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National Energy Policy: Crude Oil and Refined Petroleum Products.
Subcommittee on Energy and Air Quality
Mr. Peter D'Arco
Good Morning Mr. Chairman, and committee members. I am Peter D'Arco and I am the President of SJ Fuels. We are a third generation company located in Brooklyn, New York and deliver fuel to nearly 5000 locations. I am here on behalf of the Petroleum Marketers Association of America. PMAA represents 7,800 petroleum marketers. These marketers ell 40 percent of the gasoline, 50 percent of the diesel and nearly 75 percent of the heating oil distributed in the United States. As the country reflects on the last year's energy issues, I welcome the opportunity to discuss the status of the refined petroleum products industry with you. It has been six months since I testified before this Committee and I applaud you for holding another hearing. As you know, Mr. Chairman developing natural resources is a long term proposition and what we do today will have an impact on America's energy future ten and twenty years from now. However, the core of any energy strategy must continue to be the free market. Today, I would like to review the state of the oilheat industry, and the progress that has been made since last year. I would also like to discuss the future of the motor fuels industry, and the recently finalized rules affecting both gasoline and diesel. In particular, I would like to encourage you and the committee to closely examine the rule recently issued by the Environmental Protection Agency (EPA) to lower the sulfur in diesel fuel. First, I would like to update the committee on the heating oil industry. Last year, its ability to respond and its resilience was questioned as prices rose sharply when the weather became extremely cold in the winter. The problems related to unusual weather patterns that caused transportation problems, and refinery problems. However, as you know our company as well as thousands of other businesses both large and small responded. Refineries increased production, wholesalers searched the globe for product, and marketers like myself staggered deliveries to ensure all customers had product at all times. I would like to contrast that behavior with what has occurred in California where monopolies or semi-monopolistic utilities unilaterally decided to cease distribution of electricity to selected communities. Now, the state of California is subsidizing electricity purchases on a daily basis, and has just imposed a massive rate increase That stands in sharp contrast to the industry I represent. Last winter forced many firms from the business, others sold out at the end of the year. However, at no time did the federal or state government begin to pay their bills. In fact many of the energy experts predicted a similar debacle this year. There was an obsessive focus on inventories, and the fact that they were below normal. Many said that prices would spike or we would run out of product because these inventories of distillate were below normal. However, the free market that I represent did many things to avoid a problem. First, many interruptible consumers of natural gas entered into contracts for supply. Additionally, many residential consumers entered into contracts for supply, while others merely transferred their business to dependable vendors. And what we have seen is an industry that has responded to a winter that is colder than normal for the first time since 1993 and 1994. Last year, the winter was 10 percent warmer than normal, and this year the winter in many areas is 5 percent colder than normal, for a total swing of 15 percent. Additionally, record prices for gas led many interruptible consumers to switch to heating oil for generating electricity and heat. The market responded by searching internationally for product, and in January, imports of distillate into the northeast were 2.5 times higher than normal. As a result we have seen level and declining prices in many markets. According to the Department of Energy prices in New York have fallen nearly 15 cents since the beginning of the year. There has been no concern about supply and our customers are pleased that they are not tied to utility pricing, and product is being delivered consistently. For my industry, failing to deliver product to a customer is the same as losing the customer. As I said last spring we will do anything necessary to get supply to customers, and since I am a customer to my supplier, he will do the same. The one lesson that we must take from this is that the free market works. Particularly when there are competitors to force competition. PMAA believes that as the Congress considers establishing a new energy strategy, how to ensure that markets have multiple competitors must be the guiding principle. Congress must work to have competitors in the various energy fields, in oil at every level, in natural gas at every level, and in electricity at every level. Further, attempting to encourage one of these sectors to be dominant will necessarily be harmful. We are dismayed by many proposals now circulating which could encourage consumption of natural gas or electricity. We believe consumer choice will lead to people selecting the best fuel for their use, and the best fuel for the future, tilting the playing field will always decrease competition, and thus should be avoided. Flexibility comes from competition, as competitors adapt to changed circumstance. And as you know each winter is different, each year competition is more intense. As the heating oil industry demonstrated this year, many wholesalers searched worldwide for product. Brokers distributed the product between markets. Refiners worked round the clock to increase production. Finally the ability of oil to be stored at every level, from homeowner to refiner allowed the industry to distribute the product efficiently. Similarly, the final customer was able to time his or her purchases, how much they should store who should they buy from and what type of contract they should enter into with their supplier. And as every business knows, the best discipline for a market is a customer, and the competitors I described are each customers of each other, and they are always trying to get the best value and deliver the best product to the ultimate consumer. This is in sharp contrast to the continuing and persistent problems now confronting the natural gas and electricity industry. While I am not an expert in either area, it is apparent that at the residential level in California there are only one or two suppliers, and that the grid is controlled by a single entity. This limited and controlled competition has been proven to be incapable of matching a competitive field. As we debate energy policy, many raise the issue of imports of crude oil into the country. As you know, the heating oil industry relies on domestic crude for approximately 50 percent of the fuel oil produced, and uses domestic refineries plus Canadian refineries for nearly all the refined product consumed. Similarly, the vast majority of gasoline and diesel consumed in the United States is refined in the United States. However, as we have seen in California, their isolation from the country for fuel and electricity makes their problems worse, perhaps we should recognize that an international market is preferred to a domestic market. We would again contrast the oil industry with the natural gas industry. While gas is generally domestic sourced and distributed, it cannot utilize worldwide energy resources in a problem time. As we know, natural gas prices have risen sharply and likely will not drop substantially until more production goes on line in the United States. Again, the oil industry because of the easy