WHY GASOLINE PRICES REMAIN HIGH DESPITE

EXCESS SUPPLY

WEDNESDAY, JUNE 18, 1980

U.S. SENATE,

SUBCOMMITTEE ON ANTITRUST, MONOPOLY

AND BUSINESS RIGHTS,

COMMITTEE ON THE JUDICIARY,

Washington, D.C.

The subcommittee met, pursuant to notice, at 9:30 a.m., in room 5110, Dirksen Senate Office Building, Senator Howard M. Metzenbaum (chairman of the subcommittee), presiding.

Present: Senators Metzenbaum and Thurmond.

Also present: Herman Schwartz, chief counsel; Margery Baker, counsel; Peter Chumbris, minority chief counsel; Joseph Lanham, minority chief economist; and Marilyn Falksen, chief clerk. Senator METZENBAUM. The subcommittee will come to order.

OPENING STATEMENT OF SENATOR METZENBAUM

Elementary economics says that when supply exceeds demand, prices will fall. So why do prices of gasoline and heating oil keep going up?

Supplies of crude oil, gasoline and heating oil are way above normal, and the U.S. gasoline and heating oil consumption have dropped for 2 years in a row. But in defiance of the principle of supply and demand, prices are not falling-and most experts say prices will even rise further.

Those are my views. Those are the questions I want answered. But I am not alone in raising this issue. For the words and questions I have just recited are a direct quote from an article in last Friday's Wall Street Journal.

The people of this country have heard a lot of inspiring rhetoric over the last several years on the need to conserve energy.

The administration has used conservation to justify its policy of promoting higher and higher energy prices. The oil industry has filled the airwaves with advertisements calling upon the country to "go on an energy diet."

We have heard time and again from the industry and the administration about letting "the market" set the prices. In fact, on Monday of this week, Mobil published an ad with this conclusion:

We think that most Americans, given the choice, would prefer the scramble of free markets-and the cost efficiencies that only competition can produce.

I agree with Mobil 100 percent. The American people believe in competition. They believe in the free market. They are entitled to the benefits that competition brings.

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But what we are asking today on behalf of the American people I is a very simple question-and that is, why is the oil market in this country so totally exempt from the economic laws that prevail in a truly free market?

Consider for a moment the perverse behavior of gasoline prices since January. We see gasoline supplies way up-in fact, stocks of gasoline over this period were far above the normal range, according to the Energy Information Administration of the Department of Energy.

We see that gasoline consumption came down. But prices-prices rose, then leveled off somewhat. But in spite of excess supply, prices did not drop and are not dropping today. In fact, the experts are predicting sharply higher prices in the months to come-with gasoline reaching $2 a gallon in 1981.

Now I am familiar with the argument that OPEC is to blame for the fact that oil prices rise, even in times of glut. That is how the o companies explained what happened last winter, when oil and diesel fuel prices went up by nearly 90 percent over the level of a year before.

But what really caused those whopping increases?

According to a thorough investigation conducted at the time by Congressman Benjamin Rosenthal, last year's increases in diesel fuel and heating oil prices were far in excess of the levels that could be justified by higher crude oil prices and the general effects of inflation. Between September 1978 and September 1979, refiners' margins for these fuels increased by an incredible 200 percent-from 7 cents gallon in 1978 to 21 cents a year later.

Oil company profits from heating oil rose in the same period by 800 percent and diesel fuel profits went up by 700 percent.

Where, I wonder, was that "cost efficiency" and "scramble of free markets" which Mobil so lavishly praises in this week's canned economic wisdom?

Why was it that one of those fierce competitors in the oil industry could not have settled for-say-a mere 100-percent increase in heating oil profits, as against the actual 800 percent.

Wouldn't that have been more in the competitive manner?

In the immortal words of Yogi Berra, "You can observe a lot just by watching."

Congressman Rosenthal was not the only one who was watching. The prestigious National Bureau of Economic Research, for example, has published a study which concludes that soaring OPEC prices go hand in hand with soaring oil industry profits.

In September 1979, the Wall Street Journal ran an article entitled "Refiners Are Suspected of Using Heating Oil To Warm Their Profits." Now all of these analyses make it clear that the oil companies of this country cynically used 1979's OPEC price increases to camouflage their own gouging of the American consumer.

Let those with short memories remember what that unconscionable price runup meant for millions of people in this country.

Let us not forget the emergency legislation that the Congress had to pass to get the poor through the winter without freezing.

Let us not forget the millions of Americans-particularly the elderly-who had to choose between heating and eating.

Let us not forget either that the extraordinary oil company profits derived from diesel fuel showed up in higher transportation costs and, therefore, in higher prices for everything that every one of us must buy.

Above all, we cannot afford to forget how the oil companies, with the active assistance of the Treasury and Energy Departments, used the phony "Iranian shortfall" of 1979 to create gaslines and to double gasoline prices.

Remember when we were told last year that the loss of Iranian imports meant gaslines and higher prices? But now we know that imports from other countries more than offset the loss of imports from Iran.

As a matter of fact, world production of crude oil in the first half of 1979 was almost 6 percent higher than it was for the comparable period in 1978, and U.S. imports were up almost 8 percent in 1979. No, there was plenty of crude around-it was just not being brought on line by an industry whose refineries were operating at the extraordinarily low rate of 83 percent. What gasoline there was went into stockpiles-and off the market.

Now Treasury knew there was no shortage. The DOE knew it too. But revealing the true acts would have been inconsistent with the administration's high-price policy. So Americans waited in line, and paid the extortionist prices, while their own Government sat by with arms folded and did nothing.

The inaction was profitable-immensely so-for the oil companies of this country.

