Hearing of the Subcommittee on Antitrust, Competition Policy Policy and Consumer Rights - Crude Oil

Federal News Service

HEADLINE: HEARING OF THE SUBCOMMITTEE ON ANTITRUST, COMPETITION POLICY AND CONSUMER RIGHTS OF THE SENATE JUDICIARY COMMITTEE

SUBJECT: CRUDE OIL: THE SOURCE OF HIGHER GAS PRICES?

CHAIRED BY: SENATOR MIKE DEWINE (R-OH)

WITNESS PANEL I:

SENATOR RON WYDEN (D-OR)

PANEL II:

WILLIAM KOVACIC, GENERAL COUNSEL, FEDERAL TRADE COMMISSION; JOHN FELMY, CHIEF ECONOMIST/DIRECTOR, AMERICAN PETROLEUM INSTITUTE;

JUSTINE HASTINGS, YALE UNIVERSITY DEPARTMENT OF ECONOMICS;

GEORGE BERMANN, COLUMBIA UNIVERSITY SCHOOL OF LAW;

MARK COOPER, DIRECTOR OF RESEARCH CONSUMER FEDERATION OF AMERICA

LOCATION: 226 DIRKSEN SENATE OFFICE BUILDING, WASHINGTON, D.C.

BODY:
SEN. CHARLES SCHUMER (D-NY): Thank you. I want to thank you, Mr. Chairman, for holding this hearing.

I want to thank you and Senator Kohl for being leaders on this issue, as you are on so many other antitrust issues.

And I want to thank our witnesses today as well and appreciate the opportunity to talk about natural gas as well as oil, although obviously I want to talk about both.

And let me say, Mr. Chairman, that I believe that the federal government has an obligation to take decisive, aggressive and immediate action to curtail energy price spikes and make sure that energy costs stop creating hardships for working families throughout the United States.

I'm sure that everyone here is familiar with the legend of the Bermuda Triangle, where planes and ships mysteriously disappear and are never heard from again. Well, over the past few months, American consumers feel like the same thing has happened to their energy dollar. But this triangle is the "Saudi Triangle," composed of OPEC, big oil companies and a lack of action by the administration to stem the tide of increasing prices.

At one point in this triangle we have OPEC, which just last week announced its continued commitment to reducing production by a million barrels a day, despite the fact that crude oil was already approaching record prices. The decision is motivated purely by greed, a desire to bolster budgets and increase profits for OPEC's largest producers, like Saudi Arabia, by taking money out of the wallets of average American families. There are also indications that more OPEC action to pinch us at the pump may be on the way. They've sort of thrown out the window the $28 ceiling and they're now maximizing their profitability because, basically, no one is stopping them. And they've been getting a green light.

At the second point in the triangle is the trend of consolidation in the oil industry. Over the past five years, mergers between the biggest players in the market and increasing vertical integration have made consumers more vulnerable to exploitation at the pump. Currently, the top five oil companies in the U.S. control 14 percent of global production, almost as much as the Middle Eastern members of OPEC, over half of domestic refiner capacity, and 60 percent -- 60 percent-of the retail gasoline market. This lack of competition has made the oil and gasoline markets vulnerable to market manipulation through the withholding of supply and other means, leading to longer, increasingly frequent price spikes and weakening any downward pressure on prices that exists in healthy and competitive markets.

To make matter worse, these highly concentrated companies are sometimes directly tied to OPEC producers, as in the case of Motiva, 50-50 venture between Shell and Saudi Aramco. The companies do nothing but benefit from high prices by reaping windfall profits and creating a win-win scenario for big oil at the expense of the American consumer.

As prices go up, and as OPEC raises prices, oil company profitability goes up. So they're right along-they're on board for the ride.

And at the third point of the triangle, I regret to say, Mr. Chairman-at the third point of the triangle lies the administration, which has a hear-no-evil, see-no-evil, do-no-evil attitude. They have not taken any aggressive action to provide needed relief to the American driver. It's bad enough that it hasn't happened so far, but if they don't do anything soon, gas prices are going to be sky high as we go into the summer months.

