TESTIMONY OF R. TIMOTHY COLUMBUS
ON BEHALF OF THE
SOCIETY OF INDEPENDENT GASOLINE MARKETERS OF AMERICA
FEDERAL TRADE COMMISSION'S
"FACTORS THAT AFFECT PRICES OF REFINED PETROLEUM PRODUCTS"
August 2, 2001
Good morning. My name is Tim Columbus. I am a member of the law firm of Collier Shannon Scott and appear today on behalf of our client, the Society of Independent Gasoline Marketers of America ("SIGMA").
SIGMA is an association of approximately 260 motor fuels marketers operating in all 50 states. Together, SIGMA members supply over 28,000 motor fuel outlets and sell over 48 billion gallons of gasoline and diesel fuel annually -- or approximately 30 percent of all motor fuels sold in the nation last year.
II. Executive Summary
I appreciate the invitation to testify today on SIGMA's behalf on factors that affect prices of refined petroleum products in the United States. The title of this hearing is accurate, because there is no single cause for the wholesale and retail price volatility we have witnessed in the gasoline and diesel fuel markets over the past three years. Instead, this volatility has been caused by an amalgamation of factors, including: reduced finished product supplies; reduced and concentrated domestic refining capacity; the balkanization of the nation's motor fuels distribution system through the proliferation of "boutique" fuels; the concentration of market power into fewer and fewer companies; and, the enormous environmental compliance costs that the motor fuels refining and distribution industries have borne over the past two decades.
One factor, in SIGMA's opinion, that is not at work in the current climate of price volatility is refiner collusion. Historically, SIGMA has not been shy to challenge the nation's refiners regarding their pricing and distribution practices. However, the evidence emerging from the marketplace does not point to such collective action.
Instead, as the Commission itself concluded in its March 21, 2001 report on the gasoline price volatility in the Mid-West during the Summer of 2000:
In sum, the evidence does not indicate that the price spike in Midwest gasoline in the spring and early summer 2000 was caused by a violation of the antitrust laws. The spike appears to have been caused by a mixture of structural and operating decisions made previously (high capacity utilization, low inventory levels, the choice of ethanol as an oxygenate), unexpected occurrences (pipeline breaks, production difficulties), errors by refiners in forecasting industry supply (underestimating supply, slow reactions), and decisions by firms to maximize their profits (curtailing production, keeping available supply off the market)." (1)
SIGMA concurs with the Commission's conclusions. It is important, however, to understand how the motor fuels refining and distribution industries came to be in the current situation. Because, right now, there is no assurance that SIGMA or any other participant in the motor fuels distribution system can give the Commission that the market will consistently deliver the right motor fuels to the right place at the right time -- and at an undistorted retail price.
III. The Role of the Independent Petroleum Marketer
Independent petroleum marketers have long been recognized as the most efficient operators in the gasoline marketing industry. This historic role was emphasized by the U.S. Court of Appeals for the Sixth Circuit in Marathon Oil Company v. Mobil Corporation, (2) when it noted that independent marketers and dealers ". . . are the most competitive factor in the industry at the wholesale and retail levels." (3)
Independent marketers of motor fuels have survived in this extremely competitive industry by occupying a strategic niche: they are the most efficient providers of motor fuels to the public. Independent marketers' overhead costs are, as a general rule, significantly lower than the average refiner-operated outlet.
However, the economic viability of an independent marketer is completely dependent upon its ability to obtain supply at an acquisition cost which permits it to re-sell that product in the retail market at a price which reflects its superior economic efficiencies. The only reason that an integrated competitor would sell product to an independent marketer at a price which would permit that independent marketer/competitor to compete with the retail operations of the integrated company is the integrated company's knowledge that if it does not make such a sale than the independent marketer has an alternative source of product, will acquire product from that alternative source, and as a consequence, reduce the integrated company's overall sales by displacing its volume. Historically, independent marketers have been able to rely upon not only multiple integrated companies but numerous independent refiners as well as foreign sources of supply to serve as the inducement for the marketers' integrated supplier/competitor's sales to these marketers.
In short, independent marketers, to remain economically viable, must operate in a market involving numerous, willing sellers. Absent plentiful supply, as well as numerous supplier alternatives, the ability of the independent marketing segment to make its superior operating efficiencies relevant to the consumer will disappear.
IV. The Current State of the Domestic Refining Industry
If the continued economic viability of independent petroleum marketers is predicated on diverse and plentiful sources of supply, then this viability is currently in jeopardy.
A. Consumer Demand for Motor Fuels Is Growing
The nationwide demand for motor fuels is increasing every year, as is the amount that the average American household spends on motor fuel.
- The Energy Information Administration ("EIA") expects motor fuel (gasoline and diesel fuel) demand to increase by 1.4 percent per year through 2020.
- According to EIA, the average U.S. household spent $1,479.00 on motor fuel in 1999. By 2005, EIA predicts that this annual expense will increase by $192.00 per family to $1,661.00.
