the smoke-filled 
rooms. We don't have the handwritten notes. We often lack 
cooperating witnesses in these cases. But the kinds of evidence 
that should and would be admissible under the proposals made 
this morning I think would enable more effective prosecution.
    And, finally, I would say that these documents show also 
that this industry as a whole needs to move in the direction of 
more independence, more independent owners and operators and 
refiners. It needs more unintegrated patterns of dealing, and 
it needs more unbranded products. Independence, unintegrated 
patterns of dealing, and unbranded products all will help to 
open this industry to more competition.
    Senator Levin. Thank you, General Blumenthal. General 
Granholm.
    Ms. Granholm. Yes, the euphemism of ``bearing fruit'' you 
were lucky to find in a document, but I think this speaks 
exactly why we do have to change the burden of proof. This is 
basic economics. It's supply and demand--wink, wink. You know, 
we tighten the supply, the price goes up. I don't even know you 
need a document to tell you that. Anybody who's in this 
industry knows that.
    It was just interesting that you were able to find smoking 
guns that revealed their knowledge of what they were doing. But 
we've got cases that have been tossed out because--on this 
notion of tacit collusion, where you've had a lot more--you've 
had joint price communications between firms, including 
meetings. You've had price verification calls, price changes 
between competitors, and the Eighth Circuit threw that out. So 
it wasn't enough.
    Some courts are requiring too many factors to be able to 
determine that this kind of collusion is going on. But, the 
reality is I don't even think you need to have evidence of--
it's almost a basic textbook on economics that would 
demonstrate that they know very well when you turn off the 
spigot, the price is going to go up.
    So, yes, if we have any documents that would reflect this, 
I would be thrilled to forward them on to you. But I think that 
this does call for a shifting of the burden of proof or of the 
standards that courts might look at in order to determine 
whether collusion has occurred.
    Senator Levin. Thank you. Mr. Greene.
    Mr. Greene. Senator, I would certainly agree. The documents 
that relate to CARB certainly are part of the Aguilar 
litigation, which was the case that I was referring to earlier 
that was decided against the plaintiffs because they had 
insufficient evidence. I think these documents are really quite 
remarkable.
    But currently, with the Federal courts leading the way, the 
burden of proof has gone up quite dramatically. They also 
illustrate, I think, really a key point of your hearing today 
as well. In a fully competitive market, if this were a grain 
market or this were some other more ordinary market, if 
somebody were to withhold supply from the marketplace, they 
would be unable to sustain that and sustain an increase in 
price because other marketers would come into that gap and fill 
it.
    We are in a situation now in which concentration has 
reached the point where it's both in the interest of an 
individual company to withhold supplies from the marketplace 
and others will not step in. Now, that may be a consequence of 
oligopolistic coordination. It's sort of the classic sort of 
perspective here, but we have reached the point where that 
certainly is theoretically possible, and we now have direct 
evidence that 's exactly what's going on.
    Senator Levin. Let me ask you about exchange agreements. I 
know you have had experience in California with that, and I 
don't know if other States have or not. But we have several oil 
company documents. Here is one from BP-ARCO. It reads: 
``Exchange in trade selectively to preserve market 
discipline.'' That is a direction from a BP-ARCO executive. 
Then it says at another point in that document, ``From time to 
time, ARCO may need to endure brush fires to discipline the 
market.''
    The particular witness did not know what was meant by that. 
He said it occurred before his time, so that was his answer.
    One way to discipline the market, I guess, would be to buy 
up a competitor's product--in the case of a product that was 
being sold in California--that is selling at a price lower than 
yours, and then reselling it at a higher price. Mobil 
apparently did that in California with respect to the Powerine 
refinery. There is an internal memo from Mobil, which you 
probably have, or you may have had, that is talking about the 
Powerine refinery and the threat that it poses to Mobil, and 
here is what it suggests: ``One other thought. If they do start 
up''--that is, if Powerine does start up--``depending on 
circumstances, might be worth buying out their production and 
marketing it ourselves, especially if they start to market 
below our incremental cost of production.'' And then it goes on 
to say that Mobil already did that. ``Last year,'' it said, 
``they were dumping RFG at below cost of MTBE, we purchased all 
their avails, marketed it ourselves, which I believe was a 
major reason that the RFG premium last year went from 1 cent 
per gallon in January to 3 to 5 cents per gallon through to 
their shutdown.''
    In other words, Mobil accomplished--at least the year 
before what it wanted to--by buying out the Powerine product, 
selling it at a higher price, and then increased the premium 
for all of the RFG several cents a gallon by doing that.
    Is that a document which you are familiar with, by the way?
    Mr. Greene. Yes, certainly.
    Senator Levin. OK. Now, apparently--was that one of the 
issues that was debated or litigated?
    Mr. Greene. These documents came to public light through 
the discovery process in the Aguilar case. We were actually 
amicus curiae, the Attorney General was amicus curiae in that 
case. But just from the analytics from an antitrust 
perspective, if an individual company does things on its own, 
that is, buys fuel and then resells it, that's an individual 
activity.
    Senator Levin. Sure.
    Mr. Greene. So we don't have that key agreement or 
conspiracy that Senator Wyden was speaking to. And it is also 
the case that doctrinally the monopolization statutes typically 
now require a very large market share, for example, 75-plus 
percent of a relevant market. But it may be the case that we 
need to look back at actual market power.
    One of the real implications of these documents is that 
everybody in these marketplaces has market power. They all have 
the ability to increase the price in the marketplace based on 
the individual steps that they take.
    Senator Levin. Right. Well, I want to get to that point, 
though. When you say we should look at it, a problem is that 
even though this is the activity that they engaged in and were 
able to raise prices 3 to 5 cents, acting on their own, without 
collusion, as it is currently defined, that may not be or 
apparently isn't illegal under the current definition in the 
statute of collusion.
    The question I would like to ask you, and perhaps the 
others, if they want, is: Shouldn't that be illegal? You said 
``considered.'' I mean, it is pretty glaring here what went on, 
to be able to say I am going to buy up my competitor's product, 
and as a result raise the price 3 to 5 cents. If you have that 
kind of market power, if it is that kind of concentrated 
oligopoly that you have got in that market, should we not say, 
as Senator Wyden was suggesting, in terms of change the 
definition of collusion or broaden it, shouldn't that be one 
area where we ought to look seriously at broadening the 
definition of an anti-competitive practice? General Granholm.
    Ms. Granholm. To me, this goes to the question of using an 
objective standard rather than having to rely on documents like 
this. If you could make this judgment based upon the HHI index 
as sort of just a pure objective factor, then you could 
determine whether or not that is legal or not. Do you stop a 
merger when somebody arrives at a tipping point in the industry 
based upon objective factors? Because, otherwise, if you are 
relying on the subjective stuff, what is very sophisticated 
language--I mean, this is a little more obvious than what we 
would normally find. But, they wouldn't put it in writing. They 
would have it in a verbal meeting or something. Everybody knows 
what's going on. To have to rely on that is a little more 
difficult proof-wise, which is why I think an objective 
standard would be easier.
    Senator Levin. What you are then saying is that we should 
make it a presumption that----
    Ms. Granholm. Yes.
    Senator Levin [continuing]. You will not approve mergers in 
markets that are highly concentrated by some objective 
measures, and I guess there are objective measures----
    Ms. Granholm. The Herfindahl--what is it?
    Senator Levin. The HHI measure, right.
    Ms. Granholm. The Herfindahl-Hirschman Index would----
    Senator Levin. We call it ``HHI'' around here because we 
can't pronounce it.
    Ms. Granholm. HHI is much easier, yes.
    That 1,800 threshold I think is a very basic and fair way 
of looking at it.
    Senator Levin. OK.
    Mr. Blumenthal. I would add on the issue of merger 
approval, not only suggesting a moratorium but also that 
consumer benefit ought to be an essential ingredient or element 
of showing to justify a merger to the FTC or to the Department 
of Justice as a part of the standard for approval.
    I think this kind of practice, and from what I know about 
it, clearly an anti-competitive practice, a practice with an 
anti-competitive effect, ought to be at the very least 
admissible as evidence of an antitrust violation. And that goes 
to the suggestion that you and Senator Wyden have made as to 
what kind of facts and documents and practices ought to be 
admissible, especially in a highly concentrated market, and in 
a highly concentrated market ought to be perhaps regarded as 
proof of an antitrust violation if otherwise substantiated.
    But I would add that part of the perspective in the 
courtroom and in the court of public opinion ought to be what 
the effects as well as the purposes are, because the effects of 
many of these industry practices have been simply to maintain 
market share, not to compete, not even to gain market share. 
The Subcommittee report is very pointed and persuasive on this 
point, that this industry is very unusual insofar as a lot of 
its motive is to maintain market share, which perhaps is 
typical of an oligopoly, but especially so in this one--and, 
again, also maintaining shortages of supply. Ordinarily, higher 
sales produce more revenue and more profits. In this industry, 
the goal is to keep supplies tight and squeeze inventory so as 
to retain control and increase profit.
    So I think that this kind of document and this kind of 
practice are very pertinent to the laws that exist now, but 
ought to be made part of proof in court.
    Senator Levin. I want to talk about parallel pricing 
because it really fits in exactly with what we have been 
talking about and what you just testified to. In Michigan, we 
have a phenomenon that I think exists in a few other States, 
and it is what I call ``Speedway bumps.'' Not speed bumps but 
Speedway bumps. And as you can see from the chart \1\ and as 
has been referred to already, prices spike up on Wednesday or 
Thursday. You can see those spikes in greater detail on the 
chart on the right, and in smaller bumps going up on the chart 
on the left. The smaller peaks going up to the big spike on the 
left are what I refer to as ``Speedway bumps.''
---------------------------------------------------------------------------
    \1\ See Exhibit No. 11 and 12 which appear in the Appendix on pages 
260 and 261.
---------------------------------------------------------------------------
    They drift back down at the end of the weekend, and when 
you look at it more closely, 1 month at a time, Speedway is 
running up the price and then it is followed by other brands. 
