Chairman Barton, Congressman Boucher, and Members of the Subcommittee, thank you for this opportunity to testify regarding the implications of a National Energy Policy on Crude Oil and Refined Petroleum Products. My name is Greg King, and I am Executive Vice President and Chief Operating Officer of Valero Energy Corporation. 

Valero is a Fortune 500 company based in San Antonio, with over 3,000 employees. The company currently owns and operates six refineries in Texas, California, Louisiana and New Jersey with a combined throughput capacity of approximately one million barrels per day, making it the nation's largest independent refining company. Valero is recognized throughout the industry as a leader in the production of premium, environmentally clean products such as reformulated gasoline, CARB Phase II gasoline, low-sulfur diesel and oxygenates. The company markets its products in 34 states through an extensive wholesale bulk and rack marketing network, and in California through approximately 85 Valero branded retail and 270 other retail distributor locations. 

Valero is a member of the National Petrochemical and Refiners Association, and is pleased to appear on NPRA's behalf today. NPRA's membership includes virtually all U.S. refiners, as well as petrochemical manufacturers using processes similar to refineries. Its members own and/or operate almost 98 percent of U.S. refining capacity. NPRA includes not only the larger companies, but also many small and independent companies. 

Valero is proud of its record of environmental achievement, which goes beyond its commitment to produce cleaner-burning fuels and additives. Investing millions of dollars in pollution prevention and waste minimization, Valero was the first petroleum refiner ever to receive the prestigious Texas Governor's Award for Environmental Excellence and was recognized during the Clean Air Celebration for its "outstanding environmental stewardship and leadership." 

Current State of the Refining Industry 

The United States has long recognized the importance of domestic refining to its economy.  Many people in various states across the country have found high-paying jobs in the refining sector, and the energy sector plays a vital role in the gross domestic product of the U.S. 

Unfortunately, the refining capacity of the United States has been in a continual decline for a number of years. In the past twenty years, the number of domestic refineries dropped from a high of 315 to only 152, a 48% decrease. During the same period, domestic refining capacity fell from 17.9 to 16.5 million barrels per day, a 9% decline, while gasoline demand increased 20% since 1984. 

While refiners have historically been able to meet consumer demand by simply expanding capacity, U.S. utilization is currently at virtual capacity so there's not much room to increase production.  Utilization rates hit a high of 97% last summer and were as high as 94% in December.  Expansion of existing capacity has been constrained by permitting challenges, raising questions about our industry's ability to meet future demand domestically. 

To compound the problem, the one thing that all of the new environmental regulations have in common is that they reduce supply. And, to make matters worse, refiners must direct much of their capital investments to meet environmental regulations so there is less capital available for much-needed expansion projects. In fact, increasingly stringent environmental regulations, often adopted in piecemeal fashion, have created operational constraints and have sharply curtailed the flexibility of refiners to expand. Over the course of the last decade, the National Petroleum Council estimated that total investments to comply with the Clean Air Act Amendments in the refining sector exceeded the total book value of the refineries brought into compliance by $6 billion dollars. Things are even worse today. Refiners face near simultaneous implementation of reductions in gasoline sulfur and air toxic constituents, changes to diesel fuel to reduce sulfur to ultra-low levels, and, perhaps, limitations on the use of clean-fuel additives like MTBE. At the same time, the U.S. Environmental Protection Agency has made it increasingly difficult for refiners to expand capacity based upon novel and restrictive interpretations of the New Source Review (NSR) program. 

Of course, the Clean Air Act is just one piece of the puzzle. A regulatory blizzard swirls around the U.S. refining industry. We have included a more comprehensive list of the real and potential federal regulatory burdens that can interfere with an adequate supply of refined product. See Appendix I.  In addition, individual state actions (e.g., NAAQS implementation, California, New York and Connecticut bans on MTBE) will further jeopardize fuel supplies.

Unfortunately, the conditions that have caused our current stretched capacity in refining are not likely to resolve themselves in the near future without careful planning and a balanced energy policy that takes refining issues into account. Indeed, as we enter the summer driving season, refiners will struggle to make up inventory deficits created by the need to produce more home heating oil this past winter. Also, unusually high natural gas prices last winter directed natural gas into direct usage and away from feedstock usage. As a result, less MTBE and alkylate were made, thus further depriving the summer driving season of some of its usual cushion in gasoline inventories. The tight market for MTBE is already fueling predictions of another summer of high gasoline prices. According to the Energy Information Administration, MTBE inventories in February were down 22.4% from a year ago and MTBE production declined by 9.2% from the year-ago level. This decline has contributed to lower production of RFG at a time when demand for RFG continues to grow. This problem could be exacerbated by the unreliability of electricity supply in California, which could result in power outages that force refiners and pipelines to shut down. 