In the first quarter of this year, while profits in the non-oil-manufacturing sector of our economy dropped by 6 percent as compared with the same period last year-and in this chart over here you can see where other manufacturers have had difficulty-oil company profits were up an average of 80 percent.

[Senator Metzenbaum pointing to charts.]

Senator METZENBAUM. That is, 80 percent above the record pace that oil profits set in 1979. And as extraordinary as these profits figures are, they may, in fact be understated.

Charles Breecher, a member of the Republican National Committee's Council of Economic Advisers, has pointed out that the industry's use of sophisticated accounting techniques has "successfully camouflaged" true earnings that are even higher than the outrageous levels to which the industry will admit.

Today, we are going to hear from several major oil companies and the Secretary of Energy. I hope that they will be able to shed some light on issues that are profoundly disturbing to me and to the people of this country. We need answers-and we need them now.

The Chair wishes to acknowledge the presence of the Secretary of the Department of Energy. I am aware of the fact that his presence here this morning was at some inconvenience to himself. He was out of the city. He came back. He has two hearings this morning, one with Senator Bayh on another subject. I want to say to him that I am very

grateful to him for finding the time to be with us this morning. I know that the Secretary has a statement and will take a few questions and then has to leave, but Mr. Doug Robinson will remain, in his stead. But I do want to express my appreciation to you for finding the time to be with us this morning. Your testimony is very important to us.

We will be very happy to hear from you now, sir.

STATEMENT OF HON. CHARLES W. DUNCAN, JR., SECRETARY, DE PARTMENT OF ENERGY, ACCOMPANIED BY DOUGLAS ROBINSON, DEPUTY ADMINISTRATOR, OF POLICY, ECONOMIC REGULATORY

ADMINISTRATION

Mr. DUNCAN. Thank you very much, Mr. Chairman.

I appreciate the opportunity to discuss with you recent trends in gasoline supplies and prices.

We believe that the apparent anomaly of increasing gasoline prices coupled with high gasoline supplies has one main explanation; that is, higher costs for gasoline producers, particularly the skyrocketing price of the crude oil they refine.

We estimate that from June 1979 to June 1980, the average cost of crude oil to domestic refiners increased by 70 percent, from about $17 per barrel to about $29 per barrel.

The price of gasoline at the pump increased a little over one-half, from about 80 cents per gallon to about $1.23 to $1.25 per gallon.

In the testimony this morning, I am going to briefly outline the conclusions that we have reached on this issue. I have a prepared statement that I will submit for the record, Mr. Chairman, which has some exhibits.

Senator METZENBAUM. Your prepared statement will be included in the record at the conclusion of your oral testimony.

Mr. DUNCAN. It will go into the question in more detail than I will in my brief statement. As you indicated, Mr. Douglas Robinson, who is the Deputy Administrator for Policy of the Economic Regulatory Administration, is here with me and will stay after I leave to help respond to your questions.

During the past several months, the supply situation in the United States for crude oil, gasoline, and other products has improved sig nificantly over the corresponding period in 1979.

The stocks of crude oil are about 18 percent higher than at the same time 1 year ago. Gasoline stocks at the primary level are at near record highs, about 18 percent above the level of 1979.

Similar supply conditions have been reported in other parts of the world. Much of the credit for this improvement in the United States must go to the people and the businesses of this country. They have increased dramatically their efforts to conserve fuel. Let me add & word of caution. The fact that supplies are relatively sufficient today in no way guarantees that they will be adequate tomorrow. World supply and demand are in a very tenuous balance. It is a balance that could be upset very easily and suddenly. We must continue to make every effort we possibly can to reduce our dependence on imported oil.

In spite of the relatively adequate supply of crude oil average crude oil prices, both foreign and domestic, have continued to rise at a substantial pace.

We have seen OPEC price increases in December, in January, in April, and now in June.

Last June, 1 year ago, the average cost of oil-foreign and domestic-to U.S. refiners was about $17 a barrel. The average cost of the imported barrel was around $21. Based on the recently announced price increases by many producing countries, we now estimate that average refiner acquisition cost during this month will be over $29 per barrel for all crude oil, and about $35 a barrel for imported crude oil.

Even in a market that is characterized by relatively ample supplies, most of these cost increases would be reflected in the prices of products such as gasoline.

In the long run, suppliers must price their products in such a way as to recover their costs. This is recognized in the Department's gasoline price regulations which provide that increased crude oil costs may be passed through to the price of gasoline.

Therefore, even the presence of abundant supplies is not likely to reverse the trend of increasing prices if crude oil prices and other costs are also increasing significantly.

But, in a competitive market one can expect adequate supplies to have a moderating effect on the upward price trend, as refiners and marketers keep their profit margins lower than they otherwise would be in order to sell gasoline.

In fact, precisely that appears to have happened over the past few months.

Recently, the price of gasoline at the pump has risen at a very modest rate. Since March, it has increased only about a penny or two a gallon. That statement is based on independent surveys that were published by Platt's Oilgram.

We are generally finding that fewer and fewer dealers are actually pricing at or above their maximum margins, a result that we think is caused by the relatively ample supplies and, therefore, increased competition.

The refiners' "banks" or "banked costs," the unrecovered costs from previous months, have risen very dramatically in the past year. All of this evidence leads to the conclusion that both increased gasoline supplies and increased competition have kept the price of gasoline lower than the increased costs alone would have made those prices.

In short, product prices will continue to rise even in a market of ample supplies if refiners continue to experience substantial increases in cost, particularly in crude oil cost. But the existence of relatively ample supplies is moderating these price increases by reducing refiner and marketer profit margins from the levels they would otherwise have reached.

Gasoline prices are higher, but they are not as high as they would be if we did not have our current high inventory levels.

We have had some success in our program. The percentage of imported oil in the total mix of oil we use was approaching 50 percent. It is now down to approximately 40 percent.