And then the next Wednesday and Thursday, the same thing 
happens. So Speedway is the price leader in Michigan. It has 
this pattern of weekly mini-spikes. And I am just wondering 
here--General Granholm, let me ask you about that. We asked 
Marathon about this, and here is what their reaction was a 
couple days ago: ``Our pricing policy is every day. We look at 
our costs. We look at our sales. We look at how competitors are 
pricing, and we elect to always match the lowest price on the 
street. And then there comes a time when our costs have 
increased that we elect to raise''--``when our costs 
increase''--like every Wednesday and Thursday, I guess, our 
costs increase--``we elect to raise the retail price to try to 
recover some of our costs. Every day''--and he repeats the 
``every day'' part. ``I hope it's not predictable,'' he says, 
``because we look at our prices every day.''
    What is your reaction to that?
    Ms. Granholm. I tell you, you ask any person in Michigan 
and you know very well what happens. Everywhere I go, people 
say, how about that? Everybody fills up on Wednesday because 
you know on Thursday the price is going up. They hold off on 
filling up until Monday so that they can get a better deal. It 
is like clockwork. I cannot believe he would say, I hope it is 
not predictable, because it certainly is.
    They are the leader because they are the ones that have the 
most market share and they are the ones from whom the 
independents are buying the gas. So they can lead the rise of 
the gas to perhaps a place where they are comfortably able to 
make a profit, and then on Monday, they shoot it right back 
down and the independents have difficulty even meeting that 
because sometimes they are below even the price that they would 
be charging the independents. So the independents are finding 
it very difficult to compete because they have to compete with 
their main competitor on the wholesale level buying from them. 
That is the difficulty of this vertical integration.
    Senator Levin. Now a question for each of you. There is 
another pricing practice that is discussed in our report where 
lessee branded dealers enter the long-term contracts with oil 
companies, and under those contracts, the oil companies set 
what is called a dealer tank wagon price, or DTW price, and 
there is not much that the lessee dealer can do about it. As a 
matter of fact, I think under those leases, they are required 
to pay the price that is set by the oil company.
    Under the antitrust law, the oil company, though, cannot 
set the retail price that dealer can charge. Several oil 
companies, however, acknowledged when we talked to them that 
they do provide lessee dealers with a recommended price for the 
retail price. What they charge the dealer is unilateral. They 
do not admit that, but there is a lot of evidence that even the 
leases themselves say you must pay the price, if you are a 
lessee, the price that we charge you. But when it comes to what 
you, the dealer, charge, we recommend a price to you, but by 
law, you have the right to set that price.
    We have heard now from several dealers the following. They 
believe the oil companies enforce recommended prices through 
their dealer tank wagon prices. They do that, these dealers 
say, as follows. If the dealer charges a price that is higher 
than the recommended price, the oil company will capture that 
increase with a commensurate increase in the next dealer tank 
wagon price.
    Have any of you heard those kind of allegations from 
dealers, that, yes, in theory, I set the price, but because I 
have to pay that wholesale price by my lease--I have no option 
on that--heck, if I change the price, raise it, for instance, 2 
cents, the company will capture that 2 cents in the next DTW 
price that they charge me? Is that something familiar to you? 
General Blumenthal.
    Mr. Blumenthal. Yes, it is, Senator. That practice is one 
of a slew of practices that the big oil companies use, in 
effect, to control and manipulate the prices and markets in the 
zones they establish. It complements the zone pricing practices 
that are imposed in States across the country. Those practices 
are documented in this report and so are the motives for them 
in the MPSI study that is referenced.
    But one problem here is, and I will be very blunt to you, 
Senator, what we find, at least what I find is that many of the 
owners, the franchisees, that is, are very reluctant to come 
forward because they are very fearful of retaliation, again, 
another reason for making these cases easier to prove. The 
degree of fear, that is, the fear factor simply cannot be 
overemphasized, and so, no doubt, your staff and you have heard 
about many of these kinds of abuses, but proving them in court 
through witnesses who are willing and sufficiently courageous 
and brave to help us is another challenge.
    Senator Levin. Do either of the two of you have a comment 
on that?
    Mr. Greene. I think you are describing, Senator, a very 
common practice in the industry. One of the sad realities, I 
think, for lessee dealers is they are increasingly in a form of 
indentured servitude. It is a problem that they are squeezed by 
their leases, they are squeezed by the DTW. Much of their 
historic independence has been lost. This DTW-lease combination 
is the way the zone pricing system is actually enforced and 
works. It is through these DTW price sets that you get 
differences between down the block, down the street. So these 
are absolutely key mechanisms for controlling price at the 
retail level. That is certainly true.
    Senator Levin. Thank you. I have just a couple more 
questions for you. One has to do with parallel pricing, which 
we have talked about, where companies stay in the same fixed 
price relationship with each other, going up and down. 
Currently, that is not a violation of the antitrust laws unless 
you can prove that there is an agreement or conspiracy, some 
kind of explicit collusion between the two.
    This is one example. Where prices are in a fixed 
relationship with each other and go up and down these peaks 
together, the question is whether or not we should amend the 
antitrust laws to make that at least either presumptively anti-
competitive or, at a minimum, evidence of an anti-competitive 
practice, which can go to the jury. Now, I believe that one of 
you has testified already on that, and I think it was you, 
General Blumenthal.
    Mr. Blumenthal. Yes, sir.
    Senator Levin. That you have already said that should be 
enough evidence to get you to a jury.
    Mr. Blumenthal. In a highly concentrated market, certainly, 
it should go to a jury and it should enable the case to go to a 
jury.
    Senator Levin. And I think that is a very important point 
that I should restate, that we are talking about in the highly 
concentrated markets when we talk about changing the antitrust 
laws or making mergers presumptively not going to be approved 
by the FTC in highly concentrated markets.
    General Granholm, do you have a comment on the parallel 
pricing question?
    Ms. Granholm. Just so that we are very clear about what the 
court has done, as we currently speak, the quote from the most 
recent court who decided this said tacit collusion, sometimes 
called oligopolistic price coordination or conscious 
parallelism, describes the process, not in itself unlawful, by 
which firms in a concentrated market might, in effect, share 
monopoly power, setting their prices at profit maximizing 
supra-competitive levels by recognizing their shared economic 
interests and their interdependence with respect to price and 
output decisions. It is well established that where a market is 
dominated by a few major players, parallel pricing is not 
uncommon and is generally insufficient to prove an antitrust 
conspiracy. So that mindset has got to be changed.
    Senator Levin. OK, thank you. Did you want to add anything, 
Mr. Greene?
    Mr. Greene. I think you do need to look at this very 
closely. If you were to take a look at the In Re Petroleum 
Products Litigation decision in the Ninth Circuit of 1990, one 
of the key points there was the existence of a sawtooth 
pattern, much like the first one you saw with the retail 
station. That was a key piece of evidence.
    Under current law, that might not even survive summary 
judgment.
    So I think, at the end of the day, I personally would feel 
more comfortable with evidence of parallel pricing plus, but at 
this point, that combination is probably not enough to get you 
to a jury and I think that is a wholly appropriate result, and 
insofar as the Subcommittee could suggest legislation that 
would get us there, that would be very helpful.
    Senator Levin. And the position that you favor would be 
that evidence of parallel pricing would be either enough to get 
to the jury, get you past summary judgment, or precisely what 
is your position?
    Mr. Greene. I think that it should be parallel pricing 
plus.
    Senator Levin. Plus what?
    Mr. Greene. Plus communication patterns. There is a whole 
body of law that existed circa 1990, 1989, in which, basically, 
parallel pricing plus not a whole lot more would get you to the 
jury. I think that is, at the very least, where we should be in 
this concentrated industry.
    Senator Levin. But short of the explicit concerted 
agreement? When you say plus----
    Mr. Greene. It is a way of inferring the existence of an 
agreement.
    Senator Levin. I have got you.
    Ms. Granholm. The only problem with having an agreement is 
you do not need one. It is out there on the corner. I mean, who 
needs to talk to anybody when the price is up posted per gallon 
on every street corner? So the plus part of it is what is hard 
to get at when it is open and notorious.
    Mr. Blumenthal. And I would simply add that a jury should 
be permitted to infer an agreement, in this case an illegal 
agreement, from those factors, including conscious parallelism 
and parallel pricing, and these kinds of patterns are so 
dramatic, to use the old expression, a picture is worth a 
thousand words, this kind of picture should go to a jury and 
evidence of signaling or the opportunity to communicate and 
other kinds of implicit or tacit communication should be part 
of that case, as well.
    Senator Levin. I am just trying to get the exhibit number 
there so we can put in the record what the picture is that you 
are referring to. That is Exhibit 10.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 10 which appears in the Appendix on page 259.
---------------------------------------------------------------------------
    This is the response of the representative who was here 
from ChevronTexaco when the parallel pricing issue was put to 
him. ``I happen to think that the reflection of a reasonably 
stable relationship of prices is actually an indication that 
the market is working exactly as it should.'' He was shown the 
same picture. ``The fact that market prices are going up and 
going down and that individual companies are in relative 
position not changing quite often, is, in fact, an indication 
to me that the market is working.'' Do you have any comment on 
that comment? Let me start with you, perhaps, Mr. Greene.
    Mr. Greene. Generally, the economics of this are that if it 
was an unconcentrated market, again, think of a grain market, 
prices will converge on a particular price. But it is not the 
case, typically, that each of the players stays in an 
individual position vis-a-vis the other players. I think that 
is a pattern much more closely associated with a concentrated 
market, which is what you are dealing with here.
    Senator Levin. Thank you.
    Ms. Granholm. I think, in general, players do see what the 
others are doing and they respond accordingly. That is the 
market. But I do think this issue of concentration is really 
the best place to start to prevent that, because I think that 
is really much easier to get at than this issue of parallel 
pricing, because that is a symptom.
    Mr. Blumenthal. I agree, to emphasize the importance here 
of market concentration in this industry, and also to, just as 
a footnote, to say that zone pricing, as the Subcommittee 
report shows, actually produces disparities, in my view, 
artificial disparities, in very closely located areas with no 
competitive or economic rationale.
