Illinois House Special Committee on Gas Pricing
FINAL REPORT 

February 1, 2001

 

SUMMARY

The House Special Committee on Gas Pricing was created by House Speaker Michael J. Madigan on June 27, 2000 for the purpose of investigating the reasons for dramatic increases in gasoline in Illinois during May/June as well as to monitor fluctuations in gasoline during the summer and fall months.  The House Special Committee conducted its investigation through a series of fact-finding public hearings and by reviewing all reports and analyses on Midwest gas prices issued in 2000.  Four public hearings were held on July 12, August 11, September 28 and November 1.  The following is the summary of findings by the House Special Committee:

 

Ø      FINDING #1.  The economic forces of supply and demand may drive gasoline prices on an international scale but do not fully explain the steep price hikes in Illinois in May/June 2000.

 

Ø      FINDING #2.  The transition to the new summer-grade reformulated “clean air” gasoline may have accounted for some start-up difficulties for refiners but do not fully explain the steep gas price hikes in May/June 2000.

 

Ø      FINDING #3.  The imminent closure of Premcor’s Blue Island refinery could result in supply disruptions in unbranded gasoline and a repeat of steep gas spikes during the summer of 2001.

 

Ø      FINDING #4.  In order to maintain clean air standards while protecting Illinois’ water supply, pollution credits and tax incentives are needed to assure the economic competitiveness of ethanol.

 

Ø      FINDING #5.  There is evidence that the large variety of gasoline blends required for Illinois and Midwest markets may impact gasoline prices by making it more difficult to correct temporary supply disruptions.

 

Ø      FINDING #6.  The evidence is inconclusive whether the temporary suspension of the State Sales Tax on Motor Fuel had the greatest benefit for motorists, gas stations, truckers, or the major oil companies.

 

Ø      FINDING #7. Remaining issues require further investigation to understand completely the reasons for high Illinois gasoline prices in May/June as well as the price spikes that are likely to occur in the future.

 

The recommendations of the House Special Committee are found on pages 10-11.

 

FINDINGS & ANALYSIS OF

THE HOUSE SPECIAL COMMITTEE ON GAS PRICING

 

 

 

Impact of International Crude Oil Prices

 

Testimony before the House Special Committee as well as documents reviewed by the Committee point to the cost of crude oil and low gasoline stocks on the international level as the largest factors in gasoline price increases during 2000.  The cost of crude oil rose from a low point in December, 1998 of under $11 per barrel to $31.74 as of June 13, 2000 and $33.92 per barrel as of October 27, 2000.[i]   With crude oil prices increasing throughout 1999, refineries produced less gasoline nationwide and gasoline inventories dipped.  These low stocks demanded higher prices and correspondingly greater margins for wholesalers.

 

These factors added the initial 47 cents to the price of gasoline during the summer of 2000:  33 cents per gallon due to crude oil price increases and 14 cents per gallon from wholesale gasoline profits.

 

However, the Federal Trade Commission concluded that reduced OPEC and refinery production levels affected prices and inventories in all sections of the United States in a “broadly similar way” but do not explain the steep price hikes in the Midwest.[ii]

 

Impact of Midwest Gasoline Supply Levels

 

There is evidence that during the first 5 months of 2000, there was a tight but adequate level of Midwest supply of reformulated gas (RFG) — the blend of “clean air” gasoline required in ozone non-attainment zones such as the Chicago/Gary/Milwaukee metropolitan area. The federal Energy Information Administration, charting the production of RFG in the Midwest since 1995, concluded that “overall refinery production in the Midwest did not vary greatly in the first half of 2000 compared to the previous year especially in volumes of reformulated gasoline”[iii] — although stocks of Midwest conventional gas were “very low” and RFG was “not as extreme”.[iv] 

 

The U.S. Environmental Protection Agency disputed the notion that weak supplies justified the price hikes[v] and stated that “RFG supplies appear to be tight but adequate to serve immediate supply needs.”[vi] 

