Causes and Solutions for New Jersey’s High Gasoline Prices

September 15, 2005

Testimony of Tyson Slocum, Research Director
Public Citizen’s Energy Program
Before the New JerseyAssembly Transportation Committee
Causes and Solutions for New Jersey’s High Gasoline Prices

Thank you, Mr. Chairman and members of the Transportation Committee for the opportunity to testify on the issue of gasoline prices. My name is Tyson Slocum and I am Research Director of Public Citizen’s Energy Program. Public Citizen is a 34-year old public interest organization with over 160,000 members nationwide. We represent consumer interests through research, public education and grassroots organizing.

I have testified before the U.S. Congress on how recent mergers in the domestic oil refining industry have consolidated control over gasoline, making it easier for a handful of companies to price-gouge consumers. This price-gouging has not only been officially documented, but it is also evident in the record profits enjoyed by large oil companies. Since 2001, the five largest oil companies operating in America—ExxonMobil, ChevronTexaco, ConocoPhillips, Shell and BP—have recorded $254 billion in profits. While of course America’s tremendous appetite for gasoline plays a role, uncompetitive practices by oil corporations are a cause—and not OPEC or environmental laws—of high gasoline prices around the country and in New Jersey.

Fifty-three percent of the oil consumed in New Jersey is used as fuel for cars and trucks. Twenty-five percent is for residential home heating oil, with the remainder largely for industrial processes. Gasoline prices in the Central Atlantic region of the U.S.—which includes New Jersey, Delaware, Maryland, New York, Pennsylvania and Washington, D.C.—average $3.17, or 7% higher than the national average, and up 70% from one year ago. Some states are addressing these higher prices by suspending taxes on gasoline. Public Citizen does not support such a move, as it not only fails to address the underlying market problems causing higher prices, but reduces revenues that states need to help finance solutions such as mass transit.

Oil and gasoline prices were rising long before Hurricane Katrina wreaked havoc. U.S. gasoline prices jumped 14% from July 25 to Aug. 22. Indeed, profits for U.S. oil refiners have been at record highs. In 1999, U.S. oil refiners made 22.6 cents for every gallon of gasoline refined from crude oil. By 2004, they were making 40.8 cents for every gallon of gasoline refined, an 80% jump.

While New Jersey doesn’t have as many tools at its disposal as the federal government does, there are still things the state can initiate to help remedy price-gouging. First, New Jersey’s Attorney General can announce an investigation into the prices being charged by the five oil refineries operating in New Jersey. ConocoPhillips’ Linden refinery holds a 34.5% market share; Valero’s Paulsboro facility has 24%; Sunoco’s Westville refinery has 21.8%; ChevronTexaco’s Perth Amboy facility has 12%; and Citgo’s Paulsboro facility has 7.7%.

Second, the state should consider classifying gasoline as a commodity regulated by the Board of Public Utilities in order to better ensure that prices are tied to costs. Hawaii has already implemented such a reform, and other states, including California, are considering it.

Third, New Jersey should take aggressive steps to reduce demand for oil in the state by promoting mass transit, carpooling and fuel efficient and alternative fuel cars.

Fourth, the state must put pressure on the federal government to limit the financial incentives oil companies have to keep gasoline supplies artificially tight by investigating anti-competitive practices, re-regulating oil trading and reevaluating recent mergers.

Recent Mergers Create Uncompetitive Markets

Over the past few years, mergers between giant oil companies—Exxon and Mobil, Chevron and Texaco, Conoco and Phillips, just to name a few—have resulted in just a few companies controlling a significant amount of America’s gasoline, squelching competition. A number of independent refineries have been closed, some due to uncompetitive actions by larger oil companies, further restricting capacity. As a result, consumers are paying more at the pump than they would if they had access to competitive markets and five oil companies are reaping some of the largest profits in history.

Although the U.S. is the third largest oil producing nation in the world, we consume 25% of the world’s oil every day, forcing us to import oil. We are also the third largest oil-producing nation in the world, providing us with 40% of our daily oil and gasoline needs.

And of the oil we are forced to import, some may be surprised to learn that the New Jersey region isn’t hugely dependent on Middle Eastern oil. Foreign imports of oil, gasoline blending components and gasoline into the U.S. region to which New Jerseybelongs—Petroleum Administration for Defense District I,[1] Middle Eastern OPEC nations supply only 10% of the region’s oil and gas imports. Other OPEC nations, Nigeria and Venezuela, supply 25%, and non-OPEC nations—such as Canada, Mexico, Norway and England—provide 65% of the region’s imports.

So it isn’t so much an OPEC oil cartel, but rather a corporate cartel that should concern policymakers. Consider that the top five oil companies also produce 14 percent of the world’s oil. Combined, these five companies produce 10 million barrels of oil a day—more than Saudi Arabia’s 9 million barrels of oil a day.

The consolidation of downstream assets—particularly refineries—also plays a big role in determining the price of a gallon of gas. Recent mergers joined vertically integrated companies, which own significant market shares of exploration, production, refining, and marketing of oil and gas. As a result, just five companies now control 48% of domestic crude oil production, 50% of domestic refining capacity, and 62% of the domestic retail gasoline market.