    Senator Levin. I just have one more question, but on this 
particular subject, let me just say this, that where you 
already have a concentrated market, it seems to me the question 
of parallel pricing becomes more than a symptom. It becomes 
something which may be one of the problems that you can get at 
if you make it presumptively an anti-competitive act, because 
you already have the concentration. Your alternatives, then, 
are, I guess, either to break up the concentration, which is 
mighty complicated, or to go at some of those symptoms and to 
try to address the symptoms.
    I happen to agree with you. It is better to try to avoid 
the problem by preventing the mergers and the concentrated 
market, or that would create a concentrated market to begin 
with, but that is not the situation that we have now in half 
our States. We are already there, so we have to deal, I am 
afraid, with symptoms, and one of the issues we will face as to 
whether or not the parallel pricing symptom should be one that 
is addressed, even though it does not get to the underlying 
problem.
    One other symptom, and then we are going to let you go, and 
you have addressed this, I believe, Mr. Greene, and that is the 
question of whether we should mandate or let States mandate 
increased inventories. I believe you said that you are 
considering in California mandating a higher inventory level, 
which really is a critical part of this problem. If I heard you 
correctly--is that right, that you are thinking about doing 
that?
    Mr. Greene. That is certainly correct. The Attorney General 
recommended that we look, that the legislature and our expert 
energy agencies look very closely at this as a possibility. Our 
inventories are now so low that, literally, if a refinery 
coughs, we are in a price spike situation.
    So in my prepared materials, there is a very substantial 
report from one of our consultants explaining how that might 
work. Now, we are, as I mentioned, a very isolated market, so 
this may or may not be something that the Nation as a whole may 
want to look at. I would note, though, that our European 
partners, all of whom have these kinds of structures to deal 
with pricing problems.
    So I think it is something that may not be right for the 
Nation, but we are certainly looking at it in our market in 
California.
    Senator Levin. General Granholm, do you have any comment on 
that?
    Ms. Granholm. I think it is something worth looking at.
    Senator Levin. OK. Thank you.
    Mr. Blumenthal. I think it is worth considering, Senator. 
It has potential disadvantages in costs and difficulty to 
manage. That is, a regional or, in California's case, a State 
reserve might be very expensive and very problematic as a 
management challenge.
    But I do think at the Federal level, there should be much 
stronger oversight and perhaps inventories that are mandated, 
and I think there are other ways, even at the State level, to 
intervene in these situations. We had just a week ago the 
announcement from one of our major companies, Motiva, that it 
is closing a 200,000 barrel terminal facility, and it is not 
closing it and selling it, it is mothballing it. So that 
storage capacity is removed from our State inventory and, 
presumably, from the supply available to consumers at a time 
when, obviously, in the summer months, demand is going to 
increase. I think providing the legal means for some kind of 
intervention in that situation would be very welcome in a lot 
of States, but I do think that inventories perhaps are a 
Federal task.
    Senator Levin. Thank you. You have been a terrific panel. 
We thank you all and appreciate your testimony.
    Ms. Granholm. Thank you very much.
    Mr. Blumenthal. Thank you, Mr. Chairman.
    Mr. Greene. Thank you.
    Senator Levin. Let me now introduce our third panel of 
witnesses. First, Peter Ashton, who is President of Innovation 
and Information Consultants; next, Dr. Justine Hastings, 
Assistant Professor of Economics at Dartmouth; Dr. R. Preston 
McAfee, who is the Murray Johnson Professor of Economics at the 
University of Texas; and then Dr. Philip Verleger, President of 
PK Verleger, LLC.
    Let me first swear you all in, as is required by our rules. 
I would ask you just to stand and raise your right hands.
    Do you swear that the testimony that you will give before 
this Subcommittee this morning will be the truth, the whole 
truth, and nothing but the truth, so help you, God?
    Mr. Ashton. I do.
    Ms. Hastings. I do.
    Mr. McAfee. I do.
    Mr. Verleger. I do.
    Senator Levin. We have a panel of academics, experts this 
morning to discuss price volatility, to discuss mergers 
approved by the FTC, and a number of other topics that we have 
discussed both Tuesday and this morning. We would ask you, 
given the hour, if you could keep your oral remarks to 10 
minutes or less and we will make sure your printed testimony is 
entirely in the record.
    Let me just go alphabetically here. Mr. Ashton.

  TESTIMONY OF PETER K. ASHTON,\1\ PRESIDENT, INNOVATION AND 
        INFORMATION CONSULTANTS, CONCORD, MASSACHUSETTS

    Mr. Ashton. Good morning, Mr. Chairman, and thank you. It 
is certainly a pleasure to be here to discuss issues related to 
gasoline pricing.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Ashton with attachments appear in 
the Appendix on page 204.
---------------------------------------------------------------------------
    As you indicated, my name is Peter Ashton. I am the 
President of Innovation and Information Consultants, an 
economic and financial consulting firm, and over the last 20 
years, I have had the opportunity to act as a consultant to 
various States, the Federal Government, and also different 
firms in the industry with regard to gasoline and oil pricing 
issues.
    My comments, very briefly this morning, will relate to four 
issues. First, I will talk about trends in market concentration 
due to mergers in the refining and marketing industry. Second, 
I will address recent episodes of price spikes, particularly in 
the Midwestern region of the country. Third, I have a couple of 
brief comments to make about your staff's excellent report. I 
guess I am telegraphing what I am going to say. And fourth, I 
have a few suggestions and a couple of additional thoughts 
based on what I have heard this morning in terms of potential 
policy recommendations.
    Let me first start by talking about recent trends in terms 
of merger activity. As you are aware, in the last 5 years, the 
domestic refining and marketing industry has witnessed a wave 
of mergers not unlike what was observed during the early 
1980's. During that time frame, several larger mergers in the 
industry were approved by the Federal Trade Commission, and in 
a report it issued in 1989, the Federal Trade Commission 
commented at that time that those mergers had led only to 
modest increases in concentration and that such increases 
stemmed as much from closure of independent, inefficient 
refineries as it had from the mergers themselves. The recent 
wave of mergers, however, has led to, I think, a fairly 
different conclusion in terms of having a much more significant 
impact on market concentration.
    I do not need to go into and belabor what an HHI is. You 
have certainly used that term and understand it. I have looked 
at HHIs for both refining capacity as a whole and also just for 
gasoline manufacturing capacity and there have been fairly 
significant increases, really throughout the country, but 
particularly in certain markets, such as the East Coast, what I 
have termed and what the FTC has defined as a relevant market 
as the Upper Midwest, which includes Indiana, Illinois, 
Kentucky, Ohio, and Michigan. There, for example, the HHI in 
both refining capacity and particularly gasoline manufacturing 
capacity is now over 1,800, which signifies a highly 
concentrated market.
    And in California, which I have also spent time looking at, 
due in part to its unique gasoline specifications and its 
location, is a relatively isolated market. Here, the HHI for 
gasoline production has risen from about 1,300 5 years ago now 
to close to 1,800.
    Concentration has also increased at the wholesale level. 
This level of the market, in my opinion, is critical to 
understanding pricing and supply, as it is the link between 
refinery production and the consumer. In my experience, this is 
often the point at which the greatest control over supply may 
be exerted, where significant interdependence exists, and also 
often where regulatory authorities fail to adequately examine 
competitive impacts.
    Finally, at the retail level, today, over 65 percent of all 
retail sales now occur through branded stations, whereas only 5 
years ago, that number was less than 45 percent, according to 
DOE statistics. In some areas of the country, such as 
California, independent marketers have virtually disappeared. I 
would note that considerable research over the years, including 
by my colleague next to me, has demonstrated the competitive 
importance of maintaining a viable independent segment of the 
retail market.
    Let me turn now to the reasons that I see for the increased 
gas price volatility over the last 2 years, particularly in the 
Midwest. One naturally thinks of the cost of crude oil as 
having a significant impact when the price at the pump goes up. 
Indeed, crude oil represents about 75 percent of the cost of 
making a barrel of gasoline. However, in my opinion, crude oil 
price increases were not the cause of the price spikes in the 
late spring of 2000 or during the spring and summer of 2001, 
and that is shown in two of the figures that I have presented 
as part of my testimony, Figures 1 and 2.\1\
---------------------------------------------------------------------------
    \1\ Figures 1 and 2 which is attached to Mr. Ashton's prepared 
statement appears in the Appendix on page 213.
---------------------------------------------------------------------------
    Other possible explanations for the increase in gasoline 
prices could include supply curtailments, either caused by a 
reduction in inventories or production, or surges in demand. 
Data on consumption reveal no unexpected surges in demand that 
could explain either of the first two price increases. However, 
demand did increase fairly significantly in the summer months 
preceding the so-called Labor Day price spike of 2001 and may 
have been partially responsible for the price increase.
    Production did not decline in any meaningful way in the 
periods leading up to and including the first two price spikes. 
Supply disruptions due to refinery outages do not appear to be 
a plausible explanation for the magnitude of the price spikes 
that we observed. During the third price spike, there was a 
nationwide decline in production, although not in the Midwest, 
but this does appear to have had some impact on prices.
    Inventories, however, present a more interesting picture. 
First, it is important to understand that the absolute level of 
gasoline inventories relative to consumption has fallen 
significantly in recent years. Refining and marketing companies 
made a conscious decision in the mid-1990's to carry lower 
inventories of refined products, including gasoline. Such just-
in-time inventories were rationalized as a cost cutting 
measure, but they appear to have led to greater price 
volatility, as well. The reduction in inventory levels is 
illustrated in Figure 3 \2\ to my written testimony, where the 
average carrying level has now been reduced from about 30 days' 
supply to less than 24 days' supply.
---------------------------------------------------------------------------
    \1\ Figure 3 which is attached to Mr. Ashton's prepared statement 
appears in the Appendix on page 214.
