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National Energy Policy: Crude Oil and Refined Petroleum Products.
Subcommittee on Energy and Air Quality
Mr. John Cook
Summary Last year, the United States
experienced a major surge in distillate prices during the winter and again in
gasoline prices during the spring. The
petroleum market balance was tight last year, and remains tight this year, as
evidenced by low inventories in both crude oil and products. For crude oil, Iraq is probably the biggest
wild card that could generate higher prices in the short term. The strength of the global economy also is
uncertain, which will impact world petroleum demand. With this in mind, OPEC has continued to adjust production in an
effort to stabilize the price of crude oil. We face the possibility of
gasoline price volatility again this summer. With high crude oil prices, low gasoline inventories going into the
driving season, especially in the Midwest, and little excess U.S. gasoline
production capacity during the summer, the system is dependent on high imports
and smooth distribution and refinery operations. On the positive side, though, it is expected that with a year's
experience behind them, the refining industry's ability to make the summer
Phase II reformulated gasoline first required last year should be
improved. STATEMENT Thank you, Mr. Chairman. I would like to thank the Committee for the opportunity to testify on behalf of the Energy Information Administration (EIA) I will begin with an
overview of recent crude oil and petroleum product trends and the underlying
factors behind them. I will then
address our near-term forecast. A combination of factors
contributed to the sharp increases in both oil and refined petroleum product
prices experienced over the past year or so. On the demand side, strong economic growth through the first half of
2000 led to increased oil consumption. Additionally, this winter started out very cold, unlike the previous 4
winters, which were much warmer than normal. November and December were very cold in certain parts of the country,
requiring significantly more energy for home heating than in recent winters. On the other hand, supplies
of crude oil and petroleum products in 2000 just kept pace with demand growth,
resulting in continued low inventory levels, and leaving high prices. Crude oil prices have been a
key factor driving refined product prices in recent years. Although the cold winter, robust economy,
and some fuel switching from natural gas to oil had an impact on petroleum
product demand, it was action taken by OPEC and a rebounding Asian economy that
sharply increased oil prices from the $10 per barrel low levels seen in
December 1998. OPEC dramatically
reduced its crude oil production in 1998 and early 1999, so that even after
four separate production increase agreements in 2000, inventories remained at
extremely low levels. Scarce crude
supplies encourage high near-term prices relative to those several months
out. This situation, referred to as
backwardation, discourages robust growth in inventories, and discourages
maximum refinery production. With low
crude oil and product inventories, there is little flexibility to adjust to
changing conditions, and the stage is set for volatility. I would now like to focus
next on our short-term forecast, beginning with Crude Oil. At their March meeting, OPEC members agreed to reduce production
quotas by 1 million barrels per day effective April 1. This production quota reduction is in
addition to a 1.5-million-barrel-per-day cut agreed upon in January. Combined, the 2.5-million-barrel-per-day
quota reduction is expected to continue the very tight balance between global
crude oil supply and demand, resulting in continued low inventories worldwide,
and especially in the developed countries of the OECD (Figure 1). Given low stocks, EIA expects prices for
OPEC's basket of crude oils to remain toward the high end of its target range
of $22 to $28 per barrel, at least for the balance of 2001. However, West Texas Intermediate (WTI), the
U.S. benchmark crude oil, tends to run about $3-$4 per barrel higher than the
OPEC basket price, given its higher quality. Our forecast then, projects WTI to average about $29 to $30 per barrel
(Figure 2) again this year and next. This forecast assumes that Iraqi oil
exports bounce back to levels easily achieved beginning in the second quarter
of 2001. But Iraq is probably the
biggest wild card that could generate higher prices in the short term. Now, Distillate Fuel.
In spite of
strong demand this past winter, heating oil stock levels have not weakened over
the past month or two as would normally occur. Warm weather in Europe, in combination with high heating oil margins,
encouraged record levels of imports and refinery production of heating oil,
countering strong demand. Thus, for the
country as a whole, distillate stocks are now back within the normal range
after being well below normal for most of the winter. This indicates refiners may not have to produce and import as
much product to build inventories prior to next winter to maintain them in the
normal range. However, this does not
take into account the potential for continued unusually high demand from the
industrial and electricity sectors. Hot
weather this summer could result in higher diesel demand as more peaking units
and backup generators are used. With the heating season
ending, retail heating oil prices are expected to remain at or possibly decline
some from current levels as seasonal demand diminishes. Nevertheless, retail prices remain
relatively high on an historical basis, resulting in higher bills for
consumers. This past winter, the
average bill for heating with oil in the Northeast was nearly $1,000, compared
to $760 last winter and under $600 the previous two winters. Although consumers did not face the price
spike they saw last winter, preliminary data indicate consumption was about 11
percent higher than last year, because of colder weather and high natural gas
prices encouraging some fuel switching. Higher consumption levels, lower initial stock levels, and higher crude
oil prices relative to last winter have combined to push up the average cost of
a gallon of heating oil by 18 percent this winter. Together, the increases in
consumption and price raised winter oil heating bills by about 31 percent. Turning to Gasoline. With crude oil prices rebounding from their recent lows, and
continued lower-than-normal gasoline stock levels, EIA projects that prices at
the pump will rise modestly as this year's driving season begins. While EIA expects little difference from
last summer's average price of $1.50 per gallon, gasoline inventories going
into the driving season are projected to be about the same or even less than
last year (Figure 3), which could set the stage for regional supply problems
that once again could bring about significant price volatility, especially in
the Midwest and on both coasts. With little stock cushion to
absorb unexpected changes in supply or demand, regional problems can arise from
temporary or permanent losses of refining capacity, or pipeline disruptions,
particularly since there is little or no excess U.S. refining capacity
available in the summer. This lack of excess capacity leaves the domestic
gasoline system dependent on high imports and smooth operations from the
infrastructure, both pipelines and refineries, if it is to avoid a substantial
near-term price run-up. However,
imports cannot function as a relief valve for tight gasoline markets as
effectively as in the case of distillate, since few overseas refiners make the
summer grade Phase II gasoline that is required in many parts of the United
States. The prospect of regional supply
problems is also increased by the differing regional gasoline product
requirements, arising from Federal and State air quality programs, which limit
the distribution system's flexibility to respond. On the positive side, though, it is expected that with a year's
experience behind them, the refining industry's ability to make the Phase II
reformulated gasoline first required last year should be improved. Finally, I would like to
expand briefly on U.S. refining capacity. Capacity constraints are more of an
issue with gasoline during the summer than with heating oil during the winter
(Figure 4). Refineries usually run at
their peak capacities when gasoline demand is highest during the summer. In 1997 we saw for the first time, a
situation where a temporary shortage at the end of the summer could not be
resolved with an increase in domestic production because operating refineries
were running at very near full capacity. Last summer, while individual refiners ran at full capacity, the industry
as a whole did not run as high as we have seen historically. This was generally due to a 550,000 barrel
per day increase in operating capacity since 1998. While this suggests some potential for higher domestic gasoline
production this summer, any incremental production will necessarily be quite
small, given that further capacity growth in 2001 and 2002 is not expected to
be significant. For almost 20 years, we
have had an excess of refining capacity in this country, but that is no longer
the case. This concludes my testimony,
and I would be pleased to answer any questions the Committee may have. Figure
1.
Figure
2.
Figure
3.
Figure
4.
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