The Oil Industry, Gas Supply and Refinery Capacity: …

  The Oil Industry, Gas Supply and Refinery Capacity:
               More Than Meets the Eye
                         An investigative report presented
                             by Senator Ron Wyden
                                  June 14, 2001


"As observed over the last few years and as projected well into the future, the most critical
factor facing the refining industry on the West Coast is the surplus refining capacity, and the
surplus gasoline production capacity. The same situation exists for the entire U.S. refining
industry. Supply significantly exceeds demand year-round. This results in very poor refinery
margins, and very poor refinery financial results. Significant events need to occur to assist
in reducing supplies and/or increasing the demand for gasoline."
                                                    Internal Texaco document, March 7, 1996

"A senior energy analyst at the recent API (American Petroleum Institute) convention
warned that if the U.S. petroleum industry doesn't reduce its refining capacity, it will never
see any substantial increase in refining margins...However, refining utilization has been
rising, sustaining high levels of operations, thereby keeping prices low."
                                               Internal Chevron document, November 30, 1995


America is indeed facing an energy crunch. For much of the year, gas prices have soared and
supply has trailed demand.

During the course of my ongoing investigation into potential anti-competitive and anti-
consumer practices by the oil industry, I have obtained documents that raise serious
questions about the circumstances leading to limited gas supply and high prices.

The oil industry and its allies would have the public believe that insufficient refining
capacity, restrictive environmental standards, growing gasoline demand and OPEC
production cutbacks are the primary reasons for the current oil and gas supply problem.

However, the record shows ­ supported by documents I have obtained ­ that there is more to
the story. Specifically, the documents suggest that major oil companies pursued efforts to
curtail refinery capacity as a strategy for improving profit margins; that competing oil
companies worked together to subvert supply; that refinery closures inhibited supply; and
that oil companies are reaping record profits, yet may benefit from a proposed national
energy policy that would offer financial incentives to expand refinery capacity.

For the last several months limited domestic refinery capacity has taken center stage as the
purported reason for insufficient domestic gasoline supply and higher prices.


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In the mid-1990s too much refining capacity, not too little, concerned the nation's major oil
companies. At that time, the oil and gas industry faced what they termed "excess refining
capacity," a circumstance they viewed as a financial liability that drove down overall profit
margins. The industry reduced the total amount of potential supply by closing down more
than 50 refineries in the past decade. Since 1995 alone, 24 refinery closings have taken
nearly 830,000 barrels of oil per day.

In September 1999, I released a report looking into the anti-competitive practices of zone
pricing and redlining by West Coast oil companies. At the time of the 1999 investigation,
industry officials explained higher gas prices as the result of refinery fires in California and
worldwide production cuts spurred by OPEC. They did not blame inadequate domestic
refining capacity as the culprit for restricted supply or high prices.

Today, the nation's major oil companies are experiencing record profits, thanks in no small
part to higher prices at the pump. Despite the across-the-board financial gains of the
industry, the Bush administration's recently released National Energy Policy seeks to
provide incentives, perhaps including relaxed environmental regulations, to quickly boost
refining capacity.

Information I have received during my ongoing investigation raises serious concerns that
the nation's major oil suppliers have set out in a strategic effort to orchestrate a financial
triple play, a coordinated effort that would reduce supply, raise prices at the pump and
relax environmental regulations. Unfortunately, in each case, it is the consumer who
takes the hit.

While the documents target activity on the West Coast and refinery closings in 11 states,
they point to practices with significant national ramifications. The companies involved
are national companies that operate in multiple states. In addition, gas and oil is a
fungible commodity and the amount of capacity that has been taken offline is significant
enough to affect national markets.

The following information reflects what I have found to date during the course of my
investigation.

FINDING 1:
Oil Companies Articulated their "Need" to Reduce Oil and Gas Supply to Increase
Prices and Grow Profit Margins

Facing what they deemed inadequate profit margins in the mid-1990's, oil companies
readily recognized that the surest way to drive up profits was to drive down oil and
gasoline supply. By restricting supply, they would be able to demand higher prices and
reap higher margins for their product. Oil company documents raise questions as to
whether this mindset was the underpinning of a strategic business approach in which the
industry willfully engaged to control gas supply.