---------------------------------------------------------------------------
    As a result, the difference between the average level of 
inventories maintained and the minimum operating inventory 
level has shrunk, so that now even brief supply disruptions can 
cause major problems. This reduction in inventories means that 
small changes in gasoline supply can result in very large 
changes in prices, and is in my opinion the most likely reason 
for the increase in price volatility in recent years.
    Examination, for example, of inventories immediately 
preceding the first two price spikes in the Midwest indicates 
lower than normal levels, although not necessarily of the 
magnitude to cause such a huge spike in prices. And it is 
important to note that in each case, inventories return to 
relatively normal seasonal levels within about 2 weeks after 
the start of the price spike, and this is shown in Figure 4 \1\ 
to my written testimony.
---------------------------------------------------------------------------
    \2\ Figure 4 which is attached to Mr. Ashton's prepared statement 
appears in the Appendix on page 214.
---------------------------------------------------------------------------
    During the June 2000 price spike, for example, the surge in 
wholesale and retail prices began the last week in May, when 
inventories were at abnormally low levels. Within 2 weeks, 
however, inventory levels were back to normal, yet gasoline 
prices continued to rise for the next 2 to 3 weeks, on the 
order of 15 cents per gallon in the Midwest.
    With each of the two succeeding price spikes in the Midwest 
in the spring of 2000 and late summer 2001, much of the same 
story played out. The August 2000 price increase, as I already 
alluded to, is somewhat more puzzling as there appears to have 
been not the reduction in inventory as much as a nationwide 
increase in demand, as well as reduction in production. This 
does not, however, explain the fact that Midwest prices 
appeared to rise considerably more than in other parts of the 
country.
    I have also done some statistical analysis of the 
relationship between changes in gasoline prices over the years 
and various other economic factors that could explain those 
prices, such as changes in crude oil prices, inventory levels, 
production, capacity utilization, and the like. I have found 
that in normal, relatively stable times, crude oil price 
changes, along with changes in inventory and production levels, 
do explain a significant portion of the change in gasoline 
prices.
    But changes in crude oil prices and these other factors do 
not explain the price spikes observed in the Midwest, and also 
to a large extent on the West Coast, in the last 2 years, even 
accounting for possible lags. I have also found in my 
statistical analysis that beginning in approximately 1998, a 
measure of market concentration has become a more significant 
statistically explanatory variable for those changes in 
gasoline prices, not necessarily a large magnitude of the 
change, but it has become a statistically significant factor.
    Let me turn briefly to comments on the staff's report. I 
have had the opportunity to review the Majority staff's report 
and I share many of the same conclusions as contained in that 
report. It is a highly professional piece of analysis and 
points quite correctly, I believe, to the tightening of the 
supply-demand balance, as well as increases in concentration, 
as ways in which supply can be affected and which, given 
inelastic product demand, has allowed gas prices to rise 
significantly at certain times.
    Staff's conclusions, importantly, are based on a 10-month 
investigation that included interviews with industry officials, 
trade associations, and others, as well as review of internal 
company documents. It is, in my experience, rare when one is 
able to catch a glimpse of the workings of an industry in this 
way, and staff's analysis is more compelling to me as a result.
    In light of these findings, let me talk just briefly about 
possible measures to deter future price volatility. First, I do 
believe that the FTC must be more vigilant in its merger 
review, focusing more closely on competitive impacts, 
particularly at the wholesale level, and encouraging, where 
possible, the competitiveness of independent marketers and 
refiners.
    Second, due to the fact that many markets are already 
highly or moderately concentrated, the FTC, as well as other 
regulatory authorities, including FERC, should take a tougher 
stand on various practices and behavior that might be conducive 
to price fixing or price signaling.
    Third, and I think we heard this recommendation earlier, I 
think resources should be added to the enforcement agencies, 
particularly the FTC in terms of its merger oversight, and it 
should tend to view these mergers not in isolation but together 
with other changes going on in various markets.
    Fourth, I would recommend investigation of measures to 
encourage greater supply flexibility. This would include, among 
other things, increasing the role of unbranded competition, 
greater consistency in regulatory policies, especially as it 
relates to gasoline specifications, and other ways to increase 
the general absolute levels of product inventories.
    And in that vein, and I heard the suggestion from Mr. 
Greene of California, I am intrigued and would at least suggest 
that a study of some kind of maintenance of minimum inventory 
levels, or perhaps even a reserve. I think that might be a very 
interesting option.
    Finally, I have also heard this morning, I think, some 
interesting suggestions about changes to both the antitrust 
laws as well as potentially enforcement. A couple of those 
cases that I have heard mentioned in the discussion earlier 
this morning were ones that I was involved with and I certainly 
think that some of those moves should be considered.
    That concludes my remarks, Mr. Chairman. I certainly 
appreciate being here and I would be happy to try to answer any 
questions.
    Senator Levin. Thank you very much, Mr. Ashton. Dr. 
Hastings.

  TESTIMONY OF JUSTINE S. HASTINGS,\1\ ASSISTANT PROFESSOR OF 
      ECONOMICS, DARTMOUTH COLLEGE, HANOVER, NEW HAMPSHIRE

    Ms. Hastings. Thank you. Mr. Chairman, my name is Justine 
Hastings and I am an Assistant Professor of Economics at 
Dartmouth. I received my Ph.D. in economics from UC-Berkeley.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Hastings appears in the Appendix 
on page 215.
---------------------------------------------------------------------------
    My research focuses on the effects of vertical 
relationships between refiners and retailers on retail and 
wholesale gasoline prices. I have analyzed extensive data on 
gasoline market structure for a diverse group of U.S. 
metropolitan areas covering the 1990's. I have used this data 
to conduct independent academic research into the relationships 
between vertical market structure and competition in gasoline 
refining and marketing. My independent research and my acquired 
knowledge of the industry form the basis of my testimony before 
the Subcommittee today.
    I will now summarize the results of two of my research 
papers and discuss their possible implications for government 
policy. Both analyses use changes in vertical integration 
generated by mergers to identify their main results.
    The first study, entitled ``Vertical Relationships and 
Competition in Retail Gasoline Markets,'' finds that 
independent retailers are uniquely important for retail price 
competition. This paper uses detailed station-level data for 
Southern California, coupled with the 1997 purchase of the 
independent retail chain Thrifty by ARCO to show that the loss 
of independence contributes to higher retail prices.
    Specifically, the analysis concludes that retail prices in 
markets affected by the acquisition increased, on average, 5 
cents a gallon relative to unaffected markets. When 
independents exit and are replaced by integrated branded 
competitors, competition in the market is softened and prices 
increase. What matters for competition is whether there are 
independent, unbranded retailers, not what types of contracts 
integrated refiners have with their stations.
    The second paper is entitled, ``Vertical Integration in 
Gasoline Supply: An Empirical Test of Raising Rivals' Costs.'' 
This work is done with Dr. Richard Gilbert. This paper asked 
the following question: Does vertical integration affect 
wholesale gasoline prices?
    Using Tosco Corporation's acquisition of Unocal's West 
Coast refining and marketing assets, we find that integrated 
refiners raise wholesale prices to independent retailers. This 
allows them to increase prices at their own retail stations, 
thus increasing their own retail profits. These results are 
consistent with the strategic incentive to raise competitors' 
input costs and show that the extent of a wholesaler's vertical 
integration into downstream markets can have a significant 
impact on wholesale competition and prices.
    We then look at a broad panel of 26 metropolitan areas over 
the 1990's, including ones in the West Coast, Rocky Mountain, 
and Gulf Coast States. We find a positive correlation between 
the extent of vertical integration and unbranded wholesale 
price, consistent with the effect we identified in the Tosco-
Unocal event study. Our main result concludes that vertically 
integrated refiners have an incentive to increase wholesale 
prices to independent marketers in order to increase retail 
profits. This implies that it is very important to consider 
such interactions between vertical integration and competition 
in antitrust and merger policy.
    The main conclusions from my research are that independent 
refiners and independent retailers are important contributors 
to competition in retail and wholesale gasoline markets. 
Independent retailers are uniquely important for competition 
because they are incredibly price competitive and increase 
competition at the retail level. In addition, they are the only 
type of station that can purchase from the lowest price 
wholesaler, thus introducing and forcing competition at the 
wholesale level. Furthermore, they allow outside entry of other 
refiners into concentrated markets when prices in those markets 
are excessively high.
    Independent refiners are also uniquely important for 
competition, and this is because independent refiners do not 
have the incentive to raise rivals' costs that integrated 
refiners have. Independent refiners compete intensely on 
wholesale price, unlike branded wholesalers, and because of 
these two factors, unintegrated refiners are important to 
ensure sufficient wholesale gasoline supply at competitive 
prices. This is necessary for the entry and survival of 
independent retailers, including new chains such as RaceTrac, 
Wawa, Costco, or Wal-Mart.
    What are the positive policy implications of my research? 
First is that antitrust and merger policy should more carefully 
consider the impacts of vertical integration on competition, 
both in merger analysis and in divestiture requirements. 
Mergers that result in a significant increase in the degree of 
vertical concentration should be scrutinized more carefully.
    In addition, competition may best be served by designing 
divestiture requirements to increase the retail market share of 
independent retailers and decrease the degree of vertical 
concentration in the market. For example, divestitures required 
from recent mergers consistently require the divestiture of a 
refinery and retail stations to a single new integrated 
competitor.
    Take, for example, the divestiture requirements for 
ExxonMobil merger on the West Coast and the Ultramar Diamond 
Shamrock-Valero merger on the West Coast. In both cases, the 
refinery and stations were divested to a single integrated 
competitor. Why not divest the retail stations and the refinery 
to separate companies? The results from my research imply that 
divesting the refinery and station separately would do more to 
increase competition in California's gasoline markets.
    I encourage the current efforts of the Federal Trade 
Commission to incorporate vertical integration issues into 
merger and antitrust regulation. For example, in Michigan, 
mergers between Marathon and Ashland and Ultramar Diamond 
Shamrock's, or UDS's, total assets resulted in a significant 
decrease in the number of competitors supplying unbranded 
gasoline at wholesale racks. A traditional measure of HHI would 
not have picked this up. It seems to me that we should adapt 
the HHI to include specifically components of vertical 
integration when looking at mergers. My colleague, Dr. McAfee, 
has proposed such an alternative to the HHI.