OPEC's ability to brazenly raise prices and fill its coffers is, in part, is a result of the administration's inability to engage and influence oil-producing nations to cooperate with U.S. needs, and as a consequence of hostility that the administration's foreign policy has engendered towards America throughout the world. The president says he's close to the Saudi royal family, but time and time again when dealing with the Saudis it's America that gets the short end of the stick. They tolerate Wahhabi extremists who preach hate and terror against the U.S. They refuse to allow our law enforcement the access it needs to investigate crimes. And now, they're holding us hostage to high gas prices.

What Uncle Sam gave us with the tax cuts, the $400 rebate every family got, he's now allowing the Saudis to take away with exorbitant prices at the pump. The president has the power to weigh in against the Saudis, but he's not using; it's time he did.

So we have this new Bermuda Triangle. OPEC consolidated big oil and a do-nothing policy from the administration.

Let me say, one, we have some weapons.

First, we should stop adding 100,000 barrels of oil a day to the SPR. A majority of senators voted for that amendment. The administration has missed an opportunity to prevent gasoline price spikes by failing to approve oxygenate waiver requests from states like New York and California, which are being forced to use ethanol this summer; raising prices; and, most importantly, they refuse to use the SPR as our ace in the hole against the Saudis and against big oil and bring prices down.

As you know, Mr. Chairman, I've been advocating this for a long time. It took me about a year to get the Clinton administration to use it. When they did, prices went down; they stayed down and the amount of oil in the SPR went up, because the swap enabled us to get more oil for what we put into the market several months later.

So we need a long-term solution. That's not what we're here to talk about today. That involves both new exploration and conservation. But we need a short-term solution, lest our economy go down the drain. And I hope that we can break the influence of this triangle, get to work and do something good to reduce prices.

Thank you, Mr. Chairman.

BREAK IN TRANSCRIPT
SENATOR CHARLES SCHUMER (D-NY): Thank you, Mr. Chairman. I want to thank the witnesses. I apologize for missing a few of you. We had a banking hearing at the same time.

First I want to ask a little bit about natural gas to Mr. Kovacic and the others. You know we had a dramatic price spike in natural gas last year, this last winter. It is much higher than it has been before. And yet, if you looked at supply and demand, it wasn't terribly different; in fact, it was a little less stringent this past winter than it was in previous winter. Has the FTC investigated last winter's price spikes? If so, what's the status of the investigation? If not, since you can't speak for the commission, what's your thoughts? I mean, gas just went through the roof. It's a different type of-obviously it's a different type of market than oil, with pipelines and everything else. Tell me what you think.

MR. KOVACIC: Senator, our work to date has basically been focused on looking at mergers involving natural gas companies, seven in the past two-and-a-half years. In the course of those investigations we've had some occasion to look at behavioral issues in the industry, but to my knowledge we don't have a current investigation simply looking at conduct. But I would be happy to check that and to report on --

SEN. SCHUMER: Would it be within the purview of the FTC?

MR. KOVACIC: Yes it would, sir.

SEN. SCHUMER: And would it be in the purview to see if the mergers that have occurred have helped contribute to-since one of my premises is we've had less and less competition in the energy industry, and that's increased-that's in part increased the price, whether it be overseas with Senator DeWine's bill with OPEC or domestically with the mergers that we've seen throughout the '90s? By the way, many of them under Democratic administration; this is hardly a partisan-type issue.

MR. KOVACIC: We have several projects under way to look at the consequences of past petroleum mergers. I think it's-again, speaking for myself, I think it is a wise policy for the commission to expand its efforts to assess the effects both of past decisions to prosecute and not to prosecute, and in a number of areas not involving petroleum or natural gas. The commission has begun to do this in health care and in-without being able to predict how the agency will act in the future, I see a growing interest in looking at the rearview mirror to see the actual consequences of what we have done, so my view is that that's wise policy.

SEN. SCHUMER: Good. That would be very helpful. I hope you will do it. Tell the commissioners about that.