                                            page 2
Internal oil company documents reveal that in 1995 and 1996 competitor companies
strategized about opportunities to tighten product supply as a means of increasing profit
margins.

A "Competitor Intelligence Report" from Chevron dated November 30, 1995
states:

           "A senior energy analyst at the recent API (American Petroleum Institute)
           convention warned that if the U.S. petroleum industry doesn't reduce its
           refining capacity, it will never see any substantial increase in refining
           margins...However, refining utilization has been rising, sustaining high
           levels of operations, thereby keeping prices low."1

This concern over too-ample supply driving down profits was echoed in a Texaco
document dated March 7, 1996:

           "As observed over the last few years and as projected well into the future,
           the most critical factor facing the refining industry on the West Coast is
           the surplus refining capacity, and the surplus gasoline production capacity.
           The same situation exists for the entire U.S. refining industry. Supply
           significantly exceeds demand year-round. This results in very poor
           refinery margins, and very poor refinery financial results. Significant
           events need to occur to assist in reducing supplies and/or increasing the
           demand for gasoline."2

Not only did the oil companies view excess refining capacity as a financial liability, they
openly suggested that eliminating the excess capacity and tightening supply would help
improve their bottom line.

These documents show that oil companies had the intent and motive to hamstring supply
and reduce refining capacity. Subsequent events show that they acted.

FINDING 2:
Oil Company Competitors Planned Opportunities to Subvert Oil and Gas Supply

On June 11, 2001, the Wall Street Journal reported that Marathon Ashland Petroleum
intentionally withheld reformulated gasoline supply in the Midwest in a contrived effort
to keep prices, and profits, artificially high.3 Although Marathon was reported to have
operated alone in this instance, documents suggest that over the past five years other
leading oil companies have worked together to control the amount of gasoline available
on the market.
1
    Chevron document ­ Competitor Intelligence Information, November 30, 1995
2
    Texaco memo - Future Gasoline Specifications, March 7, 1996
3
    Wall Street Journal Article, Marathon Ashland Withheld Gasoline, June 11, 2001


                                                   page 3
A thankyou note dated April 25, 1994, from Tosco CEO Thomas O=Malley to ARCO
Executive Vice President James Middleton raises serious questions about how the two
companies worked together to control gasoline supply in a manner financially beneficial
to both companies:

           "ARCO represents an important part of Tosco=s business. We want to
           do everything we can to nurture this important business relationship
           and make sure it keeps up the tradition of being mutually beneficial." 4

By highlighting the mutually beneficial "tradition" in which these two competitors
engaged, the note points to intentional cooperation to improve their respective bottom lines.

During the mid-1990s California, facing severe air quality problems, transitioned to
cleaner-burning, reformulated gasoline referred to as CARB (California Air Resources
Board) gas. Because this formulation of gasoline was only required in California, fewer
suppliers produced the fuel; those who did could play a significant role in setting the price.
Documents obtained by my office indicate that several West Coast refiners and suppliers
sought cooperative arrangements through which they could keep the supply of CARB gas
tight and demand higher prices as a result.

The President of ARCO Products Company William Rusnack admitted in a deposition
taken May 15, 1997, that he met with Tosco CEO Thomas O'Malley to discuss
opportunities to work together to control supply of the cleaner burning gasoline, thus
propping up the overall price.

           "... explore whether or not there was any mutual benefit, any mutual
           interest, any profit for both ARCO and Tosco to find a way to have
           ARCO purchase or Tosco sell CARB [cleaner burning California Air
           Resources Board] gasoline to ARCO, recognizing that the agreement
           that was in place at that time did not provide for the supply of CARB
           gasoline."5

Cecil Blackwell, a senior Chevron official, described during a deposition a conversation
he had with Jay Kowal, a senior ARCO official, in which they discussed possible
agreements affecting supply.