    Furthermore, the Environmental Protection Agency needs to 
incorporate secondary impacts on market structure and 
competition when designing environmental regulations. The 
current system of boutique fuels further segments markets and 
leads to market power for local refiners. It creates barriers 
to entry and, thus, increases price levels and volatility. In 
addition, price volatility caused by market segmentation drives 
out independent retailers in the long run, further lessening 
competition. The EPA should attempt to minimize the number of 
fuels required while still protecting the environment in order 
to minimize segregation of gasoline markets and increase price 
volatility.
    I would now like to comment on a couple of legislative 
ideas that have been proposed and are aimed at increasing 
competition in gasoline markets. The first of these falls under 
wholesale price regulation and this legislation has the 
following title. It comes under fair wholesale pricing, branded 
open supply, or zone price elimination legislation. These types 
of legislation are most likely regressive policies that will 
lead to price increases in low-income neighborhoods. 
Furthermore, they may lead to further vertical concentration, 
lessening competition in the long run.
    What would zone price elimination do? Currently, as has 
been noted here, refiners price discriminate, charging higher 
wholesale prices in less price sensitive markets and lower 
prices in highly competitive markets. Zone price elimination 
would require refiners to charge one wholesale price. In order 
for this policy to lead to lower retail prices, two things have 
to happen. First, zone price elimination must lead to lower 
wholesale prices. Second, that lower wholesale price must be 
passed on to the pump by the dealers who set the retail price.
    If refiners are forced to charge one wholesale price, it 
actually could be the case that average wholesale prices would 
rise. In addition, they would certainly rise in low-income 
neighborhoods, currently the most price sensitive 
neighborhoods. Zone price elimination could be a very 
regressive policy.
    In addition, if zone price elimination leads to higher 
average wholesale prices, this may lead to the closure of 
independent marketing stations. Independent dealer-owned 
stations may go out of business in the long run, further 
increasing vertical concentration and lessening competition.
    I would also like to point out one more fact. Branded open 
dealers pay one rack price and it is not the case that we see 
less price discrimination at those stations than we do at 
lessee dealer stations where the oil companies price 
discriminate.
    I would like to sum up my comments by stating that members 
of your staff have worked incredibly hard to produce an 
extensive and excellent report, and I am certain that, by now, 
they are deeply aware of the following two facts. First, there 
is a pressing need for more independent academic research into 
the factors that affect petroleum pricing at all levels of 
production. Second, it is incredibly difficult to acquire data 
to conduct such research.
    I would like to propose creating a program at the Energy 
Information Administration modeled after the excellent program 
that the U.S. Census Bureau has to disseminate and make 
available to highly screened researchers proprietary data that 
would allow for excellent studies needed to inform public 
policy debates.
    This concludes my comments, and I look forward to answering 
your questions.
    Senator Levin. Thank you so much, Doctor. Dr. McAfee.

TESTIMONY OF R. PRESTON McAFEE,\1\ MURRAY S. JOHNSON PROFESSOR 
        OF ECONOMICS, UNIVERSITY OF TEXAS, AUSTIN, TEXAS

    Mr. McAfee. Mr. Chairman and Members of the Subcommittee, 
my name is Preston McAfee. I am a professor at the University 
of Texas and I have worked extensively with the Federal Trade 
Commission in evaluating mergers. This includes the ExxonMobil, 
BP-ARCO mergers, and others. I also assisted the Commission 
with the summer 2000 Midwest gas price spike investigation.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. McAfee appears in the Appendix on 
page 227.
---------------------------------------------------------------------------
    As part of my studies of these mergers, I have had access 
to and studied a substantial amount of information, including 
the documents that the FTC had gathered in the course of its 
investigation. Much of this information is confidential. In the 
case of ExxonMobil, it is more than 100 million pages of 
documents.
    I am pleased to be here today to discuss the economic 
issues I have researched as they pertain to your examination of 
gasoline prices in the United States. I will concentrate on 
volatility and antitrust.
    Let me start by saying I appreciate the effort and thought 
that went into the Subcommittee's report. I want to compliment 
the Chairman, the Subcommittee, and the staff on this report 
and I am going to highlight a few issues considered in the 
report and disagree with a few.
    First, on volatility, a basic fact of the gasoline market 
is that the combination of inelastic demand and inelastic 
supply magnifies the effects of supply disruptions. Short-run 
price changes can easily be three to five times the quantity 
changes. So a 10 percent change in quantity can result in 30 to 
50 percent price increases. This is a feature of consumer 
values and production costs that cannot be changed by policy. 
That is, unless you can change the way consumers value 
gasoline, you cannot change this demand response.
    Consequently, there is only a limited role for government 
in reducing price volatility. Some level of fluctuations in 
price is unavoidable and are caused by large-scale phenomena 
like demand increases and short-term phenomena like pipeline 
breaks.
    I want to emphasize that price controls are not a fix for 
volatility. We have lived through the gasoline lines of the 
1970's, which were created by price controls, and I hope never 
to see these again. Preventing the establishment of market 
prices through price controls does not change underlying 
conditions, but instead creates severe shortages and eliminates 
investment.
    Price volatility is increased by the proliferation of 
boutique fuels, which certainly contributed to the Midwest 
price spikes. As a Nation, we should be aware that every time 
an area is assigned its own fuel specifications, the rest of us 
lose a little bit of insurance. We should attempt to reduce the 
total number of distinct types of gasoline in use. Currently, 
there appear to be 19 different regular unleaded 
specifications, and that means you need 19 distinct storage 
units for those fuels.
    The greater the extent to which the Nation is 
interconnected, the less will be the overall volatility of 
gasoline prices. Easing the construction of pipelines may 
reduce volatility by linking geographic areas more tightly. 
This is certainly relevant to Michigan.
    Price volatility is not unambiguously bad. Gasoline prices 
are volatile because the value of gasoline varies over time. 
Stabilizing prices at a high level, which is essentially the 
Canadian policy, is much worse than allowing fluctuation where 
sometimes we get the benefit of low prices.
    The tendency to reduce taxes when supply is temporarily 
disrupted is a very bad policy. This was used by Illinois. The 
price must rise to ration demand to the available supply. 
Removing the taxes does not change this fact. It does not 
change the fact that consumers must pay a higher price to 
reduce their demands. A tax holiday during a price spike does 
not decrease the prices but, in fact, creates a windfall gain 
to the oil companies by transferring the taxes from the 
government to the oil companies.
    In terms of the response to price spikes, long-distance 
transportation typically takes about 4 weeks. Refining adds 
another 4 weeks. So a 2-month response to an unexpected 
shortage is a normal competitive response.
    In the case of the Midwest price spike, the possibility of 
EPA waivers actually contributed to the problem. There were 
several companies that expected EPA waivers that never came. 
Because they were expecting waivers to the reformulated 
gasoline specifications, they waited, hoping to be able to 
supply regular unleaded. It would be very useful for the EPA to 
clearly delineate the criteria under which waivers are issued.
    In the case of the Midwest, the need to clean storage tanks 
between summer and winter creates a window of severe 
vulnerability to supply disruptions. Essentially, all companies 
have their storage units empty at the same time, and that 
contributed to the Midwest gas price spike. This problem is 
easily cured by staggering the imposition of fuel requirements 
across the companies. And so just a matter of a few weeks' 
difference would actually ease this burden and reduce our 
vulnerability.
    Let me now turn to antitrust. Parallel pricing is a feature 
of both perfect competition and collusion. That is, firms that 
are aggressively competing will display parallel pricing. Firms 
with similar costs engage in parallel pricing. It is not 
possible to conclude from parallel pricing alone anything about 
collusion. As a result, parallel pricing should not be made 
illegal, in my opinion. It is equally evidence of competition 
as it is evidence of collusion. Something else is needed.
    As the report noted, the West Coast gasoline market is 
controlled by an oligopoly of seven firms, ChevronTexaco, 
Shell, BP, Tosco, Valero, ExxonMobil, and probably Tesoro, 
depending on a spin-off. It is hard to keep up with this 
without a scorecard. I want to note that is actually still 
seven firms, just as it was before the ExxonMobil merger. That 
is, the wave of mergers has not resulted in a significantly 
more concentrated market in this very inter-dependent market.
    I agree with the Subcommittee's finding that these firms 
are inter-dependent and aware of each other's behavior and that 
significantly reduces the likelihood of competitive behavior. 
As Dr. Hastings emphasizes, vertical integration exacerbates 
the risk of noncompetitive behavior.
    The Federal Trade Commission is quite aware of the threat 
created by increasing vertical integration and the 
interdependence of the firms and it actively blocks it by 
requiring divestitures. Unfortunately, while we would like to 
actually improve the situation, the law dictates that you can 
prevent a lessening of competition, so we cannot force the 
firms to increase the competition. So we cannot break up the 
vertical integration when divestitures are required. I am sure 
the FTC would greatly appreciate more resources for its 
investigations.
    My bottom line is that the FTC does a thorough job 
investigating large oil company mergers and that extensive 
divestitures to preserve competition have been required.
    Elimination of zone pricing by statute will not tend to 
reduce average gasoline prices. Instead, as Dr. Hastings 
emphasized, it will tend to increase prices in the most 
competitive and also the poorest areas. Zone pricing is 
essentially the same phenomenon as the senior citizen discount 
at the movie theater. That is, the companies give a lower price 
to the more price sensitive consumers, like students and senior 
citizens. My 84-year-old mother very much appreciates the 
senior citizen discount at the movie theater and would not like 
to see it made illegal.
    Finally, let me turn to conclusions. Industry executives 
are justifiably pessimistic about the ability of this Nation to 
produce new refineries, especially on the West Coast. Even in 
their private documents, they say there will never be a new 
West Coast refinery built.