 

Six oil companies serving the Midwest reported to the EPA that they had adequate supplies of the summer blend RFG. This was stated in a challenge to requests by Illinois and Wisconsin gasoline marketers to the EPA to waive the requirement for the new blend of RFG.[vii]

Oil companies testified before the Special Committee on Gas Pricing that they resorted to a variety of measures to make sure there would be adequate supply.  Marathon Ashland Petroleum arranged to barge product from Canada to the Midwest and to drive transports “around the clock”[viii] — with a net result of 10% more gasoline for the company in the Midwest market in 2000 than in 1999.  BP Amoco “took action to avoid supply outages” by maximizing total gasoline and RFG production at their refineries, chartering barges and marine vessels, and leasing third party tanks.[ix]

 

Finding #7 of this report lists additional questions and issues that relate to the adequacy of supply and to inventory practices, affecting market dynamics “when supplies are tight. . . [to] bid the price of gasoline higher than economic principle would dictate.”[x]  

 

Impact of Temporary Pipeline Disruptions

 

Oil company representatives testifying before the House Special Committee on Gas Pricing repeatedly pointed to pipeline disruptions as contributing to low supplies and the corresponding price spikes in May/June, 2000.

 

Although the Explorer Pipeline from Texas to Tulsa and Chicago malfunctioned on March 10 and the Explorer pipeline was thereafter required to operate at 10% reduced volume, [xi] there is contradictory evidence that the 10% reduction in flow affected only the segment between Houston and Tulsa and did not affect Chicago.[xii]  The segment of the Explorer Pipeline that runs from Tulsa to Chicago apparently has been running at full capacity since March, and was delivering the same supply as last year with an increase in June over last June’s flow.  

 

In the St. Louis area, the Pipeline Explorer leak did cause RFG inventories to become sufficiently low that the Missouri Governor sought and received three separate waivers from the U.S. Environmental Protection Agency to allow distribution of conventional gasoline in that area.  The waivers were intended to encourage terminals to build their RFG inventories.  Testimony before the House Special Committee indicated that “this act exacerbated the supply shortage” because the St. Louis market began to draw down supplies of conventional gasoline intended for other markets, including Illinois.[xiii]   This factor may explain a question that Illinois legislators repeatedly posed to industry representatives on fluctuations in conventional gasoline prices throughout downstate Illinois counties during May/June — but does not explain the fluctuations continuing to this day.

 

In addition, oil industry representatives pointed to problems with the Wolverine Line in Michigan, which did experience an outage on June 7.  However, it is unclear how this pipeline that transports product from the Chicago region impacted on Chicago gasoline supply, except that there may have been additional demands on Chicago supplies from Michigan marketers. 

 

Impact on Earnings

 

“Cashing in on high energy prices”[xiv], during the tenure of the House Special Committee, the largest U.S. petroleum companies reported record second-quarter and third-quarter earnings. 

 

 

Impact of New Federal Standards for “Clean Air” Gasoline

 

Oil company representatives blame the introduction of new federal regulations for “clean air” gasoline for the price spikes in May/June.  By 1995, oil industry producers and refiners knew that Phase II of Clean Air Act regulations for summer blend reformulated gasoline in high ozone urban areas would be effective on May 1, 2000 at the wholesale level and by June 1, 2000 at the retail level.

 

Despite the five-year advance notice, refiners assert that they had “an initial learning curve”[xv] in producing the new Phase II RFG blend. The new low-volatility blend (refers to the speed of evaporation) specifically used in the Chicago/Milwaukee area apparently was more complex to produce than the Phase I product.  While all 6 refineries supplying this market made the investments in preparation for Phase II RFG, some refineries experienced difficulties in making the same level of gasoline as in prior years, while other refineries increased production compared to last year.  The refineries with production decreases met their own company market commitments, but required independent marketers to find new supply sources in the marketplace, driving up prices on the “spot market”.[xvi] 

 

Moreover, refiners state that since Phase II RFG cannot be co-mingled with other products at the terminals or the gas pumps, tanks had to be emptied of winter-grade gas prior to May 1 in preparation for the new Phase II blend.  While this process of “drawing down” the tanks to low levels is a common annual process in transitioning from winter blend to summer blend fuels, oil industry representatives reported they had to drain tanks empty this spring with the introduction of the more stringent Phase II blends.