           "And he, as I recall, confirmed their interest ...and if we can reach
           a commercial agreement with them, that he felt, you know, this
           could change some of their investment decisions or change
           investment decisions of others on supplying CARB gasoline."6
4
 Thank you note to ARCO Exec. VP James A. Middleton from Tosco CEO Thomas O'Malley, April 25,
1994
5
 Summary of Deposition of William C. Rusnack, President of ARCO Products Co., taken May 15, 1997
6
    Summary of Deposition of Cecil Blackwell, Senior Chevron Official, taken February 19, 1997


                                                  page 4
Based on information obtained during this and other depositions related to a court case
currently before the California Supreme Court, the plaintiff's attorney compiled an index
that documents face to face meetings between top competitors in the West Coast oil
industry. These meetings between ARCO and Tosco, ARCO and Exxon, ARCO and
Chevron, Chevron and Tosco, etc., expose efforts among the companies to reach
agreements to control the supply of oil and gas in the West.

Documents obtained as part of the legal proceeding also verify that major oil and gas
companies supplying CARB gas to the California market entered into 44 supply-sharing
agreements. These agreements were generated to control the quantity of CARB gas on
the market, reduce efforts to expand CARB refining capacity, limit imports of CARB gas
and discourage excess CARB gas from being sold on the spot market to independent
purchasers. Exxon, ARCO, Chevron, Shell, Texaco, Tosco and Unocal all entered into
such supply-sharing agreements with at least one of their competitors.

Because such agreements benefited the major suppliers and excluded independent
operations from the process, significant questions are raised about whether these
agreements had the effect of forcing independent refiners to close down ­ further
decreasing overall gasoline supply.

In February 1993, Mobil, Texaco and Chevron (with the financial support of Exxon) filed
a lawsuit to overturn the small refiners' exemption to the CARB gas program, reducing
the ability of small refiners to compete in the CARB gas market.

An internal Mobil document highlighted the connection between an independent refiner
producing CARB gas, the depressed price that would result, and the need to prevent the
independent refiner from producing.

           "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."7

The Powerine Oil Company refinery closed in 1995. Despite documented attempts to
work in conjunction with major oil companies to restart the Santa Fe Springs, Calif.
refinery8, the major oil companies stood in the way and the refinery remains closed.




7
    Internal Mobil Corp. E-mail regarding Powerine refinery, February 6, 1996
8
 Powerine Oil Co. Letter to Mr. M.R. Diaz, General Manager of Supply & Distribution for Texaco
Refining & Marketing Inc.


                                                   page 5
FINDING 3:
Closing Refineries: Oil Companies Act to Inhibit Supply

While oil companies were making agreements to control oil and gas supply, refineries
were closing. Since 1995, 24 refineries have closed, including refineries in California,
Illinois, Arizona, Oklahoma, Indiana, Kansas, Louisiana, Texas, Mississippi, Michigan
and Washington (the Tosco refinery has subsequently reopened), taking nearly 830,000
barrels a day of refining capacity offline. While capacity at some existing refineries
expanded during this time, the fact is that more capacity would exist if these refineries
were still operating.

According to Energy Information Administration, the following refineries were shut
down between 1995 and 2001:

Year               Refinery                                  Location
1995 9             Indian Refining                           Lawrenceville, IL
                   Cyril Petrochemical Corp.                 Cyril, OK
                   Powerine Oil Co.                          Sante Fe Springs, CA
                   Sunland Refining Corp.                    Bakersfield, CA
                   Caribbean Petroleum Corp.                 San Juan, Puerto Rico

1996 10            Tosco                                     Marcus Hook, PA
                   Barrett Refg. Corp.                       Custer, OK
                   Laketon Refg.                             Laketon, IN
                   Total Petroleum, Inc.                     Arkansas City, KS
                   Arcadia Refg. & Mktg.                     Lisbon, LA
                   Barrett Refg. Corp.                       Vicksburg, MS
                   Intermountain Refg. Co.                   Fredonia, AZ

1997 11            Gold Line Refg. LTD                       Lake Charles, LA
                   Canal Refg. Co.                           Curch Point, LA
                   Pacific Refg. Co.                         Hercules, CA

1998 12            Gold Line Refining Ltd.                   Jennings, LA
                   Petrolite Corp.                           Kilgore, TX
                   Shell Oil Co.                             Odessa, TX
                   Pride Refg. Inc.                          Abilene, TX
                   Sound Refg. Inc.                          Tacoma, WA