MR. KOVACIC: I will, sir.

SEN. SCHUMER: Dr. Hastings, you, as the economist with only a Ph.D. and not a JD --

MS. HASTINGS: (Laughs.)

SEN. SCHUMER: -- who has maybe studied these markets a little bit, do you have --

MS. HASTINGS: I am not an expert in natural gas markets. I am an expert in gasoline markets, and they are very different.

SEN. SCHUMER: But just using your knowledge as an economist, you know, given the fact that we have pipelines from gas fields connected, they are generally monopolies as you can't go to two different natural gas producers and the natural gas companies have a limit in terms of who they can get the gas from, what would explain such a large-I've asked lots of people, and no one has come up with a good explanation as to why natural gas spiked so in price last year, this past winter.

MS. HASTINGS: Okay.

SEN. SCHUMER: No idea?

MS. HASTINGS: I am not an expert to speak to that.

SEN. SCHUMER: Do you, Dr. Cooper, have anything to say about that?

MR. COOPER: Well, in my testimony we look at natural gas, and we observe that over the past four or five years natural gas has risen much more rapidly than crude oil.

SEN. SCHUMER: Correct.

MR. COOPER: The domestic market has changed in the last five years to close that gap, and what changed was the majors-say, folks who were concentrating in the refining industry-moved into the natural gas market in a big way. They invest differently. They behave differently. They manage their assets differently. So the same attitudinal factors that look at the way they maximize their profit as opposed to compete for market share afflict the natural gas market as-in my opinion, as they do the domestic gasoline market.

The other point is that the natural gas prices now sit in the in the spot markets, the hubs. Well, it turns out that those hubs, most of them didn't even exist 10 years ago, and we're now discovering that all of them have been afflicted by manipulation. Almost daily you read press accounts from the Federal Energy Regulatory Commission, discovering that people were misreporting gas, et cetera. So these are very thin markets.

There's a court case going forward. Just a couple weeks ago I believe it's a federal district court judge allowed the case to go forward, and he pointed out that on any given day in 2001 Enron accounted for 40 percent of the gas being transacted at the Henry Hub. Now, the Henry Hub is the key referent price. The Department of Energy has discovered that that is setting the price of natural gas, and it's tracking crude much more closely than it used to do. Enron controlled 40 percent of the transactions in that market. When Enron went away for clearly very, very nasty reasons, these markets got to be very thin, and they have been laboring along. They're not transparent, and the Federal Energy Regulatory Commission is struggling to figure out how to get real, clear price signals out of the gas market and still doesn't have a program.

And again, this is the fundamental-the fundamentals in this industry are exactly like the gasoline industry. Inelasticity of supply in the short term, inelasticity of demand in the short term. So last spring we had the Department of Energy with a natural gas crisis, the prices popped up and everyone is wringing their hands about how storage was inadequate again. How did that happen? It's a business decision. And when the stocks finally moved up over the course of the summer, by the end of the winter people pointed out there was more in storage than there was in the previous two years, and the price is still too high. So this is a market that is not setting prices in a competitive, pro-consumer manner.

SEN. SCHUMER: So you'd recommend the FTC do what Mr. Kovacic said maybe they should do?

MR. COOPER: But they have to begin to look at these markets, given what we know about the inelasticity of supply and demand. If we just do routine antitrust analysis-as Senator DeWine mentioned, if you look at their market shares, they don't look very concentrated, although certainly some of the gasoline markets have gotten very concentrated. But knowing the economic fundamentals, knowing about how inelastic are supply and demand, that magnifies market power. And maybe we can't do that under the antitrust laws. Maybe we need different laws that are on different premises, but that's a fundamental problem.

SEN. SCHUMER: Like I mentioned before, my great concern is this sort of triangle I mentioned: OPEC, the small number of large oil companies, and administration friendliness to that.