    There is a role for the government to moderate the ``not in 
my backyard'' mentality that makes it more difficult for us to 
build adequate refineries, adequate electric power generation 
facilities, pipelines, electric transmission lines, and even 
cellular phone towers.
    And finally, for the big picture, over the past 30 years, 
this country has deregulated or partially deregulated trucking, 
airlines, rail, gasoline, oil, natural gas, and long-distance 
telephony. We are in the process of deregulating electricity 
and local telephony. Overall, economic studies indicate that 
the deregulation of the U.S. economy has produced enormous 
gains for the American consumer.
    We should not let a few problems, and price spikes are a 
problem and also the California electricity crisis is a 
problem, but we should not let a few problems deflect us from 
our market economy or send us back to the miserable regulated 
environment of the 1970's. In almost all instances, competitive 
industries deliver more, higher quality goods to consumers than 
regulated industries do. Gasoline lines, which are the 
archetypal outcome of regulation, are worse in the long run 
than volatile prices.
    Finally, on the presumption of guilt, let me end with this. 
My understanding of the American system is innocent until 
proven guilty. We should not be presuming guilt for what could 
be competitive behavior. Thank you very much.
    Senator Levin. Thank you very much, Dr. McAfee. Dr. 
Verleger.

    TESTIMONY OF PHILIP K. VERLEGER, JR.,\1\ PRESIDENT, PK 
            VERLEGER, LLC, NEWPORT BEACH, CALIFORNIA

    Mr. Verleger. Thank you very much, Senator Levin. It is a 
pleasure to be here.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Verleger appears in the Appendix 
on page 239.
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    Let me start by saying I am the BP Senior Fellow in 
International Economics at the Council of Foreign Relations and 
I also have my own consulting firm. What I am saying here today 
are my own opinions and not those of the council.
    I have studied energy now for more than 30 years. I have 
written extensively on commodity markets and on the linkage 
between commodity prices and stocks. I am a member of the 
National Petroleum Council. I was a member of Attorney General 
Lockyer's task force to look at California gasoline, testified 
in the Aguilar matter, testified to the Senate Monopolies 
Committee on the announcement of the BP-Amoco merger at the 
request of the Chairman, consulted on ExxonMobil, BP-Amoco, and 
on the Shell-Texaco joint venture. I also testified and 
consulted extensively on the Unocal patent. I am an energy 
person much more than an antitrust person.
    Let me break the order of my testimony and start, by saying 
that something has gone unmentioned here, that is the role of 
the new competitors. Wawa, Sheetz, and most importantly, Wal-
Mart have entered the gasoline marketing business in many parts 
of the country. Where local regulations permit them and where 
State regulations do not prevent them from charging low prices, 
they are bringing to the consumer the same benefit that they 
have brought the consumer of every other commodity. That is, 
they achieve economies of scope and scale and we see much lower 
prices.
    I think your Subcommittee report noted this. It is a little 
hard to get information on this, but the Federal Trade 
Commission has just recently issued a letter to Virginia 
essentially trying to stop legislation which would impose 
minimum cost selling prices. This entry is an important change 
and it will progress. In Europe, it has brought much lower 
prices. The officials at DG-9, which is the antitrust group at 
the European Community, say that in France and in England, 
where these competitors have been permitted to enter, consumer 
prices have dropped sharply--I do not have a percentage 
number--as compared to Spain and Portugal and other countries 
where they are not permitted to market.
    The second point is we have a fundamental inconsistency in 
our national energy policy and our competition policy. In the 
debate on the energy bill, the Senate and the House both 
decided that nothing would be done, really, to limit CAFE 
standards. This means that gasoline demand will probably 
increase by around 2 percent per year for the next several 
years. Unfortunately, supply will not. Unless imports are 
available, that means each summer, we have to expect to see 
higher prices than the summer before to balance supply and 
demand. The very large sports utility vehicles that are being 
sold create a demand for gasoline that we just cannot meet.
    My third point is that refinery capacity in this country 
has increased. The Federal Trade Commission will hold hearings 
next week asking what has changed between 1985 and 2000, and in 
preparation for this, I examined the refineries that were in 
existence in 1985 and the refineries that exist today. What we 
find is the number of refineries has declined, but total 
refining capacity has increased by about 10 percent, to 16 
million barrels a day. That is, the average refinery that 
remained in operation increased in size roughly by 40,000 
barrels a day.
    One of the ways this occurred was by merging inefficient 
older units with newer units. One of the major constraints on 
building a refinery, I am told, is land. That is, if you do not 
have enough land, you cannot expand capacity due to the 
problems associated with fire and explosion. I regret that at 
least in the case of two mergers, one in the case of Shell and 
Texaco, there was an opportunity to achieve some real gains in 
the State of Washington, where two refineries that were next 
door to each other could have been combined. Unfortunately, the 
FTC interpretation--correct interpretation--of antitrust laws 
made that impossible.
    The fourth point is that the sisters are diminishing in 
importance. Senator Hart from Michigan held an excellent 
hearing on the role of the seven sisters in the oil industry 
years ago. Today, you are dealing with four sisters. The Gulf 
has vanished, Texaco has vanished, Mobil has vanished.
    Between 1985 and 2000, the four sisters disposed of 26 
percent of their U.S. refining capacity. That is, they sold 
over two million barrels a day of refining capacity, and they 
have gone from firms that had surplus gasoline supplies to be 
essentially short, and what we see is a set of firms that 
really want to supply their own needs, their own branded 
dealers, and leave the other unbranded dealers to the mercy of 
other firms. There is nothing wrong with this. There is no 
parallel decisionmaking in this. This is just something where 
we see them moving back. It also seems to be the case, although 
I have studied it less, in the case of Marathon, Ashland, and 
others.
    Fifth, the big firms have been replaced by smaller firms, 
fringe suppliers, that now provide 35 percent of the refining 
capacity in the United States. I have been afraid for years 
that these firms, one, cannot afford to make the upgrades 
needed to produce the very clean gasoline that EPA is 
demanding, and two, would face problems holding sufficient 
inventories. I note that in the last 48 hours, we have seen one 
of those firms, Valero, cut its capital budget by 25 percent 
and another of those firms, Tesoro, announce that it may not be 
able to proceed with the purchase of a refinery in San 
Francisco due to financial constraints.
    The question, then, is what to do. What can be done? I 
applaud the hearings and I applaud the report.
    First, one of the reasons the gasoline market does not work 
very well is there are no forward buyers. This is an arcane 
subject that comes out of commodity markets, but the jet fuel 
markets and the heating markets and the natural gas markets 
work very well because buyers are willing to make purchases 6 
months, a year ahead of time. I work with one major airline 
which regularly will cover half to two-thirds of its supply 
ahead of time to control its costs, and it actually reported a 
profit in the fourth quarter of 2001 because of its fuel 
management procedures offset some of their losses. Home heating 
consumers in New England regularly buy their winter heating oil 
by the end of October.
    It is not possible to do this in gasoline for the average 
consumer because any program you put together would conflict 
with the Petroleum Marketing Practices Act. It is possible, 
however, for State Governments and the Federal Government to 
enter into forward contracted fixed prices to essentially 
create that forward market. That is, the State of California 
could buy its gasoline in the future.
    Such purchases, we know, would cause inventories to be 
increased. We teach it when we teach commodity market 
economics. You see it in grain markets. If there is a forward 
market, the buying causes inventories to rise and you get a net 
gain in inventories.
    So that one of the elements is to convince State 
Governments, county governments, city governments, to enter 
contracts to buy in the forward market. Now, many bureaucrats 
will not do this for fear of what we call adverse publicity. 
That is, they buy forward, prices go down, and everybody looks 
at them and says, that was a stupid decision. We are going to 
find somebody else to manage the job. So there needs to be some 
sort of suggestion that, perhaps even a requirement, that 
governments buy forward at fixed prices. One of the largest 
buyers could be DFSC, the Defense Fuel Supply Agency.
    A corollary to this rule is that attempts to require 
stockpiles or to build strategic stockpiles by government are a 
mistake. We know from extensive studies of commodity markets 
that when the Federal Government or the government builds 
inventories, private inventories go down. In my conversations 
last week in Brussels, I find that there are many problems 
associated with the Europeans.
    The third point is to echo the comments made by the 
Attorney General from Michigan that one needs to focus very 
closely on bottlenecks such as pipelines. The Wolverine 
Pipeline example in your report is excellent. In California, I 
think we have a problem with the SFPP Pipeline, particularly in 
the way they establish tariffs at their terminal facilities, 
which are not regulated. These tarriffs could raise the cost of 
entry for smaller independent firms.
    Fourth, going to what Professor McAfee was saying on 
regulations on fuel, Professor Bornstein of Berkeley has 
proposed that instead of prohibitions, environmental agencies 
impose fees. That is, require a supplier that wants to sell 
unleaded gasoline in an area that requires reformulated 
gasoline to pay a fee to the government agency and introduce 
that gasoline into the market. Set a fee of 5 cents or 7 cents 
a gallon, for example. That would allow conventional gasoline 
into the market and would cap the price spikes. It is a very 
clever solution. It goes back to what we have learned over the 
last 30 years, that prohibitions and controls are a much 
inferior method to some sort of fee-based system or taxation.
    Finally, I will note that gasoline prices are affected by 
winter weather. The reason gasoline prices rose in the spring 
of 2000 was that January 2000 was very cold and the price spike 
associated with heating oil forced refiners to make heating oil 
for a longer period of time, preventing the normal conversion 
to producing gasoline. Thank you very much, sir.
    Senator Levin. Thank you, Dr. Verleger, very much for your 
testimony.
    Your reference to strategic purchasing by government raises 
a question which I would like any of you who feel qualified to 
address to comment on. It is my understanding that some 
companies are using crude oil that is produced in the North Sea 
called Brent to help fill up our Strategic Petroleum Reserve in 
Louisiana, to replace oil which had been removed from it. So 
they are using that particular kind of crude oil to fill the 
reserve in response to the Department of Energy's program to 
now replenish that reserve.