 9
     Energy Information Administration/Petroleum Supply Annual 1995, volume 1, p. 80
10
     Energy Information Administration/Petroleum Supply Annual 1996, volume 1, p. 119
11
     Energy Information Administration/Petroleum Supply Annual 1997, volume 1, p. 80
12
     Energy Information Administration/Petroleum Supply Annual 1998, volume 1, p. 119


                                                  page 6
Year                Refinery                                 Location
199913             TPI Petro. Inc.                           Alma, MI

200014             Pennzoil                                  Rouseville, PA
                   Berry Petroleum                           Stephens, Ark.
                   Chevron                                   Richmond Beach, WA

200115             Premcor                                   Blue Island, IL

These refinery closures took more than 830,000 barrels per day of refinery capacity out
of production.

             Refinery Capacity Lost Due to Refinery Closures Between 1995 - 2001
                         < Numbers in Barrels per Calendar Day >

                            1995                     191,750 bbl/cd 16
                            1996                     268,750 bbl/cd 17
                            1997                      87,100 bbl/cd 18
                            1998                     123,650 bbl/cd 19
                            1999                      51,000 bbl/cd 20
                            2000                      25,700 bbl/cd 21
                            2001*                     80,515 bbl/cd 22
                        Total Capacity Lost:         828,465 bbl/cd

The major oil companies had a financial interest in seeing the closure of independent
refineries. By reducing the overall supply of oil and gas and reducing the number of
companies involved in producing it, the major oil companies can have tighter reins on the
supply and the price.


13
     Energy Information Administration/Petroleum Supply Annual 1999, volume 1, p. 116
14
     Phone Conversation with Mark Connor, Energy Information Administration Analyst, May 9, 2001
15
     Ibid.
16
     Energy Information Administration/Petroleum Supply Annual 1995, volume 1, p. 80
17
     Energy Information Administration/Petroleum Supply Annual 1996, volume 1, p. 119
18
     Energy Information Administration/Petroleum Supply Annual 1997, volume 1, p. 80
19
     Energy Information Administration/Petroleum Supply Annual 1998, volume 1, p. 119
20
     Energy Information Administration/Petroleum Supply Annual 1999, volume 1, p. 116
21
     Phone Conversation with Mark Connor, Energy Information Administration Analyst, June 12, 2001
22
     Ibid.


                                                  page 7
FINDING 4:
Record Profits: Oil Companies Reap Benefit of Higher Prices at Pump

Despite complaints indicting the cost of environmental compliance and manufacturing
"boutique" fuels, in the 2000 the oil and gas industry enjoyed record profits that reflect
record gas prices.

According to Texaco's 2000 Annual Report, the company's production steadily
decreased from 1998 to 2000, yet its net income more than quadrupled during the same
period ­ with Texaco posting well above $2.4 billion in net income in 2000.

The following charts show this dramatic relationship and point to the tremendous
increase in profits for Texaco.

Texaco Production Steadily Dropped from 1998 ­ 2000 23




Texaco's Net Income Quadrupled from 1998-2000 24




Commenting on Texaco's strong first quarter 2001 showing, Chairman and CEO Glenn
Tilton said in a news release, "Our outstanding first quarter results follow our record fourth
quarter and mark the third consecutive quarter that earnings surpassed $800 million."25

23
     Texaco 2000 Financial & Corporate Highlights (www.texaco.com/investor/2000ar/index.html)
24
     Ibid.
25
     Texaco Press Release: Texaco Reports First Quarter Earning Data ­ April 26, 2001



                                                  page 8
Chevron's net income increased from $2.07 billion in 1999 to $5.185 billion in 2000,26 a
250 percent increase. During the same period, ExxonMobil Corporation's net income
jumped from $7.9 billion to $17.7 billion.27 The trend continued with BP Amoco p.l.c.
whose 2000 profits were $11.87 billion, up from $5.008 billion in 1999.28

Among these four companies alone, profits for the year 2000 increased by over $22
billion dollars in one year. In light of these substantial profits, oil industry claims that
they cannot afford to comply with environmental regulations or expand their refining
capacity lack credibility.