Therefore, American consumers may see an increase in prices at the pump this summer. As USA Today reported earlier this month, gasoline prices might exceed $2.50 per gallon in some areas. Tightness in capacity is much of the problem: even as EPA eased the clean air restrictions on ethanol use for Milwaukee and Chicago, one Midwest refinery announced that it would be unable to meet regulatory constraints and therefore will close down. Loss of one refinery may reduce Midwest supply by as much as 9% -- eliminating the potential gains that might have resulted from EPA's actions. See USA Today, March 9, 2001, at 3B. 

After his first briefing with the National Energy Policy Task Force, President Bush recognized the dire situation with refining capacity and its direct relationship to high prices at the pump. The President stated on March 19 that: "it's important for American consumers to understand that if we have a price spike in refined product, it's not going to be because of the price of crude oil being $25 or $26 a barrel; it's going to be because we don't have enough refining capacity."  He concluded: "We think that the major impact on gasoline prices, if they go up, is a result of not generating. enough refined product to meet the demand of U.S. drivers. And we haven't built a refinery in 25 years in America." We concur with the President's assessment and believe that a key component of any National Energy Policy must create an environment that enables domestic refiners to invest in and increase our nation's refining capacity. Such an environment can only be created if an appropriate amount of consideration is given to the supply/demand impact of future regulations. 

MTBE 

One challenge for policy makers is to avoid making the situation worse.  Precipitous action to eliminate the fuel additive MTBE that has been detected in ground and surface water would be problematic from an environmental, energy price and supply perspective. 

In a January 2001 presentation, authors from DOE's Office of Policy and the Oak Ridge National Laboratory reminded us that an MTBE ban is equivalent to a loss of 300,000 barrels per day of premium blendstock. Since MTBE is an exceptionally clean burning, high-octane gasoline additive, it allows refiners to extend the gasoline pool by bringing in lower octane components. Eliminating MTBE would effectively reduce the domestic gasoline supply by 550,000 barrels a day or roughly 6.8% of the total daily consumption of gasoline. The severe energy and environmental consequences of proceeding in this fashion will further increase our dependency on imports. 

Banning MTBE does not address the potential problem of MTBE in groundwater. The fact remains that MTBE is most often detected in groundwater as a result of gasoline leaking from underground storage tanks. Assessments of MTBE were made prior to implementation of the current Underground Storage Tank regulations. As more data is developed-including data from California-the percentage rate of MTBE detections seems to be declining.  With regard to surface water concerns, a recent report confirmed that a water-quality sampling project completed in 46 Texas Lakes on behalf of the U.S. Geological Survey concluded that, "health concerns about MTBE in water is not a factor." 

MTBE concerns can be directly addressed through programs to detect and fix leaking underground storage tanks and through effective remediation programs.  As I know the Chairman would not follow California's path on electricity deregulation, I urge the Committee and Congress not to follow California's lead with a ban on MTBE. 

Ethanol Mandate 

Some in Congress and elsewhere have further suggested that mandating a certain amount of ethanol usage could boost supply. Actions like this tend only to compound problems, not alleviate them. While the current fuel market includes a healthy share for ethanol, further mandates are likely to be counterproductive. An ethanol mandate will make it harder for refiners to provide cleaner fuels to consumers at acceptable prices. Due to ethanol's high blending vapor pressure, pentanes are backed out of the gasoline pool, further decreasing supply. An ethanol mandate will hinder refiners' ability to optimize the quality and volume of cleaner-burning gasoline. This will increase refining costs, and negatively impact both gasoline supplies and price. According to the California Energy Commission, the costs of substituting ethanol-blended gasoline in that state could increase refining costs by up to 7 cents per gallon. Based on our review at the Valero Benicia Refinery, an MTBE ban, coupled with ethanol blending reduces production volume by 8%. 