 

The best evidence that the start-up difficulties were transitional and short-lived is that prices for Phase II RFG fell precipitously for regular gas in Chicago (RFG) from $2.20 on June 16, 2000 to $1.46 by July 31 (Appendix A).

 

Production Costs of “Clean Air” Gasoline

 

While oil company representatives were understandably cautious about discussing any cost information, witnesses testifying before the House Special Committee agreed that the difference in production cost between conventional gas and RFG is only 5-8 cents per gallon.   This is only 1-2 cents more for Phase II than Phase I RFG. 

 

At the first hearing of the House Special Committee on July 12, 2000, the United States and Illinois Environmental Protection Agency representatives estimated the cost of the Phase II RFG requirements at 4-8 cents per gallon more than conventional gas. At the second hearing of the House Special Committee, each of the four oil company representatives was asked the following question:  “The EPA estimates that RFG costs between 5 to 8 cents more than conventional gasoline. Do you dispute that estimate?”  All four oil company representatives said that they agreed with that assessment.[xvii]

 

Comparison of “Clean Air” RFG and Conventional Gasoline Prices

 

Evidence that Phase II RFG did not drive the high price of gasoline in Illinois is demonstrated further in price comparisons with RFG and conventional gasoline in other parts of the state and nation.

 

In cities using ethanol in RFG such as St. Louis and Louisville, prices were 30-40 cents cheaper than Chicago’s in June, 2000.  Detroit has no RFG requirement and little ethanol blending yet the gasoline price there was similar to Chicago — skyrocketing above $2 per gallon. [xviii] 

 

On June 23, RFG was the lowest priced fuel available in the Chicago market — and was down by over 50 cents per gallon from the highest levels less than 2 weeks earlier. Wholesale prices on that day showed:[xix]

Ø      Phase II RFG Ethanol               Average wholesale price at $1.24, with lowest price at $1.15

Ø      Conventional unleaded              Average wholesale price at $1.24, with lowest price at $1.22

 

The Federal Trade Commission concluded that “RFG-related issues seem unlikely to provide a complete explanation for recent Midwestern gas price increases, because in the Midwest as a whole, conventional gasoline prices rose more dramatically than RFG prices from May to the end of June.”[xx]

 

 

Since the Subcommittee concluded its hearings, it was announced that Premcor is closing its Blue Island, Illinois refinery by January 31, 2001.  The closing of this 80,000 barrels/day refinery apparently takes an important unbranded gasoline supplier out of the market, possibly aggravating gasoline supply during the upcoming season.  “Unbranded” gasoline is sold by independent gasoline stations that are not owned or operated by the major oil companies.

 

In the early reports, “unbranded marketers say they face a real product squeeze.” [xxi]  Other suppliers with refining capacity in the region (BP, Exxonmobil, CITGO and Tosco) are buying additional branded gas stations and apparently are not eager to expand unbranded sales.   One oil company source already predicted $2.00 wholesale prices during the summer of 2001, with retail prices even higher.[xxii] 

 

 

Environmental Effects of Ethanol in RFG

 

Almost 100% of the Chicago and Milwaukee markets have chosen to use ethanol as the required additive in RFG and approximately 30% of the conventional gas market in downstate Illinois uses “gasohol” (gasoline with 10% ethanol).  Accordingly, use of ethanol extends the gasoline supply by 10%.