    The problem apparently is this, and it is sort of raised in 
an interesting way, Dr. Verleger, by your testimony. Brent is 
in short supply, as I understand it. That particular kind of 
crude is in short supply. What we have been told is that some 
companies that produce or trade in Brent, not exclusively, but 
who produce and trade in Brent, are putting Brent into the 
reserve in order to create, or at least with the effect of 
creating a shortage of Brent, which then drives up the 
worldwide price of Brent.
    Now, many other crude oils produced in Europe and Africa 
are priced in relation to Brent, so that as the price of Brent 
increases, the price of these other crude oils increase, also. 
Approximately 20 percent of our imported crude oil is from 
Europe and Africa, so we may be paying more for crude oil in 
this country as a result of companies putting Brent oil into 
the Strategic Petroleum Reserve, even though other oil would be 
acceptable to replenish that reserve.
    It is kind of triggered by your testimony about buying 
strategically, but this is a little different question and I am 
wondering whether this resonates with any of you. Dr. Verleger.
    Mr. Verleger. We could spend all day talking about Brent. 
Brent is the benchmark of the world crude market. It is 
produced in the North Sea by several companies. There are 
something like 25 to 30--I think, I may be wrong--500,000-
barrel cargoes a month. Over the years, the Brent system has 
been expanded to include certain other crudes, similar 
characteristics, as that production has gone down. But it is 
really the reference to the world market.
    Brent has been subject to a large number of manipulations 
over the years. About a year and a half ago, a firm named 
Arcadia, which is owned by a Japanese firm, managed to buy in 
the paper market associated with this control of all the 
cargoes, which they then took to South Africa or other places, 
and they made, evidently, a very large profit because of 
purchases of other crudes that were linked to this, and they 
took the position secretly. Tosco Corporation sued under the 
antitrust laws and it was a unique antitrust suit. It was 
settled in 3 weeks. There was no discovery. There was nothing 
else, and evidently, a large sum of money was paid.
    I do not know about the existing rules. I have had any 
number of problems with the Strategic Petroleum Reserve 
management people. Two years ago September, I wrote an article 
on the op-ed page of the New York Times calling for use of the 
Strategic Petroleum Reserve when crude prices were $35, forward 
crude was at $22, that the government should lease it out, that 
is, ask firms to take 100 barrels today and get back 105 
barrels in a year. The commodity rate of interest was a high 
commodity rate of interest. The government finally did it, but 
if you will recall, the Department of Energy managed to bollux 
the auction up so that, in one case, about a third of the oil 
they auctioned was purchased by somebody who had an apartment 
in Harlem. It was not purchased by any major oil company.
    I have a question of why we are putting light oil into the 
Strategic Petroleum Reserve. If we ever need to use the 
Strategic Petroleum Reserve, presumably, refinery operating 
rates will be reduced because we will be in a shortage 
situation on the world market and there will be some surplus 
refining capacity and most good refining capacity can take 
heavier crude oils. This may be a request of some of the 
smaller independent refiners that have not made the investment 
to upgrade it.
    There are many ways that DOE could write the specifications 
so that Brent would not be the crude but, say, a Bonnie light 
out of Nigeria, which is the same. I just do not know the facts 
on this one. I have read in the petroleum trade press that 
cargoes are being purchased.
    I will say that if the government imposes a requirement, 
say, to deliver 10 million barrels of oil of a consistent 
specification, there are very few places other than the Salom 
Voe terminal in Scotland where you can go to arrange that. The 
companies that happen to be equity producers have the crude, so 
the government may have given them an opportunity.
    Senator Levin. OK. Does anybody else have a comment on 
that? Dr. Hastings.
    Ms. Hastings. Sure. I understood your comment to be 
analogous to what could happen in gasoline markets were the 
government to engage in storage and long-term purchasing on the 
market and reselling on the market in order to smooth supply 
disruptions.
    I would like to point out one thing. Reformulated fuel has 
a much shorter shelf life than does crude oil, so if you are 
putting out this one case where we once in a while have to dip 
into the Strategic Reserve and then repurchase oil or produce 
oil and bring it back in to replenish it, actually, for 
gasoline, in order for it to meet EPA specs, this would have to 
happen on a very frequent basis, i.e., the government would 
have to go into the business of purchasing gasoline and 
reselling it as quickly as that fuel goes off spec.
    Now, it is an open debate as to how quickly the fuel goes 
off spec. It depends on what additive and stabilizers you might 
put in, something about mixing the gasoline. I am not an expert 
on this, but I know that it is some time between about 3 and 6 
months.
    So if you are worried that firms could actually use this to 
manipulate prices, i.e., get the government to be purchasing up 
gasoline and further creating a shortage, that problem is going 
to be exacerbated by the short shelf life of reformulated 
gasoline.
    The second question is, how do you sell the gasoline? If 
there is a shortage, do you sell it to the major refiners? 
Well, if they have an incentive, as was brought out in many of 
the documents that your staff put together, if they have an 
incentive to create shortages, what is to say that they have an 
incentive, then, to purchase the gasoline from the government 
and supply it through if they benefit from the shortage of the 
gasoline or from restricting supply?
    One of the documents said that Marathon-Ashland, for 
example--correct me if I am wrong--actually had reformulated 
gasoline. I know there was some debate about this between the 
executive for Marathon-Ashland and the Subcommittee on Tuesday, 
but they had supply available during one of the price spikes 
and they did not release it onto the market because they would 
make more money, right? So why would they buy gasoline from the 
government and then release it onto the market? So there is 
this second factor to take into account.
    I think what really needs to be done is that we need to 
encourage the integration between markets by decreasing 
boutique fuels. We also need to de-bottleneck systems, 
specifically in relationship to vertical integration. So we 
need to make sure that independent wholesalers, such as Quality 
Oil in Michigan, have access to pipelines and to tankage, that 
those barriers of entry have not been erected through vertical 
integration, that would enable tight oligopolies to prevent 
outside entry when there is a large price increase. We need to 
facilitate arbitrage.
    The only ones, obviously, from this case study in Michigan 
that have the incentive to arbitrage are independents, like 
Quality Oil. So it is not clear to me how the government 
reserve would actually facilitate that or not. Second, you have 
this problem that the gasoline goes off spec at a fairly rapid 
rate.
    Senator Levin. Thank you.
    Ms. Hastings. Thank you.
    Senator Levin. Did you have a comment on my question, Dr. 
McAfee?
    Mr. McAfee. I did. I have two comments. One is the purpose 
of the Strategic Oil Reserve itself is, I think, subject to a 
lot of confusion. If the purpose is military, then we probably 
should not be buying Brent because for preparedness for a war, 
if we have actually run out of imported oil or imported oil is 
being blocked, as Dr. Verleger said, we have excess refinery 
capacity and we can probably crack heavier oils. So we should, 
in fact, be using the cheapest oil we can put in there.
    If, instead, the purpose is economic, that is, we are going 
to try to stabilize world oil prices, for one thing, I think we 
need a much larger team of people figuring out, trying to out 
think the commodities market than we are, in fact, employing. 
In fact, my impression is we are employing none. The ability of 
government analysts to beat the commodities market at their 
game strikes me as unlikely. But that would actually dictate a 
very different thinking than is currently being used about the 
Strategic Oil Reserve.
    The second point I wanted to make was the ability to 
manipulate world oil prices is limited by the fact that there 
is a pretty large pool of oil out there and there is pretty 
inexpensive transportation. Now, transportation across the 
Pacific runs 75 cents per barrel, maybe $1 per barrel. 
Transportation from the Middle East to California runs about 
$1.50 a barrel at tops. So your ability to manipulate oil 
prices is relatively limited. A barrel has 42 gallons, and so 
even at the extreme of Middle East to California, we are 
looking at on the order of 2.5 cents per gallon, which is 
roughly one-for-one for gasoline.
    So while this could be important and something that should 
be studied, it is not an explanation for high gasoline prices.
    Senator Levin. Thank you. Mr. Ashton.
    Mr. Ashton. Senator, I have two comments which have, I 
think, a common theme. First, with regard to the Strategic 
Petroleum Reserve, unfortunately or fortunately, a lot of the 
decisions that are made that come out of SPRO are politically 
motivated or politically driven as opposed to economically 
driven, and I have seen that over a number of years, and to the 
extent to which perhaps purchasing a light sweet crude like 
Brent is being done in a market which we know has been 
manipulated in the past, it is probably not a very good 
decision but may, in fact, be driven by something other than 
economic motives.
    The other part of your question, which I thought you were 
also getting at, which is also where the political motivation 
comes in, is this whole idea of trying to foster and encourage 
large buyers to buy forward, such as State and local 
governments and those types of entities. I have had some 
experience trying to convince those types of entities to do 
exactly that, and I will tell you that because of their 
incredible risk averseness, which is in part driven, I think, 
by their short-term political position, they are not likely to 
do that type of activity or engage in that activity, although 
it might well make some sense.
    Senator Levin. I see that a roll call has begun in the 
Senate, so I am just going to be able to ask a few additional 
questions, but I do want to get to the role of regulation and 
boutique fuels in terms of whether they are one of the major 
causes of price spikes. A couple of you have commented about 
the importance of trying to reduce the amount of regulation, 
the number of different fuels that are required, but my 
question relates to the role of boutique fuels in the price 
spike, the large, sudden increases in prices.
    Mr. Ashton, in your testimony, you said that none of the 
factors which some people sometimes point to, which is the 
fluctuation in crude prices or inventories, provide a rationale 
for these price spikes.
    Mr. Ashton. That is correct, Senator, yes.
    Senator Levin. What about the role of boutique fuels?
    Mr. Ashton. The role of boutique fuels, again, 
unfortunately, the type of data that we would like to look at 
with regard to inventories simply does not exist to be able to 
extract out for each individual type of fuel exactly what was 
going on in the period prior to and during the price spikes.
    But looking just more generally at, for example, RFG 
inventories, in the price spike in the spring of 2000, for 
example, the RFG inventory hit its bottom actually in late 
April, before the price spike even started, and started to 
build again.
