Hearings, Reports and Prints of the Senate Committee on Government Operations

CHAPTER II. A BRIEF LOOK AT THE INDUSTRY AND ITS REGULATORS

SECTION I. THE FACTORS DETERMINING THE PRODUCTION OF FUEL OIL AND GASOLINE

There are two primary factors which regulate the quantity of fuel oil, gasoline and other petroleum products that can be produced in the United States. One of these factors is the availability and utilization of refining capacity. The second major determinant of industry production of gasoline and fuel oil is supply of crude oil which refineries process to satisfy market demand for petroleum products.

In the short run, refinery capacity utilization in the United States limits the quantity of finished petroleum products that can be processed from crude oil.

As will be shown in Chaper III, it is generally agreed that refineries can operate at 92 percent of capacity based upon crude oil inputs to distilling units.

Refinery capacity in the United States has not been expanded adequately during the past two years to keep up with demand for gasoline and distillate fuel oil. As a consequence, refining capacity is approaching physical limitations and is going to inhibit industry in meeting future demand.

Domestic production and imports are the two primary sources of crude oil. Texas and Louisiana during 1972 produced about two-thirds of all domestic crude oil with the balance being produced by 29 other States.

To augment domestic production foreign crude is imported. The Mandatory Oil Import Program that was created by Presidential proclamation in 1959 initially established the quantity of crude oil to be imported east of the Rocky Mountains in PAD Districts I-IV1 as 12.2 percent of the domestic production of crude oil. The area west of the Rocky Mountains (PAD District V) followed a "domestic supply gap" formula which permitted the level of crude oil imports to be adjusted to make up the gap between the limited domestic production and the demand for crude oil.

Prior to the 1970's, crude oil imports were maintained at approximately 12.2 percent of domestic oil production east of the Rocky Mountains. Taking into account crude oil imports, domestic crude cil production was regulated so that when combined with imports, United States refineries had adequate, but not excessive, supplies of crude oil to process. The technical name for this procedure is "demand pro-rationing."

1 Most sources of national petroleum statistics are published on both a state and a Petroleum Administration for Defense (PAD) District basis. The U.S. is divided into five PAD Districts. PAD Districts I-IV include all states except those in PAD District V-Washington, Oregon, California, Nevada, Arizona, Alaska, and Hawaii.

In recent years only the two major crude oil producing States, Texas and Louisiana, have had surplus productive capabilities and have restricted the production of crude oil. These two States, until early 1972, set "allowable rates" of production to balance demand with availability of crude oil supplies. For this reason, "demand prorationing" by Texas and Louisiana along with other States in past years acted as what the petroleum industry referred to as the "balancing wheel" for crude oil supply required for processing by domestic refineries.

In early 1970, surplus crude oil capacity east of the Rocky Mountains was nearly exhausted and it became necessary for the President of the United States to increase the level of oil imports by Executive Order to more than the established 12.2 percent of the domestic production of crude oil.

As domestic crude oil production relative to demand decreased, the "balancing wheel" activities of Texas and Louisiana could only be maintained through increases in the level of oil imports.

Since the level of crude oil imports was not increased sufficiently in 1972 to maintain spare capacity in Texas and Louisiana, the "balancing wheel" function for providing refineries with adequate levels of crude oil feed stocks passed to the administrators of the Oil Import Program in the Office of the President. It thus became the responsibility of the Executive branch of government to see that United States refineries had adequate levels of crude oil supplies to process in order to meet demand for petroleum products such as fuel oil and gasoline.

SECTION II. THE STRUCTURE OF THE U.S.
PETROLEUM INDUSTRY

The U.S. petroleum industry is dominated by large, integrated companies. Integrated companies operate in exploration and production of crude oil, transportation, refining, distribution and marketing. The 18 largest integrated petroleum companies, ranked according to their total assets as of December 31, 1972, are indicated below:

The eighteen largest integrated petroleum companies produce close to 70 percent of the domestic crude oil; operate approximately 80 per

cent of the domestic refining capacity; and market around 72 percent of the gasoline sold.2

Other integrated firms in the petroleum industry which are not big by industry standards and the non-integrated firms are frequently referred to as the independents. The majority of the independents are companies that specialize in only one or two levels of activity.