 

To make cleaner burning fuel, only two oxygenate additives are available to blend with gasoline — ethanol and MTBE (methyl tertiary butyl ether)  — but recently MTBE was discovered to be contaminating drinking water. Ethanol is a renewable fuel produced from corn, agriculture residues and waste products that does not cause water pollution and is readily available in the Midwest. 

 

There is also evidence[xxiii] that use of ethanol reduces emissions of carbon monoxide (CO) and lowers ozone levels due to the higher oxygen content of ethanol blends.  Ethanol contains twice as much oxygen as MTBE.  Governor George Ryan and the Governors’ Ethanol Coalition have sought a credit for ethanol-blended RFG based on reduced CO emissions.   The proposed new rule finally was filed by the U.S. EPA in July 2000, but not in time to ease the transition during the introduction of summer-grade RFG this spring.

 

With historic public support and tax incentives for ethanol, Illinois has successfully kept MTBE from entering the Chicago/Milwaukee/Gary RFG markets.  However, a new state law passed in the 2000 legislative session[xxiv] now requires that any gasoline with more than 1% MTBE must include a notice to this effect posted at the gas pump. Apparently some gasoline retailers are now putting MTBE labels on retail gasoline pumps, suggesting that gasoline “may contain MTBE” – as though “they were trying to desensitize their customers to understanding the environmental differences of MTBE and ethanol”.[xxv]

 

Economic Viability of Ethanol in Gasoline

 

Federal and state tax incentives have made gasoline blends with ethanol competitive in the Chicago and Illinois markets.  In Illinois, the sales tax on gasoline using ethanol is reduced by 30%.  Accordingly, for each $1.00 per gallon, the full Illinois sales tax is 6.25 cents and the tax on gasohol is 4.375 cents, close to a 2 cents difference.  It is these 2 cents that create the ethanol market.  This differential in ethanol sales tax is due to sunset on January 1, 2003.

 

In addition, the federal excise tax on gasoline using 10% ethanol is reduced by 30% — from 18.3 cents per gallon to 13 cents. 

 

At the second hearing of the House Special Committee — during the six-month period when the sales tax on all motor fuel was repealed — each of the four oil company representatives was asked the following question:  “If the sales tax advantage for ethanol were to be permanently removed, would it change your company’s business decision whether to use ethanol or MTBE in the Chicago market?”  All four companies stated that the Illinois tax incentive is a key component of this decision.[xxvi]

 

 

Oil industry representatives repeatedly pointed to problems with the large variety of “boutique fuels” required by government regulations that must be kept discrete and separated in the gasoline distribution system. 

 

In the 300-mile line between St. Louis and Chicago, three grades of gasoline are offered in each of four different EPA gasoline zones, for a total of 12 different varieties of gasoline, in the following zones:

Ø      Metro Chicago Non-Attainment Area: includes all or parts of 8 Illinois counties, plus counties in northeastern Indiana and southeastern Wisconsin

Ø      Metro-East St. Louis Non-Attainment Area: includes 3 Illinois counties

Ø      Illinois Conventional Area: includes 90 Illinois counties outside the non-attainment areas

Ø      St. Louis Non-Attainment Area

 

The Midwest RFG market is small (13% of Midwest gasoline) and isolated as a result of the region using a unique RFG fuel – blended with ethanol.  As a result, refineries outside the area are not interested in producing the unique gasoline RFG to be blended with ethanol.  During the May/June price spikes, all of the increases in supply came from the refineries in the area, selling to one another.[xxvii]

 

All oil company representatives reported to the House Special Committee on Gas Pricing that the complexity of this system prohibiting overlap between EPA zones, has “severely overloaded the transportation system” and therefore makes it impossible for gas companies to look to nearby sources in case of any supply disruptions.[xxviii] 

 

When asked whether “a more standardized RFG would be helpful?” one executive’s response to the Special House Committee was, “It truly would. We think it would improve the efficiency of the system.”[xxix]

 

 