B. Concentration of the Domestic Motor Fuels Refining Industry
In 2001, the number of the petroleum refineries in operation is less than one-half of that number in 1980. The remaining refineries are producing sufficient gasoline and diesel fuel to meet overall demand. However, refining capacity, compared to demand, is in a much closer balance than at any prior period. Moreover, that capacity is operating, in real terms, at the maximum level for the production of motor fuels.
- The number of domestic petroleum refineries has decreased from 320 in 1980 to 150 in 2001.(4)
- While the aggregate number of refineries has been cut in half, the average capacity - i.e., the volume of crude oil an individual refinery's operations can handle in a day -- has increased from 100,000 barrels per day in 1980 to 250,000 barrels per day in 2001.(5)
- According to EIA, domestic refineries utilized 92.9 percent of their refining capacity in both 1999 and 2000. By way of comparison, the domestic refining industry's capacity utilization never exceeded 90 percent throughout the 1980s. Moreover, the capacity utilization rate across all U.S. industries in 2000 was 82 percent.(6) It is important to note that in reality these refineries were operating effectively at maximum capacity with respect to the production of gasoline and diesel. Given the additional steps needed to refine these products and refinery downtime for maintenance, an average capacity utilization of about 93 percent is in effect 100 percent utilization.
C. Refiner Investments Will Be Enormous Over the Next Ten Years
Over the next ten years, refiners will be required to make further improvements in motor fuel characteristics:
- California MTBE phase-out on January 1, 2003 -- estimated cost -- with federal action to repeal oxygenate mandate of the reformulated gasoline ("RFG") program -- $1.4 billion, or three cents per gallon; without federal action to repeal the oxygenate mandate -- $4.5 billion, or 13 cents per gallon;
- production of 30 parts per mission ("ppm") sulfur gasoline by 2006 -- estimated cost -- $8.2 billion, 4.5 cents per gallon;
- production of 15 ppm sulfur diesel fuel by 2006 -- estimated cost -- $6.8 billion, 5.8 cents per gallon; and
- production of lower sulfur off-road diesel fuel -- estimated cost -- $6.0 billion, five cents per gallon.
V. The Isolation of the U.S. Markets From Foreign Supply
Historically, supply shortages of gasoline and diesel fuel from domestic production have been offset by imports of finished products from Europe, the Middle East, and South America. However, except in times of extreme price volatility, these markets generally are not an alternative source of supply for the United States because our country has moved off of world specifications for gasoline and diesel fuel. As a result, most foreign refiners either are not able to produce the fuels used in the United States or will do so only when prices reach certain levels.
This isolation of the United States from the world's motor fuels supplies will only be exacerbated when EPA's low sulfur gasoline and diesel fuel programs take effect in 2004 and 2006, respectively. No other industrialized country in the world is requiring sulfur levels in motor fuels to drop to a maximum of 80 ppm for gasoline and 15 ppm for diesel fuel. Thus, supply relief from foreign sources will continue to evaporate in the future, eliminating an historically consistent supply source to bolster domestic production.
VI. The Balkanization of the Domestic Gasoline and Diesel Fuel Markets
In 2001, as a result of the Clean Air Act Amendments of 1990 ("CAAA") and state actions to comply with the CAAA, there are over 25 grades of gasoline being sold across the country:
- At the federal level, the gasoline market has been divided into two general segments: RFG and conventional gasoline ("CG").
- At state level, many states, in an attempt to comply with the CAAA without adopting the RFG program, have mandated an assortment of conventional gasolines with Reid vapor pressure ("RVP") (7) and sulfur controls and either oxygenate-specific mandates or oxygenate-specific bans.
- The sulfur level of on-road diesel fuel was reduced to 500 ppm in 1993 and, if the federal excise tax on the fuel has been paid, may be sold "clear" of any dyes; in 2000, EPA mandated that on-road diesel fuel sulfur levels be reduced to 15 ppm by mid-2006; in 2001, EPA is expected to proposed a reduction in the sulfur levels of off-road diesel fuel, creating a third type of distillate (on-road, off-road, and home heating oil) that must be distributed to consumers.
- These overlapping federal, state, and local fuel regulations have created "boutique fuel islands" in which non-compliant fuel cannot be sold. This balkanization has destroyed the fungibility of the nation's motor fuels distribution system and impeded the marketing industry's ability to respond to supply disruptions.
VII. The Future of Motor Fuel Price Volatility
Prior to 1990, the United States had the most efficient motor fuel delivery system in the world. This system kept gasoline and diesel fuel supplies high and retail prices at historically low levels. However, as a result of the CAAA, this system has become fractured, balkanized, and stressed to the point of breaking.