According to a 1967 Federal Trade Commission Report, the independent refiners and marketers play an important competitive role disproportionate to their size in the petroleum industry. The independents have historically been the primary source of price competition and low cost innovative methods of marketing. The major integrated petroleum companies, on the other hand, are noted for their branded and traditional non-price oriented methods of selling petroleum products.

SECTION III. DEVELOPMENTS OF 1970

OIL DEPLETION ALLOWANCE

The Tax Reform Act of 1969 reduced the oil depletion allowance from 27.5 percent to 22 percent effective January 1, 1970. Oil industry spokesmen indicated that it would cost the industry some $600 million a year and warned that it would reduce the incentive to expand crude oil production.

FIXED OIL IMPORT RATIO ABANDONED

Effective January 1970, the Federal Government abandoned the 12.2 percent ratio of crude oil imports to domestic production established in 1959. The Office of Emergency Preparedness concluded that the 12.2 percent figure was too low and that more imports would be needed. Oil imports were increased 100,000 barrels per day for 1970.

CABINET TASK FORCE REPORT

In mid-January of 1970 the Cabinet Task Force on Oil Import Controls sent its report to the President. The report recommended the substitution of a tariff system for the existing quota plan: reduction of 20 to 30 cents a barrel in the price of domestic crude oil: and free access of Canadian oil into the United States. The major integrated oil companies and independent producers of crude oil were strongly opposed to the Task Force recommendations.

On February 20, 1970, President Nixon postponed his decision on the tariff plan aspect of the report of the Cabinet Task Force on Oil Import Controls.

OIL POLICY COMMITTEE

Also on February 20, 1970, President Nixon changed the management system for the Oil Import Program. Responsibility for managing the program was shifted from the Department of Interior to the Office of Emergency Preparedness. Day to day administration of the program continued in the Department of Interior.

President Nixon created an Oil Policy Committee and named as chairman, General George Lincoln, Director of the Office of Emergency Preparedness.

Source: The National Petroleum News Fact Book for 1973.

The mandate of the Oil Policy Committee was to provide policy direction on oil imports; monitor the day-to-day functions of the Oil Import Administration of the Department of Interior; and coordinate. the activities of Federal agencies, such as the Departments of Interior, State, Treasury, Defense, etc., with jurisdiction in aspects of oil import policy.

WARNING THAT SPARE OIL CAPACITY DEPLETED

In February of 1970, the Texas Independent Producers and Royalty Owners Association (TIPRO) asserted that the United States had no more surplus producing capacity and urged industry to admit that the surplus capacity had been exhausted. TIPRO stated that the reserve capacity of Louisiana oil fields had been rated too high and warned that in Texas industry had "seriously overestimated the practical potential of the few large oil fields currently producing below maximum efficient rate."

PROFITS AND RESERVES DOWN

In April the large petroleum companies reported a decline in year end earnings for 1969 to $6.092 billion from $6.125 billion in 1968. The explanation for the decline in profitability was that the prices of crude oil and petroleum products had not kept pace with the costs of doing business.

Also, in April of 1970, most of the major oil companies raised the retail price of gasoline one cent a gallon as part of an effort to improve the profitability of marketing.

The oil industry was also troubled by excessive gasoline stocks. Oilmen were hoping for an early spring season to reduce inventories.

Meanwhile, a report issued by the Department of Conservation of the State of Louisiana found that the State was rapidly approaching the time when oil production would peak. The American Petroleum Institute also announced that estimated American crude oil reserves had dipped by 1.075 billion barrels during 1969, the largest decline in history.

GASOLINE PRICES SOFT AND PRODUCTION PROBLEMS

Gasoline price wars broke out following the price rise, making it difficult to realize much profit improvement.

In mid-June President Nixon asked Congress to cancel 90 offshore leases in the Santa Barbara Channel off the coast of Southern California.

The news from overseas was not good. A dispute between Libya and the oil companies led to a reduction of 400,000 barrels a day of low sulphur crude oil.

The trans-Arabian pipeline was out of action, cutting off its usual flow of 500,000 barrel- a day to the Mediterranean. Tankers were required to move more oil from the Persian Gulf around Africa to Europe and tanker rates soared.

The higher rates made imported crude oil as expensive as domestic erude. The import tickets held by inland American refiners became worthless almost overnight.

In mid-1970 it is reported that nearly all of the 10 largest majors lost ground to the independents furing the prior year. The rate of sales increase for the independents as three times that of the majors.