For Illinois motorists, the temporary suspension of the State Sales Tax on Motor Fuel from July 1-December 31, 2000 meant a saving of 5 cents for each $1.00 purchase of gasoline.  With average statewide gas prices fluctuating almost every day -- from $1.81 on July 3, to $1.36 on August 14, to $1.56 on September 18 -- it is unclear whether motorists credited lower gas prices to the sales tax suspension (Appendix A).  Moreover, the Illinois Economic and Fiscal Commission concluded that the degree to which the reduction was passed on to motorists could not be precisely measured, in part because wholesale prices were falling at the same time the sales tax suspension went into effect.[xxx]

 

For gasoline stations in communities that border the surrounding states, the House Special Committee heard testimony that Illinois’ 6-month suspension of the state gas sales tax had a positive impact on business. Four companies submitted written testimony citing increases in gasoline sales of 5%-72% during the summer of 2000, when the Illinois gas sales tax was temporarily suspended, compared to summer of 1999.[xxxi] 

 

For truckers, a letter dated July 5, 2000 indicated that the trucking industry would be “closely watching the trend in fuel sales during the coming months and anticipate increased Illinois sales of diesel fuel”.[xxxii]  A second letter dated October 30, 2000 cited only anecdotal evidence that “feedback from some of our 2,700 member companies is that they see more diesel sales in many Illinois locations and the word among over-the-road truckers is getting out that Illinois is no longer a ‘pass through’ state where you don’t buy fuel.”[xxxiii]

 

Both the Illinois Economic and Fiscal Commission and Illinois Department of Revenue conducted small samples to analyze the impact of the sales tax suspension on total gallons of motor fuel sold and on ancillary sales (food, beverages, lottery tickets, etc.) at Illinois retail gas stations.  Based on the data available during these few months, both agencies concluded that the data was inconclusive that the gas sales tax suspension was a decisive factor in any increases in sales.  No analysis was conducted of motor fuel sales in other states, comparing summer months in 2000 and 1999, to analyze whether motorist and truck demand was increasing correspondingly throughout the nation. 

It is clear, however, that if there were increases in gasoline sales due to the gas sales tax suspension, the greatest profits were reaped by the major oil companies since it appears that only 15-20% of all Illinois gas stations are independent, i.e. have no contractual relationship with major oil companies.[xxxiv]  Of approximately 5,500 gas stations operating in Illinois[xxxv], most are owned by, operated by and/or selling “branded” gasoline on behalf of the major oil companies.  These branded gas stations — 80-85% of the total — are required to buy all of their supplies directly from the refinery owned by that oil company.

 

 

No witnesses testifying before the House Special Committee offered any reasons, except the high price of crude oil on the international market, for fluctuations in gasoline prices since May/June 2000.  Gasoline prices dropped significantly since the end of June and continuing throughout the summer, with no further pipeline problems, no changes in the Phase II RFG program and no changes in ethanol prices (which are sold by contract for RFG).  Similarly, gasoline prices have begun to increase since after Labor Day on September 5, 2000 with no further pipeline problems, no changes in the Phase II RFG program, no changes in ethanol prices and no gasoline sales taxes in Illinois (Appendix A).  

 

During the tenure of the House Special Committee, no investigation was conducted on inventory practices as well as import/export/transfer policies of the major refineries serving the various Illinois markets. The Renewable Fuels Association has criticized just-in-time inventory practices as “supply mismanagement” that leaves consumers vulnerable to even minor disruptions in supply or production.[xxxvi]  The consumer organization, Foundation for Taxpayer and Consumer Rights, issued a report that alleges “manipulations in inventory” as the main cause for the price spike, with an alleged draw down in conventional and RFG gasoline inventory levels in the Midwest just prior to the introduction of Phase II RFG.[xxxvii]  These charges are denied by the oil industry as “bogus”[xxxviii].  However, in a related matter, at the exact time that heating oil supplies in the Northeast region are tight and threatening winter price spikes in that region, it was reported recently that the U.S. Energy Secretary was forced to negotiate with oil companies to keep them from exporting refined heating oil supplies to Europe, where the products fetch a higher price.