UNOCAL 

Another challenge that could complicate the picture is the continuing difficulties with the so-called Unocal patent. As many of you know, Unocal participated in regulatory negotiation proceedings in California and then successfully patented the results of this joint exercise. Recently, the U.S. Supreme Court decided not to hear an appeal of the patent, thus leaving refiners the choice of paying a large licensing fee to Unocal (on the order of 5.75 cents per gallon), or "blending around" the patent (also a very costly alternative). In addition, refiners face four more patents that further severely limit our flexibility. Unless some relief is found from this situation, supplies of clean, reformulated gasoline will be made more costly in the near term. And, we should recall that last summer the Congressional Research Service listed the on-going controversy regarding the Unocal patent as a contributing factor in last summer's high fuel prices.

 How Do We Fix the Problem with Refining? 

Suffice it to say, the imbalance between refining capacity, supply and demand did not emerge overnight, and it won't be solved overnight. The domestic refining industry finds itself in the same position as the domestic oil and gas producers of twenty years ago. Without proper attention to the role of the domestic refiner in shaping energy policy, you will see the nation's dependence on imported petroleum products increase. The current Administration and the Congress are off on the right foot: they are cooperatively working toward a national energy policy that will include some consideration of refining issues and appropriate legislative and executive action. 

We strongly recommend you keep refining issues in mind as you fashion legislative responses to our current energy situation. In particular, remember that a diversity of refining capacity that includes robust participation by domestic independent refiners is critical to produce a system capable of meeting the economic, environmental and security demands of the United States. 

Additional concrete steps to address refining issues should include the following: 

·        Address the cumulative impact of regulations. There is a tendency to view each regulation imposed upon refining in a vacuum, particularly when measuring primary and secondary economic impacts. However, as we observed above, the plain fact is that the refining sector has numerous, overlapping regulations. Most recently, compliance deadlines have come one on top of another. When EPA, DOE and the Office of Management and Budget conducts their reviews of each regulation, the cumulative impact of regulations on the supply, distribution, and cost on transportation fuels should be fully considered before taking action.

·        Ensure thorough review of regulations. Preparation of an Energy Impact Statement for major rules could help ensure that energy supply impacts are fully understood and balanced with environmental goals.  Proper use of cost-benefit analysis to ensure cost-effectiveness of regulations is another essential tool.

·        Do not change the rules in the middle of the game.  Retroactive reinterpretation of regulatory programs such as EPA's NSR enforcement activities constitute rulemaking without due process and opportunity for comment.  Also, changes in requirements that negate good faith compliance investments waste scarce capital resources that are much needed for other projects such as refining capacity expansions. To deter unwise government intervention, Congress should also consider enacting measures which compensate impacted parties when the reversal of federal rule or regulations strand business with useless equipment which was built specifically to comply with federal law.

·        Reform the permitting and New Source Review processes in order to facilitate capacity expansion and maintenance. By questioning state permitting decisions and policy over the past 20 years, EPA will only further slow down the permitting process and divert state resources towards reviewing past decisions. This is inappropriate at a time when it is critical that state permitting authorities and refiners work together to expedite the permitting processes for important upcoming environmental regulations, such as the Tier II gasoline sulfur reduction requirements. We believe that any real reform must address both substantive and procedural issues. Real reform should ensure that NSR applies only if emissions actually increase significantly. The current system of perpetual exposure to NSR cannot be defended; and 

·        Consider tax incentives  to encourage environmental improvements. The costs associated with environmental compliance often make the difference between a competitive refinery operating in the U.S., and one that closes. Valero alone spends on the order of $100 million per year in environmental compliance expenditures. The real cost of these environmental standards  is lost international competitiveness for U.S. refiners. The Office of Technology Assessment has found that the cost to the domestic refining industry for pollution abatement is substantial and is higher than for most other industries. API has calculated that petroleum refining could account for a disproportionate 17% of the national environmental expenditure in the year 2000. Although by no means a complete solution, the Congress could consider some combination of tax credits for environmental compliance or enhanced depreciation for such investments.

Conclusion 

While these responses to current refining difficulties are by no means comprehensive, they represent a start. President Bush recently remarked that, "the solution for our energy shortage requires long-term thinking and a plan that we'll implement that will take time to bring to fruition." At Valero, we couldn't agree more. However, any plan, in order to succeed in providing the American consumer with reliable and affordable motor fuel supplies, must take into account the current state of the US refining industry and of our product distribution infrastructure. 

Thank you very much for this opportunity to testify.