STATEMENT OF

J. BENNETT JOHNSTON

Thursday, July 20, 2000

Mr. Chairman, members of the Committee. I am pleased to accept your invitation to speak on current energy problems. I hasten to say that my testimony is my own, unfortunately, unaided by staff, and is not that of The Chevron Corporation on whose Board I serve.

Every evening on television we are regaled by charges of "price gouging" by big oil companies. Numerous members of Congress echo the charge, and Chairman Henry Hyde has procured an FTC investigation on the issue.

Well, the price of gasoline has doubled in many areas in the last few months while oil companies profits are at their highest levels in years. Ergo, gouging has been proved. Case closed.

H.L. Mencken said that for every complicated problem there is a simple solution and, "it is always wrong." Few subjects have received as much distortion, misrepresentation and hypocrisy as has fuel pricing. The current FTC investigation is, by my account, the 17^th investigation since 1973. (See attached list) Not one of these investigations has found evidence of price gouging and so it will be with the current investigation.

There have been two investigations undertaken by federal authorities on the subject of current energy price escalations: one by the Energy Information Administration of the Department of Energy on the subject of "Rising Crude Oil in Gasoline Prices" and the other by the Congressional Research Service on the subject of "Midwest Gasoline Price Increases." Neither found evidence of oil company gouging.

The Congressional Research Service Report of June 30^th, 2000 focused in detail on the Midwest gasoline price increases. The Report noted that wholesale prices in the Chicago markets began to decline during the week of June 19^th and have fallen by 40 cents per gallon since. However, the earlier price discrepancy between the Midwest and the rest of the country which varied between 42 to 59 cents could be identified as to cause.

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"Contributors to the higher prices appear to be the high price

and low supply of crude oil, problems at two pipelines supplying

the area with gasoline, the use of ethanol-only formulated gasoline

(RFG) in Chicago and Milwaukee, and apparent concern among

refiners regarding use of a Unocal patent for making RFG."

The Report was also able to allocate the full amount of the difference to specific causes.

"About 48 cents of the current gasoline price is likely due to higher

crude oil costs. That affects gasoline consumers everywhere. It can

also be roughly estimated that about 25 cents of the regional price

increase is due to transportation difficulties. As much as another

25 to 34 cents, roughly estimated, could be due to the unique RFG

situation in Chicago/Milwaukee. The term 'unique situation' refers

to the combination of limited supply, the choice of ethanol for use in

the area's reformulated gasoline, and RFG transportation problems."

On June 29 the Director of the petroleum division of the EIA testified (regarding their report) before the Senate Government Affairs Committee that the crude oil price rise was "the result of a shift in the global balance between production and demand," and that "...in 1999 crude oil prices rose faster than product prices, squeezing refinery margins."

If this is so, how do we account for higher oil companies profits? Very simple. It is because these profits were made in the "upstream" part of the business. Crude oil was produced (for the most part abroad) and sold into the world market at higher world market prices. At Chevron, for example, we had the best first quarter profits in years, but made virtually nothing on the sale of motor gasoline.

Historically, oil companies profits have not been up to standard. From 1994 to 1998 oil company profits have averaged 7.2 percent, about ½ of the 14.2 percent overall average

for the S & P Industries and in 1999 fuel producers averaged 11.1 percent versus 17.1 percent for the S & P Industrial average. And even with higher crude oil prices of late, the price/earnings ratios of major oil companies have lagged behind-- compare Chevron and Texaco at price earnings ratios of less than 20 to Microsoft (with all its problems) at 49.

PROBLEMS IN ENERGY

The gasoline problem in America is easing--the retail price of gasoline dropped for the second straight week to $1.625 per gallon as of July 3^rd according to EIA.

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But real problems remain: supply, price and volatility. These problems are related and relative.

On supply, the bad news is that America's oil imports are increasing--from about 50 percent when I retired from the Senate four years ago to 56 percent today. And according to EIA, imports will be 70 percent by 2020. The good news is that there appear to be adequate reserves of crude oil worldwide for the foreseeable future.

On price, the bad news is that crude oil prices have tripled--from $11 in late 1998

peaking at $34.13 on March 7 and is still about $30. Natural gas prices have doubled in the same time frame. We can take some solace, though perhaps not much politically, from the fact that crude oil is less than one-half the $70 inflation-adjusted price of 1981, and natural gas is less than 15 percent of the inflation - adjusted peak spot price of the 1970's.