In 1993, the five largest oil companies operating in the U.S. controlled one third (34.5%) of domestic oil refinery capacity; the top ten companies controlled 55.6%.

In just ten years, because of mergers, the largest five oil companies now control half (50%) of domestic oil refinery capacity, while the top ten control 83%. This dramatic increase in the control of just the top five companies—from one-third of capacity in 1993 to one-half of capacity in 2004—makes it easier for oil companies to manipulate gasoline by intentionally withholding supplies in order to drive up prices. Because the largest companies are vertically integrated, in addition to their control over refining capacity, they enjoy significant market share in oil drilling and retail sales.

The proof is in the numbers. Profits for U.S. oil refiners have been at record highs. In 1999, U.S. oil refiners made 22.6 cents for every gallon of gasoline refined from crude oil. By 2004, they were making 40.8 cents for every gallon of gasoline refined, an 80% jump. It is no coincidence that oil corporation profits—including refining—are enjoying record highs.

Consumer advocates like Public Citizen aren’t the only ones saying this. In March 2001, the U.S. Federal Trade Commission concluded in its Midwest Gasoline Price Investigation:[2]

The completed [FTC] investigation uncovered no evidence of collusion or any other antitrust violation. In fact, the varying responses of industry participants to the [gasoline] price spike suggests that the firms were engaged in individual, not coordinated, conduct. Prices rose both because of factors beyond the industry's immediate control and because of conscious (but independent) choices by industry participants…each industry participant acted unilaterally and followed individual profit-maximization strategies…It is not the purpose of this report - with the benefit of hindsight - to criticize the choices made by the industry participants. Nonetheless, a significant part of the supply reduction was caused by the investment decisions of three firms…One firm increased its summer-grade RFG [reformulated gasoline] production substantially and, as a result, had excess supplies of RFG available and had additional capacity to produce more RFG at the time of the price spike. This firm did sell off some inventoried RFG, but it limited its response because selling extra supply would have pushed down prices and thereby reduced the profitability of its existing RFG sales. An executive of this company made clear that he would rather sell less gasoline and earn a higher margin on each gallon sold than sell more gasoline and earn a lower margin. Another employee of this firm raised concerns about oversupplying the market and thereby reducing the high market prices. A decision to limit supply does not violate the antitrust laws, absent some agreement among firms. Firms that withheld or delayed shipping additional supply in the face of a price spike did not violate the antitrust laws. In each instance, the firms chose strategies they thought would maximize their profits.

Although federal investigators found ample evidence of oil companies intentionally withholding supplies from the market in the summer of 2000, the government has not taken any action to prevent recurrence.

Additionally, a May 2004 U.S. Government Accountability Office report[3] agreed with Public Citizen that recent mergers in the oil industry have directly led to higher prices. It is important to note, however, that this GAO report severely underestimates the impact mergers have on prices because their price analysis stops in 2000 – long before the mergers that created ChevronTexaco, ConocoPhillips, and Valero-Ultramar/Diamond Shamrock-Premcor.

A congressional investigation uncovered internal memos written by major oil companies operating in the U.S. discussing their successful strategies to maximize profits by forcing independent refineries out of business, resulting in tighter refinery capacity. From 1995-2002, 97% of the more than 920,000 barrels of oil per day of capacity that had been shut down were owned by smaller, independent refiners. Were this capacity to be in operation today, refiners could use it to better meet today’s reformulated gasoline blend needs.

An internal Mobil document helps explain why independent refineries had such a tough time. The Mobil document highlights the connection between an independent refiner producing cleaner burning CARB (California Air Resources Board) gasoline, the lower price of gasoline that would result from the refinery being in operation, and the need to prevent the independent refiner from operating:

If Powerine re-starts and gets the small refiner exemption, I believe the CARB market premium will be impacted. Could be as much as 2-3 cpg (cents per gallon)…The re-start of Powerine, which results in 20-25 TBD (thousand barrels per day) of gasoline supply…could…effectively set the CARB premium a couple of cpg lower…Needless to say, we would all like to see Powerine stay down. Full court press is warranted in this case.

FTC Not Adequately Protecting Consumers

At the same time that the Federal Trade Commission concludes that refining markets are uncompetitive, the agency consistently allows refining capacity to be controlled by fewer hands, allowing companies to keep most of their refining assets when they merge, as a recent overview of FTC-approved mergers demonstrates.

The major condition demanded by the FTC for approval of the August 2002 ConocoPhillips merger was that the company had to sell two of its refineries—representing less than 4% of its domestic refining capacity. Phillips was required only to sell a Utah refinery, and Conoco had to sell a Colorado refinery. But even with this forced sale, ConocoPhillips remains by far the largest domestic refiner, controlling refineries with capacity of 2.2 million barrels of oil per day—or 13% of America’s entire capacity.