Now, in your testimony, Dr. Cooper-and I'm going to ask Mr. Kovacic and Dr. Felmy this-you made a point that when OPEC raises its international price, American oil companies greatly profit, even more from their domestic production, where their cost of production stays the same or is on the same curve as it was before, but because the international price has gone way up they make much more in profit. Certainly the profits of the oil companies seem to be quite in sync with the increase in price; not exactly, but pretty close. Is that-just give me a yes or no on that. Is that true, Dr. Cooper?

MR. COOPER: Well, there's price-following behavior in both the domestic oil market and the natural gas market. The interesting thing is that one of the reasons the large industrial gas users in this country are screaming is because the rest of the world-in the rest of the world, gas is not exhibiting that price-following behavior.

SEN. SCHUMER: Right.

MR. COOPER: They're losing their jobs to other markets where the price of natural gas doesn't run up every time the price of crude runs up. Now we can have a debate about why those domestic markets-foreign markets are any different than --

SEN. SCHUMER: But it means it's not inexorable. That's what it means.

MR. COOPER: That's right. It's not inexorable.

SEN. SCHUMER: But I had a different-my question is, the idea that the big oil companies sort of like it when OPEC raises prices because then the world price goes up and their domestic production is more profitable. Do you agree with that, Mr. Kovacic?

MR. KOVACIC: It's --

SEN. SCHUMER: And again, you can speak for yourself, not for the commission.

MR. KOVACIC: Yes, sir. I know that we have done work looking at trends in profitability and attempting to explain them. I don't have a good sense of exactly what our research has shown on the point you ask, but I would be happy to --

SEN. SCHUMER: You could submit that in writing.

MR. KOVACIC: -- do that and submit that in writing to you.

SEN. SCHUMER: Do you have any thoughts on that, Dr. Hastings?

MS. HASTINGS: On the profitability of oil companies coinciding with the profitability of OPEC?

SEN. SCHUMER: The price that OPEC sets, yes.

MS. HASTINGS: No, I have not looked into that issue.

SEN. SCHUMER: Okay. And I'll be Dr. Felmy doesn't quite agree with what I said, so let's give him a chance.

MR. FELMY: Well, actually, Senator, because domestic prices move with world prices because oil is an international commodity, you will see that, for that roughly-I guess it's 35 percent of the crude oil that we actually produce here to use, you will see higher margins for that crude as world prices go up.

SEN. SCHUMER: So if an oil company were interested, at least in the short term, at maximizing their profits, they'd be happy, at least? Let's not get into collusion, but they'd be happy to see OPEC raise its price?

MR. FELMY: Well, it depends on whether or not you're a refiner or a producer.

SEN. SCHUMER: Yeah.

MR. FELMY: If you're a refiner, the answer is a decided no. If you're a producer, it tends to benefit you. But, sir, if I may --

SEN. SCHUMER: Overall, let's take ExxonMobil, something that never should existed in my opinion; it should be Exxon and it should Mobil. Those were the two biggest in my area, and they were allowed to merge. Doesn't ExxonMobil do better profitability-wise when OPEC raises its price because their-at least the domestic share?

MR. FELMY: I am not an expert, sir, on the split between the refining, production, chemicals and all the other businesses that large corporations such as ExxonMobil has ongoing. So I can't speak to that, sir.

SEN. SCHUMER: Right. Do you want to say something, Dr. Hastings?

MS. HASTINGS: Well, I don't know ExxonMobil's exact ratio of production to consumption of crude oil. If they're a net producer of crude oil then they benefit from it. If they're a net consumer of crude oil they don't benefit from it. It depends on the balance of their --

SEN. SCHUMER: Assuming that there is pure competition at the selling end, which there isn't. (Chuckles.)

MS. HASTINGS: I'm sorry. I didn't quite understand --

SEN. SCHUMER: Even if they're a consumer, if they can pass all of that along in an inelastic way to the person who buys gasoline, home heating oil or whatever else, it's not going to hurt them, even on their consuming side. They gain on the production side, they have inelastic-because of these mergers, they have an inelastic demand curve on the consumption side, and it's a win-win.

MS. HASTINGS: Not necessarily, actually.

SEN. SCHUMER: Go ahead, explain to me why.