 

No investigation was conducted, as by the California Attorney General, on the potential for future supply disruptions caused by significant market control by a relatively few refiners, the degree of vertical integration in the local gasoline industry and the effect that a dwindling supply of independent marketers has on competition within the industry.

 

No investigation was conducted of the potential effects on diesel gas prices of new EPA regulations requiring cleaner diesel fuel for trucks and buses by June 2006.  The new standard will reduce sulfur in diesel fuel by 97 percent.  In addition, by addressing diesel fuel and engines together as a single system, the regulations will also require engines of heavy duty vehicles (trucks and buses) to significantly reduce emissions — with lead time provided for engine manufacturers to use a phased-in approach between 2007 and 2010. 

 

No study was conducted that could support ongoing pipeline projects, as requested by Marathon Ashland Petroleum Co. for its Centennial Pipeline, that would move more products from the Gulf Coast to the Midwest and thereby ease future supply shortages.

 

No evidence was solicited by or presented to the House Special Committee of collusion within the oil industry resulting in steep price hikes in May-June 2000. During the tenure of this Special Committee, it was learned that the Federal Trade Commission is in the process of conducting a comprehensive investigation on Midwest gas prices, investigating, among other issues, “the possibility of collusion or tacit coordination, conduct that could be illegal under Section 5 of the Federal Trade Commission Act.”[xxxix]  The Federal Trade Commission has the resources available to undertake that investigation and its final report is expected shortly.

 

The Governor on June 14, 2000 requested that Attorney General Jim Ryan and the Illinois Department of Agriculture fully investigate any allegations of consumer fraud in the sale of gasoline.  There may be additional issues uncovered in that investigation.

 

Finally, as to the possibility of price spikes in the future, the Special House Committee was informed: “. . . if there is a supply disruption, I think I would have to say to you all bets are off.  There could be another price spike.”[xl]

 

RECOMMENDATIONS

OF THE HOUSE SPECIAL COMMITTEE

In this era of deregulation, it is impossible to control gasoline prices.  However, the Governor and the Illinois General Assembly can and should take the following proactive measures to reduce the possibility of future price spikes while promoting public health in Illinois: 

 

1.         We recommend that the Governor direct his new Energy Cabinet to study and report to the General Assembly:

Ø   Whether adequate preparations are being made during the spring of 2001 by refiners serving Illinois to transition to summer-grade Phase II Reformulated Gasoline;

Ø   Whether adequate preparations are being made to supply Illinois’ unbranded gas stations during 2001 in view of the closure of Premcor’s Blue Island refinery;

Ø   Whether Illinois should recommend to the EPA to study the potential for a single standard for “clean air” gasoline in Illinois — rather than our current complex system of “boutique fuels” — to more efficiently supply Illinois and Midwest markets, make it possible to correct supply disruptions and also promote clean air throughout the region; and

Ø   Whether Illinois should lend support to the construction of additional pipelines or refineries to serve Illinois markets to reduce the possibility of supply disruptions.

 

2.         We recommend that Illinois refrain from seeking a waiver from the Phase II RFG Program, recognizing both the value of clean air for the health of Illinois residents as well as the short-lived nature of the difficulties encountered by local refiners in producing the new blend during May/June 2000.

 

3.         We recommend the continuation of tax incentives for ethanol, in part to keep MTBE from entering Illinois markets.  This could be accomplished by extending the differential in sales tax for ethanol past its sunset date of  January 1, 2003.

 

4.         We recommend the creation of incentives for energy conservation that (a) promote the expanded use of alternate fuels and alternate fuel vehicles; (b) enhance the transit check program encouraging employee transit use; and (c) encourage businesses to locate close to where workers can afford to live and with convenient access to transit.

 

 

 

 

ENDNOTES