Motor fuel supplies will become tighter as refineries, for which upgrades cannot be justified economically, close. Meanwhile, the maximization of the remaining capacity's utilization continues, and the number of fuels that must be supplied to different areas increases. Consequently, the likelihood that supply disruptions, shortages, or dislocations will occur also increases. Whether these shortages are due to weather, equipment failure, refinery turnarounds, new environmental regulations, or decreased overall refinery production is irrelevant. What is relevant is that when motor fuel supplies become constricted, wholesale and retail prices of gasoline and diesel will rise -- at times dramatically.
Motor fuel price volatility is a straightforward example of supply and demand. Demand for motor fuels is rising and, during the early years of this decade, supply is very closely aligned to demand. If supply is reduced -- for whatever reason -- independent motor fuels marketers are frequently either cut off from supply or they are placed on "allocation" by wholesalers and terminal operators. When such product outages occur, these marketers do not simply close their retail motor fuel outlets. To do so would be to lose the customer base they have worked so hard to attract to their stores.
Instead, these independent marketers search for gasoline and diesel fuel supplies outside of their traditional markets, frequently paying premium wholesale prices and increased transportation costs to keep their retail outlets operating, or "wet." In terms of simple economics, supply will always meet demand -- it is just a question of at what price. During motor fuel supply shortages, additional gallons of gasoline and diesel fuel will be attracted to an area in short supply, but only when the price rises sufficiently to justify the extra costs.
Motor fuel price volatility will continue into the foreseeable future -- until greater fungibility is returned to the motor fuels distribution system, new or expanded refining capacity is brought online, or demand is reduced significantly
VIII. SIGMA's Proposed Solution to the Current Situation
Despite the complex nature of the challenges facing the domestic refining and distribution industries, the solution to many of the challenges is relatively simple: increased supplies of gasoline and diesel fuel and increased fungibility of motor fuels throughout the nation. If supplies and fungibility increase, then price volatility will decrease. If supplies and fungibility increase, then independent marketers will be able to perform their traditional role in the distribution system -- resulting in increased competition and decreased retail prices. If supplies and fungibility increase, then many of the factors that affect prices of refined petroleum products -- factors the Commission has identified -- will decrease in importance.
Based on this analysis, SIGMA continues to pursue legislative and regulatory measures to increase motor fuel supplies across the nation and to stop the further balkanization of the gasoline and diesel fuel markets. Whether SIGMA will be successful in achieving these goals remains to be seen.
IX. SIGMA's Suggestions to the Commission
While there is little that the Commission can do directly to influence the factors that affect prices of refined petroleum prices, SIGMA posits that there are at least two tasks the Commission can undertake. First, the Commission must understand the reasons for motor fuel price volatility. The Commission's report on the price spikes in 2000 indicated some understanding of these reasons. Hopefully, this proceeding will augment that understanding.
Second, SIGMA urges the Commission to re-examine its traditional methods of analyzing proposed refining industry mergers and the remedies the Commission has sought in the past. These traditional methods of analysis and remedies may not be applicable to the petroleum refining and marketing industries in the first decade of the 21st Century. Specifically, SIGMA urges the Commission to examine the impact of a proposed merger on unbranded, or independent, motor fuels supply in a market. If a merger will result in reduced unbranded supply, then the Commission should examine innovative remedies to lessen this impact on unbranded supply. For example, SIGMA suggests that in fashioning remedies in connection with an otherwise anti-competitive acquisition, the Commission consider ordering an acquirer of a refinery to maintain its post-acquisition unbranded sales at a level equal to its pre-merger sales.
A variety of market-based factors, rather than collusive behavior, are responsible for the motor fuels price volatility we have witnessed in the last several years. The Commission must understand these factors and their impact on motor fuels prices. In addition, the Commission must understand the important role of independent marketers in the motor fuels distribution system. With this understanding, SIGMA urges the Commission to re-examine its methods of analyzing acquisitions and the fashioning of remedies in connection with such acquisitions to protect the unbranded, independent petroleum marketer. Independent marketers are the most price competitive force in the motor fuels distribution industry, and a healthy independent segment of the industry is the best friend consumers, and competition, can have.
SIGMA appreciates this opportunity to present its views. I would be pleased to answer any questions my testimony may have raised.
1. Final Report of the Federal Trade Commission, "Midwest Gasoline Price Investigation," March 29, 2001, pp. 4.
2. Marathon Oil Company v. Mobil Corporation, 669 F.2d 378, (6th Cir. 1981), cert. denied, 102 S.Ct. 1490 (1982).
3. Id., at 383.
4. Id., p. 89.
5. National Petroleum Council, U.S. Petroleum Refining: Assuring the Adequacy and Affordability of Cleaner Fuels, June 2000, p 7.
6. Energy Information Administration, Annual Energy Outlook 2001, p. 90.
7. Reid Vapor Pressure -- the measure of a fuel's volatility. The higher a fuel's volatility, the higher evaporative emissions the fuel will have. Higher evaporative emissions is tied to ozone formation, particularly during the summer months.