FINDING 5:
National Energy Policy Incentivizes Oil Companies to Expand Refinery Capacity

The Bush administration's National Energy Policy, released in May, points to lagging
profit margins and costly environmental regulations during the past decade as the reason
for lost refinery capacity. The report also states that, "excess capacity may have deterred
some new capacity investments in the past," and that "more recently, other factors, such
as regulations, have deterred investments." 29

Oil companies cited excess capacity in the mid-1990s as a cause of inadequate profit
margins. It was this excess capacity that the companies sought to eliminate in order to
improve their margins. Subsequently, refineries were closed. The industry documents
cited earlier indicate that oil companies may have closed those refineries specifically to
tighten supply and drive up costs.

This strategy is paying off in multiple ways. In addition to forcing higher gas prices and
realizing exploding profits, the industry now stands to benefit from a national energy
policy that could reward anti-consumer actions by weakening environmental standards.

The National Energy Policy verifies that America currently faces tight supply and high
prices, as well as the fact that oil and gas companies enjoyed higher profit margins in
2000.

           "During the last ten years, overall refining capacity grew by about 1 to 2
           percent a year as a result of expansion in the capacity of existing, larger
           refineries. Although there was a significant, sustained improvement in
           margins during 2000, those gains arose out of a very tight supply situation


26
  Chevron Press Release: Chevron Reports Net Income of $1.5 Billion in Fourth Quarter And $5.2 Billion
for 2000, January 24, 2001
27
     ExxonMobil 2000 Annual Stockholder Report, released January 24, 2001, p. 29
28
     BP Amoco p.l.c. 2000 Annual Stockholder report, released May 8, 2001, p. 34
29
     Report of the National Energy Policy Development Group, released May 17, 2001, p.7-13



                                                   page 9
            and high volatile prices. Industry consolidation has been a key response to
            this poor profitability" 30

This is precisely the situation the 1995 and 1996 oil and gas company documents
encouraged as a method of improving profit margins.

The National Energy Policy calls for efforts to "streamline" environmental regulations
and permitting to provide financial incentives for oil and gas exploration and
development and to institute cost benefit analysis when implementing environmental
regulations.

Some of the specific recommendations from the Bush administration's National Energy
Policy include:
        "Recommendations:
               · The NEPD Group recommends that the President direct
                  the Administrator of the Environmental Protection
                  Agency and the Secretary of Energy to take steps to
                  ensure America has adequate refining capacity to meet
                  the needs of consumers.
                  · Provide more regulatory certainty to refinery
                       owners and streamline the permitting process where
                       possible to ensure that regulatory overlap is limited.
                  · Adopt comprehensive regulations (covering more
                       than one pollutant and requirement) and consider
                       the rules' cumulative impacts and benefit.

                     ·   The NEPD Group recommends that the President direct the
                         Administrator of the Environmental Protection Agency, in
                         consultation with the Secretary of Energy and other
                         relevant agencies, to review New Source Review
                         regulations, including administrative interpretation and
                         implementation, and report to the President within 90 days
                         on the impact of the regulations on investment in new
                         utility and refinery generation capacity, energy efficiency,
                         and environmental protection."
                         · The NEPD Group recommends that the President direct
                              the Attorney General to review existing enforcement
                              actions regarding New Source Review to ensure that the
                              enforcement actions are consistent with the Clean Air
                              Act and its regulations." 31




30
     Report of the National Energy Policy Development Group, released May 17, 2001 p. 7-13
31
     Ibid. p. 7-14


                                                  page 10
While these recommendations stop just short of calling for weaker environmental
standards, the report identifies regulations as one of the causes of the shortage of refinery
capacity. The implication is that regulations could be relaxed as an incentive for
increasing capacity.

If this approach becomes reality, the U.S. government will reward the same oil
companies who perpetuated the gasoline supply crunch, those companies who may have
deliberately worked to close refineries and reduce supply. These companies, already
enjoying record profits because of their actions, would reap even higher profits by
recognizing the cost savings of relaxed environmental standards. As a result, oil and gas
profits would continue to rise, the public would be saddled with the costs of dirtier air,
and consumers would remain unprotected from high gas prices.




                                           page 11