The major condition the FTC set when approving the October 2001 ChevronTexaco merger was that Texaco had to sell its shares in two of its joint refining and marketing enterprises (Equilon and Motiva). Prior to the merger, Texaco had a 44% stake in Equilon, with Shell owning the rest; Texaco owned 31% of Motiva, with the national oil company of Saudi Arabia (Saudi Aramco) also owning 31%, and Royal Dutch Shell owning the remaining 38%. The FTC allowed Shell to purchase 100% of Equilon, and Shell and Saudi Aramco bought out Texaco’s share of Motiva, leaving Motiva a 50-50 venture between Shell and Saudi Aramco.

Prior to the merger, Texaco’s share of Equilon and Motiva refinery capacity equaled more than 500,000 barrels of oil per day—which was simply scooped up by another member of the elite top five companies, Shell. Had the FTC forced Texaco to sell its share to a smaller, independent company, the stranglehold by the nation’s largest oil companies could have been weakened.

As a condition of the 1999 merger creating ExxonMobil, Exxon had to sell some of its gas retail stations in the Northeast U.S. and a single oil refinery in California. Valero Energy, the nation’s fifth largest owner of oil refineries, purchased these assets. So, just as with the ChevronTexaco merger, the inadequacy of the forced divestiture mandated by the FTC was compounded by the fact that the assets were simply transferred to another large oil company, ensuring that the consolidation of the largest companies remained high.

The sale of the Golden Eagle refinery was ordered by the FTC as a condition of Valero’s

purchase of Ultramar Diamond Shamrock in 2001. Just as with ExxonMobil and

ChevronTexaco, Valero sold the refinery, along with 70 retail gas stations, to another large company, Tesoro. But while the FTC forced Valero to sell one of its four California refineries, the agency allowed the company to purchase Orion Refining’s only refinery in July 2003, and then, just last month, approved Valero’s purchase of the U.S. oil refinery company Premcor. This acquisition of Orion’s Louisiana refinery and Premcor defeats the original intent of the FTC’s order for Valero to divest one of its California refineries.

Over-the-Counter Energy Disclosure is Underegulated

Contracts representing hundreds of millions of barrels of oil are traded every day on the London and New York trading exchanges. An increasing share of this trading, however, has been moving off regulated exchanges such as the New York Mercantile Exchange (NYMEX) and into unregulated Over-the-Counter (OTC) exchanges. Traders operating on exchanges like NYMEX are required to disclose significant detail of their trades to federal regulators. But traders in OTC exchanges are not required to disclose such information allowing companies like Goldman Sachs, Morgan Stanley and hedge funds to escape federal oversight and more easily engage in manipulation strategies.

A recent congressional investigation concluded that “crude oil prices are affected by trading not only on regulated exchanges like the NYMEX, but also on unregulated OTC markets that have become major trading centers for energy contracts and derivatives. The lack of information on prices and large positions in OTC markets makes it difficult in many instances, if not impossible in practice, to determine whether traders have manipulated crude oil prices.”[4]

Public Citizen has supported efforts to re-regulate energy trading by subjecting OTC markets to tougher oversight. But the latest effort, an amendment to the energy bill, was rejected by the Senate by a vote of 55-44 in June 2003. Thankfully, both New Jerseysenators voted to support this important amendment.[5]

The Commodity Futures Trading Commission has a troublesome streak of “revolving door” appointments and hiring which may further hamper the ability of the agency to effectively regulate the energy trading industry. In August 2004, CFTC chairman James Newsome left the Commission to accept a $1 million yearly salary as president of NYMEX, the world’s largest energy futures marketplace. Just weeks later, Scott Parsons, the CFTC’s chief operating officer, resigned to become executive vice-president for government affairs at the Managed Funds Association, a hedge-fund industry group that figures prominently in energy derivatives markets. Such prominent defections hamper the CFTC’s ability to protect consumers.

Raise Fuel Economy Standards to Lower Our Oil Consumption

Due to increasing numbers of gas-guzzling SUVs on America’s roads and the absence of meaningful increases in government-set fuel economy standards, America’s fuel economy standards are lower today than a decade ago.

In April, the Environmental Protection Agency found that the average fuel economy of 2004 vehicles is 20.8 miles per gallon (mpg), compared to 22.1 mpg in 1987—a 6% decline. This decline is attributable to the fact that fuel economy standards haven’t been meaningfully increased since the 1980s. And sales of fuel-inefficient SUVs and pickups have exploded: in 1987, 28% of new vehicles sold were light trucks, compared to 48% in 2004.

Billions of gallons of oil could be saved if significant fuel economy increases were mandated. Improving fuel economy standards for passenger vehicles from 27.5 to 40 mpg, and for light trucks (including SUVs and vans) from 20.7 to 27.5 mpg by 2015 would reduce our gasoline consumption by one-third.

Dramatic reductions in consumption will not only reduce strain on America’s refinery output, but also on Americans’ pocketbooks. Comparing two Americans with identical driving habits, one driving an SUV and one a regular passenger car, reveals that the person driving the passenger car saves $510 a year due to the superior fuel economy of passenger cars compared to light trucks.