OPEC can, and is, effectively controlling the price of crude oil by limiting supply. The artificially high OPEC prices of the 1970's produced massive worldwide conservation and production and drove the price of crude oil down by more than two-thirds. And it will happen again. But it takes time.

The problem that is perhaps the most difficult of all is volatility. Doubling the price of gasoline to $2 dollars per gallon is a real problem for the tight-budgeted owner of a 12 mpg SUV. Changes to more fuel efficient cars cannot be made rapidly--or cheerfully.

In my opinion, energy is likely to again emerge as a front-burner issue, as it was in the 1970's. Currently, the problem is gasoline prices. Tomorrow, or sometime soon, it will be blackouts and brownouts from electricity shortages and disruptions. Next winter escalating natural gas prices may be a real problem for the consumer. Indeed, natural gas price rises may plague us for years to come as its constrained supply is assaulted by increasing demand for clean-burning fuel for electricity generation. The question is, how will the Congress react to these problems?

COMPETITIVE MARKETS ARE THE SOLUTION

When I came to the Senate in 1973 virtually every form of energy was highly regulated. Natural gas in the interstate markets was controlled from the well head to the burner tip. Crude oil was similarly regulated, and electricity was thought to be a natural

monopoly. Other laws and regulations that would make Rube Goldberg blush were enacted, such as the Fuel Use Act to prevent the burning of natural gas under boilers, the Small Refinery Bias, The Windfall Profits Tax, and the Synfuels Corporation.

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These regulation produced a real energy crisis. Hundreds of thousands of American workers were laid off because of natural gas shortages, gasoline rationing was seriously proposed and so-called experts were predicting that natural gas and crude oil would be depleted shortly after the turn-of-the-century.

Undoing these laws and regulations and installing free market rules in their place required a series of legislative fights that were the most controversial of any that I was involved in, in 24 years in the Senate. And in each instance, the regulators predicted disaster, and in each instance they were wrong--totally, completely, demonstrably, wrong. Today, many of those who say we don't have an energy policy seem to suggest that we should in fact install a policy that eliminates price volatility--a policy that controls prices

and supplies. To those, I say we have tried that, and the results were disastrous.

Today's energy policy--market competition--should be retained and protected.

Indeed, it should be expanded to include competition in retail electricity.

The temptation to "do something" is politically tempting. As long as it is only another investigation of the oil companies, it probably does no real harm although the results are predictable.

What does do harm is assaulting the free market. A good example of such a proposal is the "Northeast Heating Oil Reserve."

The high heating oil prices in the Northeast last winter were caused by a temporary shortage in supply. Those higher prices in a free market will elicit more supply and, in time, lower prices.

Some members of Congress and the Administration propose a 2 million barrel heating oil reserve. This sounds good, as most regulations do, but it will have exactly the opposite effect. It is an expensive proposition to purchase and store heating oil. Suppliers will, therefore, be induced to lower their own supplies and its attendant expense in anticipation of the government release of the supply. Who would get the government supply and at what price? Such a challenge recalls the crude oil regulations of the 1970's.

Moreover, heating oil supplies must be "turned"--withdrawn and refilled--to prevent deterioration. Suppliers typically turn their supplies five times a season. The government would do so less often. So the result would be that the government would buy up to 2 million barrels of reserve capacity from existing suppliers who are presently turning that

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supply five times over each season. In effect the government would be taking out of the suppliers hands 10 million barrels of capacity, but the government would be supplying only 2 million barrels of capacity, in its place.

The resulting shortage and price increases would produce calls for tighter regulation and bigger government reserves. One can't help but recall the demands for the nationalization of the oil companies during the shortage of the 1970's.

Other anti-free market proposals such as using the Strategic Petroleum Reserve to control prices are always either too late to help or counterproductive. The Reserve should be used only for its intended purpose: to alleviate a serious supply disruption.

WHAT CAN CONGRESS DO?

There are sensible things that the Congress can and should do to maximize domestic energy supplies, such as:

1. Drilling in the Arctic National Wildlife Refuge, the Destin Dome off Florida Gulf Coast and other promising areas;

2. Extending the Deep Water Royalties Relief Act which has been a huge success in eliciting drilling in the deep water OCS;

3. Restructuring the electricity industry in order to bring competition to retail markets;

4. Streamlining citing requirements and addressing right-of-way problems for gas pipelines and electricity generation and transmission facilities; and

5. Removing artificial barriers which prevent nuclear energy from competing in the market.