MS. HASTINGS: Well, it depends. So imagine the opposite happening, the opposite being, as Mr. Felmy pointed out, suppose that Exxon was actually not a producer but only a refiner. So before Tosco merged with ConocoPhillips, Tosco would have been in this category, okay? So they're only going to be purchasing crude oil. Then your assumption is actually that they're going to pass 100 percent of that crude oil on to retail.

SEN. SCHUMER: No, but Tosco is not a fair example because they didn't own gasoline stations.

MS. HASTINGS: They did own gasoline stations before they merged with ConocoPhillips.

SEN. SCHUMER: They didn't have a market.

MS. HASTINGS: They owned the West Coast refining and marketing assets of Unocal Corporation. They owned the Circle K chain since 1996.

SEN. SCHUMER: Did they have the same kind of market dominance that, say, ExxonMobil has at the pump in any part of the-in my area, in any part of the country?

MS. HASTINGS: Most definitely in Arizona.

SEN. SCHUMER: In Arizona?

MS. HASTINGS: Most definitely in Arizona, okay?

SEN. SCHUMER: So Tosco would have made money in Arizona.

MS. HASTINGS: And they most definitely had a large market share-and I'm not agreeing with that they would have made money in Arizona-they also had a large market share in California, okay?

SEN. SCHUMER: Do you know what percent?

MS. HASTINGS: It depends on the metropolitan area, so I'm thinking somewhere between 12 (percent) -- no, about-probably about 10 percent, 12 percent. I could be off on that.

SEN. SCHUMER: I think that's a lot less than ExxonMobil, say, has in my area.

MS. HASTINGS: They might be --

SEN. SCHUMER: True?

MS. HASTINGS: Perhaps.

SEN. SCHUMER: Oh, yes.

MS. HASTINGS: I actually just looked at --

SEN. SCHUMER: Why, then, perhaps?

MS. HASTINGS: I actually just looked at the percent that ExxonMobil has in the New York metropolitan area.

SEN. SCHUMER: Good. What is it?

MS. HASTINGS: And I'm just not remembering off the top of my head, but I think it is probably up closer to 20 percent. And so, yes, they have large market share in your area.

SEN. SCHUMER: Yeah. What do you say to this, Doctor?

MR. COOPER: Well, the point is that they are integrated. And that's been one of the trends, is that you've got more integrated refiners, and so it's more and more difficult to talk about THE refining sector because this is an integrated operation.

SEN. SCHUMER: Right, that's what I was trying to say.

MR. COOPER: And so the point is that, if you look at the bottom line of ExxonMobil this year, folks, it's through the roof. And it's driven significantly by crude oil prices, but also by the ability to keep-if there were price resistance at the point of sale, the rise in crude prices would have squeezed down the domestic spread, and it did not. The domestic spread-and if you look at our testimony, the reason we're having so much shouting today is that both domestic spread and crude oil prices, the input prices --

SEN. SCHUMER: Both of them.

MR. COOPER: -- are at historic highs for an April. And it's the combination of that-and I understand you could hypothesize other reasons, but the simple fact of the matter is that there is no elasticity of demand at the point of sale.

SEN. SCHUMER: Right, and Dr. Hastings in a sense made the point because she had to go to something that doesn't exist now: a large refiner that didn't have production or-I mean, that was Tosco, and who bought Tosco? I don't even know. Somebody. Who bought them?

MS. HASTINGS: ConocoPhillips.

SEN. SCHUMER: Ah, ConocoPhillips. Ah ha. Produce-a seller and a producer. Let me ask --

MS. HASTINGS: And by the way, Tosco is just the first thing that came to my head.

SEN. SCHUMER: I understand. I understand, but I don't think Tosco was the biggest sort of refiner qua refiner. And the point that I'm making --

MS. HASTINGS: Might have actually been the largest independent refiner at the time of the purchase. I can't --

SEN. SCHUMER: Yeah, the point-that's what I'm saying. The point I'm making is the greater consolidation, vertical and horizontal, in this industry over the last several years has created less competition and has created not only higher prices, but a greater incentive, either implicitly or even explicitly, for OPEC and the oil companies to-the big ones, not everybody-to cooperate.