    Now, to the extent to which boutique fuels and specific 
types of formulas or specifications are required in specific 
areas, such as Chicago or elsewhere, that does cause some 
market dislocation and does, to some extent, exacerbate the 
problem in terms of creating sort of mini-markets that cannot 
be served by all producers. There is no question about that.
    But you have to remember that the price spike that we 
observed generally, although it was different in different 
areas, certainly transcended throughout most of the Midwest 
during this period of time. So it is being driven, certainly, 
by factors other than just boutique fuels.
    Senator Levin. Does anyone want to comment further on that? 
Yes, Dr. McAfee?
    Mr. McAfee. Where the prices were highest was Chicago and 
Milwaukee, which shared a unique blend of ethanol-based RFG-2, 
and those are the only places that we are using that fuel. So 
the effect of the break in the Explorer Pipeline, which 
affected the entire Upper Midwest, was that it would hit 
hardest in the places that had the unique fuels because they 
could not, in essence, share with St. Louis and other places.
    Senator Levin. Yes?
    Mr. Verleger. I think it should be added that one of the 
problems that Wisconsin and Chicago had was that the EPA rules 
prohibited commingling of RFG-2 that has MTBE in it with RFG 
with the ethanol in the tanks, and so there was just a--the 
product was around the corner, but it could not be used.
    Senator Levin. When you say the worst price spikes occurred 
in those areas, however, price spikes occurred in other areas, 
as well, but not just to the same degree. Would you agree with 
that?
    Mr. McAfee. Yes, absolutely.
    Senator Levin. OK. Just on inventory issues, this has been 
referenced by a number of you, about the effects of inventory 
changes in the market on these price spike situations that 
really triggered this investigation. A number of our witnesses 
have talked about the importance of trying to have greater 
inventories, that would help in terms of prices. I am wondering 
whether or not you believe that increased gasoline storage in 
these areas of high concentration, at least, would lessen the 
severity and the occasion of the price spikes. Would greater 
storage have that effect, Mr. Ashland?
    Mr. Ashton. Yes, Senator. I would certainly believe that 
greater storage, investment in that type of infrastructure, 
pipelines as well as storage capacity, would certainly help.
    Senator Levin. OK. Do you have a comment on that? I think 
you perhaps have already, but let me call on you anyway, Dr. 
Hastings.
    Ms. Hastings. Sure. I have two comments. Greater storage 
would alleviate price spikes, but as I pointed out, it is not 
clear that if there is gasoline, it would actually be released 
onto the market during a price spike.
    And second, I also think that--I forget what I was going to 
say second, so----
    Senator Levin. OK. We will come back to you. Dr. McAfee.
    Mr. McAfee. Let me emphasize that it is greater total 
storage that reduces volatility and agree with a comment made 
earlier that government's own storage will tend to crowd out 
private storage, and so that you may not get much, if any, net 
benefit.
    Ms. Hastings. That was my second point. Thanks. [Laughter.]
    Senator Levin. Thank you. Dr. Verleger.
    Mr. Verleger. I have made a career, and many economists 
have in the agricultural economic business, inventories are the 
whole story. If inventory levels are higher, the prices will be 
lower and you do not get the price spikes. The question is, how 
do you get the inventory to be higher?
    Senator Levin. And I take it that you would not be 
particularly supportive of mandates, but you would be 
supportive of either incentives or perhaps advance purchases as 
the way to do that, is that an accurate summation?
    Mr. Verleger. I have made a career of testifying before the 
Senate on Strategic Petroleum Reserves when that was an issue 
10 years ago. Mandates do not work. One way or another, what 
will happen is if you mandate it, we have seen the majors 
leave. They will sell more refining capacity and we will be 
left with more firms that do not have the capital and they will 
come and they will ask for exemptions and the system will just 
become more volatile. I think that is not the solution.
    Senator Levin. But additional storage is a solution?
    Mr. Verleger. That is----
    Senator Levin. You agree with that, it is just how you get 
there.
    Dr. McAfee, do you have any comment about the importance of 
additional--you have already commented on the importance of 
additional storage--as to how you get there? Would it be worth 
doing even if you had to have some kind of a mandate coming out 
of the Department of Energy?
    Mr. McAfee. I think mandates are hard to make workable. It 
is too easy to have storage that does not actually have any 
practical use but satisfies the requirements, or lobby for 
exemptions, so that mandates are generally not such a great 
idea because they are hard to enforce. Plus, you create this 
problem that Dr. Hastings referred to of you store it and it 
goes bad, and then you cannot actually sell it, and then what 
do you do with it? It is just sitting there being a fire 
hazard.
    So how do you get there? Well, there are things like tax 
incentives. The thing that I would most emphasize is where the 
``not in my backyard'' mentality is preventing the building of 
new facilities, those companies would like to but they are just 
being blocked, the permits are too great, any ease of that 
regulation may facilitate storage increases. The more 
concentrated is the market, the less effective that is going to 
be.
    Senator Levin. Thank you. Did you want to comment on how we 
get to the increased storage capacity any further, Dr. 
Hastings?
    Ms. Hastings. No.
    Senator Levin. Thank you so much. Mr. Ashton, we are going 
to wind up with you. If we needed mandates to get there, is it 
worth considering?
    Mr. Ashton. I think it is worth considering, although I 
think the crowding out effect is potentially a problem. I think 
you also have to evaluate sort of the trade-off of the costs 
and benefits of doing that versus potentially other measures 
that might increase supply or increase inventories.
    Senator Levin. You heard the five buzzers go off, which 
means you are going to see me run a little faster than usual, 
so we will end right there, but let me just summarize as 
follows.
    This testimony today has been very helpful in a lot of 
ways, and I want to thank this panel, as I have our earlier 
panels, for your coming today to join us and to share with us 
your experiences, your testimony, your studies, and to help us 
take a look at some possible solutions, particularly in areas 
of high concentration because that is what we are really 
focusing on, where there are very few companies that have a 
large market share in a particular area.
    One of the possible solutions or options would be to have a 
moratorium on mergers, or at least a presumption against 
mergers in those areas of high concentration. We have heard 
pros and cons about that. We have heard about the possibility 
of beefing up the FTC staff in order to have a better 
understanding of the effects of the mergers. We have not really 
had a good FTC study about the impacts of previous mergers.
    We have had some suggestions about modifying antitrust laws 
to allow anti-competitive cases to get to a jury based on less 
evidence than is currently required, in other words, less than 
explicit evidence of agreement, cooperation, or collusion, but 
something more circumstantial than that in areas in highly 
concentrated markets.
    While I surely believe in the presumption of innocence and 
could never change that, as an American who believes in the 
Constitution, I do believe, also, that there are presumptions 
that are used all the time in court. That does not lead to 
criminal convictions, but they do apply in civil cases. It will 
at least allow you to change a burden of proof or to get to a 
jury based on evidence, but it does not require a particular 
conclusion.
    We also talked about inventory, increasing inventories as 
something which is important and how that might be achieved. We 
need to have greater access to important industry data in order 
to understand what is going on in industry. The reference to 
eliminating logistical bottlenecks was referred to both by 
Attorney General Granholm and by a number of other witnesses, 
including two of you, I believe, on this panel, so that we can 
move supplies more readily from market to market.
    We do have a serious concentration problem in the oil 
industry in many States and it clearly is hurting consumers 
where it exists. Competition will lower prices. We know that, 
and we should take appropriate steps, and I emphasize the word 
``appropriate,'' but I also emphasize the word ``take,'' to 
reinvigorate competition in highly concentrated areas. More 
aggressive antitrust enforcement, I believe, is part of that, 
but a number of the other solutions, I believe should also be 
considered.
    We would welcome additional comments from this panel or 
others as we develop a response to what we learned in this 
investigation, and let me conclude just by saying this. There 
is not agreement among all of you as to each of the issues that 
we discussed, but there was common agreement on something which 
is very clear to me, which is that this staff report is 
extraordinary, and each of you were kind enough to point that 
out.
    I want to just simply conclude by saying I have been around 
here a long time and I have seen a lot of staff reports. I have 
never seen one that was taking on a more complex issue and 
doing a better job of dealing with it than this staff report of 
mine is and I am very proud of them. I thank them. I think the 
Nation is better off because we have this kind of an effort to 
look at facts, see what might be appropriate to deal with those 
facts, and if that happens as a result of this report, we will 
all be better off, and I am going to do everything that I can 
to make sure that it does, indeed, happen that way.
    Thank you again for coming, and we stand adjourned.
    [Whereupon, at 12:34 p.m., the Subcommittee was adjourned.]
                            A P P E N D I X

                              ----------                              


             OPENING PREPARED STATEMENT OF SENATOR BUNNING

                              May 2, 2002

    Thank you, Mr. Chairman.
    This is the second hearing this Subcommittee has held on gas 
pricing, and I appreciate the time our witnesses have taken today to 
testify.
    I think that we can all agree that pricing gas is a complex 
undertaking. It is not only affected by the price of crude oil on the 
world market, but by a careful balance between supply and demand, the 
amount of gas we have stockpiled, and our ability to transport the fuel 
to certain areas of the country.
    Every American notices when gas prices spike, and it always seems 
that prices never fall as fast as they rise.
    Like all companies, the gas industry has a responsibility to 
consumers, and any acts of gouging or collusion should be investigated 
thoroughly.
    The solutions to fixing this problem are not easy, and I think that 
the last thing anyone would want is for the Federal Government to get 
into the game of pricing gas. However, every summer it seems that 
consumers end up paying more at the pump as prices fluctuate widely.
    I hope the gasoline industry can take steps to help alleviate some 
of the causes to this problem.
    Also, if we are serious about helping stabilize prices, State, 
local and Federal leaders have to recognize that the sheer number of 
special formulated fuels on the market can isolate communities or even 
whole States for that matter.
    We also need to make sure that our regulations and red tape for 
getting infrastructure built--like a new pipeline or some new storage 
tanks--doesn't discourage companies from making these types of 
investments.
    Thank you.








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