transportability of oil can search internationally for product. We must acknowledge that oil will always be an international product, as transportation is a small fraction of the cost, and thus, the domestic oil industry will always be tied to the international economy. Dissimilarly, both coal and gas are more difficult to transport and thus will tend to be domestic industries. We do not believe that our energy policy should in any way be altered to give these two domestic products advantages in our market. Consider the situation we would be in today, if somehow the United States was independent of international energy markets. Oil would not be available to take some of the pressure off of natural gas demand, and the utility industry would not only be coping with making more electricity for California, they would have had to supply the 5 percent increase in demand for oil in the northeast. Where would prices be today if that were our energy policy of five years ago? PMAA does of course agree that steps must be taken to increase domestic production. Having crude developed both domestically and internationally increases competition, and thus benefits consumers. PMAA would also urge the Congress to liberalize the waiver provisions within the Jones Act. During heavy weather, barges cannot transit from New York to Boston, or from the gulf coast to New York. However, many foreign flag tankers could be diverted into this trade if the government would allow waivers of the Jones act. Such a course would allow wholesalers to buy product in the gulf coast and bring it up to the northeast if the pipeline systems are at capacity. Additionally many of these tankers can be used in heavier weather that would allow product to move between Boston and New York. PMAA would now like to turn its attention to the motor fuels industry. As you know, PMAA represents the marketers who sell over 40 percent of the gasoline and 50 percent of the diesel sold in the United States. For nearly a year, the United States had significant problems with distribution and supply of refined products. The Environmental Protection Agency had to delay implementation of reformulated gasoline in St. Louis because of supply and pipeline problems, and prices for reformulated gasoline spiked in Milwaukee and Chicago, and then gasoline prices spiked throughout the Midwest. While some of the problems related to lack of refined product, much of the problem related to distribution problems. Pipeline problems outside St. Louis initiated the Midwest problem. This proceeded to Chicago where the new reformulated gasoline was more difficult to manufacture than was anticipated. A pipeline problem in Michigan exacerbated the problem. Thus, much of the problems were sourced to a distribution system that is at capacity, and thus has limited ability to recover from problems. Unfortunately, the Environmental Protection Agency has issued a rule that will impact distribution at every level. In 1990, the country used essentially two distillates for all uses. Number 2 distillate was used for home heating oil, trucks, and off-road equipment. Kerosene or Number 1 distillate was used as a jet fuel, for inner-city buses, and a blendstock for diesel and heating oil in the winter months. In the last ten years we have subdivided each of these fuels by four. We have a high and low sulfur fuel for both diesel and kerosene, and we have a dye system, which is used for the tax status of the product. Thus, each of two products described above has been divided and are now six distinct products. The Environmental Protection Agency will further divide those pools into a 500-ppm fuel and a 15-ppm fuel. However, we are not merely adding one new fuel we are adding two new fuels, one taxed, and one not taxed. Thus, there will be eight distinct distillates. How does this affect distribution? The petroleum industry has always been a high volume industry relying on fungible products. A barge would carry a large load of a single product, a pipeline would carry millions of gallons of a single product that would supply every terminal in its area before transitioning to a new product, and a truck would distribute the multiple grades of gasoline and diesel. Now each of these transportation systems must lose its economies of scale as smaller and smaller volumes of product are transported. Staging in the pipeline becomes more difficult. Terminals may choose to handle only a selection of the products, or put one of these products into smaller tanks, or perhaps not sell a particular product. Marketers may have to drive farther to find the product they are searching for, and make more stops to distribute the same volume of product. Thus, each change increases distribution costs. PMAA has thus supported a more rational approach to the rulemaking now being considered. As the Committee understands, the new rule will require the new 15 PPM fuel for new trucks, and older trucks an continue to use the older diesel at 500 PPM. There is no harm in an old truck using the new fuel, and there are some environmental advantages. However, the rule that EPA has issued will create confusion in the marketplace, lead to difficult enforcement issues and stress our distribution system. PMAA would note that the transitional program proposed by EPA is similar to that of the leaded unleaded transition that occurred in the 70's. EPA stated at that time there was 17-20 percent non-compliance with the rule as consumers used funnels to overcome the nozzle restrictors or simply removed the restrictor in their tanks. This behavior destroyed the emissions devices, and thus much of the environmental gains were lost. To counter this, EPA began an enforcement program targeted at marketers. Unbelievable as this may seem, marketers were directed to memorize vehicle designs and descriptions to prevent misfueling. PMAA distributed vehicle profiles to marketers to assist in this process. EPA also considered price controls to ensure that the leaded gasoline was sold at the same or higher prices than the unleaded program to counter this problem. The leaded unleaded program was the last transitional program with both gasoline and diesel being implemented at once. Apparently for twenty years we remembered this problem, and avoided it. Unfortunately, the diesel phase in is likely to repeat that problem, disrupting the distribution system and at the same time hampering the smooth implementation of this important environmental program. PMAA is thus encouraging Congress to override EPA and transition the fuel at a single point. We are of course concerned with supply, and whether the refiners will be able to make the fuel. While their concerns are real, we recognize that nearly all of the problems of the last year are distributional and we do not want them to occur for four straight years. Additionally, I would like to offer one final comment on the number of rules that have come out affecting the domestic refining and distribution industry. Each new rule affecting refining requires substantial capital investment. Similarly, the splitting of the fuels pools also requires substantial investment. Each time that happens, there is a bias in favor of large plants that can more readily absorb the investment and spread it over more gallons. This bias leads to an industry of fewer competitors. Additionally, each of the competitors must try to always be at 100 percent capacity. However, when demand increases or there are problems with supply, big problems await everyone. We believe that the Congress must recognize this and try to ensure that our country's energy policy is as flexible and multi-source reliant. Competition will benefit the American consumer, the economy and the environment.
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