I just have one more question here because the chairman's been very generous. This is about ethanol. Now last week there were rumors that the administration might have granted both New York and California a waiver from the ethanol mandate, and prices dropped for energy futures on the NYNEX. I think they went down 5.2 percent for gasoline, 4.2 percent for crude oil. Is this-and anyone can answer this-isn't this empirical evidence that the waivers, if we were to allow New York, California and whatever other states wanted to that are far away from the corn-growing, ethanol-producing centers-if we were to allow those states to meet the clean air standards by cracking gasoline somewhat differently, that prices would come down some? Does anyone want to take-agree or disagree?

Yeah, Mr. Kovacic.

MR. KOVACIC: We haven't tried to measure the exact effects of the substitution you mentioned, Senator, but an unmistakable finding that we've made is that measures that can be taken to preserve general levels of air quality, but introduce more flexibility into the supply system, have possibilities in many areas to put greater downward pressure on prices. A more flexible supply and distribution system consistent with broad air quality goals is better for the competitive process.

SEN. SCHUMER: Dr. Felmy.

MR. FELMY: I would agree, Senator, that any measure that allows you to be able to increase the flexibility, to be able to change that refiners-so that refiners can meet clean air without prescriptive solutions for that introduces flexibility. It also introduces the possibility of additional imports. So we would agree with that position, and we support waivers for everyone.

SEN. SCHUMER: Right. Anyone disagree with that?

MR. COOPER: I agree with it with a caveat. Bigger markets are better for consumers as long as the players in the market are more; that is, as long as you increase-if it's the same players in the same big markets, I'm not sure you diminish their market power. So when we look at making these bigger markets, we have to also make sure we increase the competitiveness of those markets or we may end up on a treadmill.

SEN. SCHUMER: Okay. One final question, and this is for Mr. Bermann, the only legal-we left the legal questions to the two former prosecutors, Senator DeWine and Senator Specter. But as a co- sponsor of Senator DeWine's legislation, given that OPEC is a cartel specifically designed to manipulate price, does the involvement of U.S. companies with OPEC raise any domestic antitrust issues? In other words, does the fact that some of the oil companies also own some of the production in the OPEC nations, such as whatever the name of that company is that I mentioned in my opening-Motiva; they changed their name-the older Amco, does that raise any antitrust issues independent of legislation, the good legislation that Senator DeWine has offered?

MR. BERMANN: Well, the fact that those companies might be dealing with foreign governments would not immunize them in any respect. The law has never gone any further than to say only the compulsion of a foreign government-compulsion of a foreign government would operate as a defense.

So if you had the kind of predicate acts that you're thinking of, there's no question that I think the Sherman Act could apply to them. And the fact that they are dealing with or consorting with foreign governments will not immunize them. And indeed, if I can revert to the Act of State doctrine, the courts have held routinely that the Act of State doctrine only applies when the legality of what a foreign government does is in question and not when, if you will, the good faith or bad motivation of the foreign government is indirectly implicated.

SEN. SCHUMER: Do you agree with that, Mr. Kovacic, and does the FTC agree with that?

MR. KOVACIC: Again speaking in my own capacity, I think Professor Bermann has accurately described the requirement that there be compulsion. So the issue of fact would be in the concession arrangements that govern their activities in these countries; are there measures in those arrangements that provide the requisite compulsion? But I think his technical assessment is correct.

SEN. SCHUMER: So would that mean that, say, Shell-which has ownership in Saudi Arabia and is part of this Aramco, which is part of OPEC because it-is susceptible to FTC actions for what they do there here because of their big network and operations here?

MR. KOVACIC: In any instance in which we would look at foreign behavior in these circumstances, we would be-we would generally take the view that without compulsion, for example, the behavior in question is fair game. So that would be the crucial factual issue.

SEN. SCHUMER: Thank you, Mr. Chairman. I appreciate your having this hearing.