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Question 3. What policies of the Federal Government encourage increased production of unleaded gasoline? Under present regulations how much of an investment in new refinery capacity can be recovered in the price of petroleum products? What provisions of law prohibit the full recovery of investment costs and/or return on investment in gasoline prices?

Answer. EPA regulations that mandate the phasedown of the overall lead content of gasoline and that require all retail stations of a certain size to carry the unleaded grade have provided a significant incentive. Regulations requiring that new cars be designed to use it complement these requirements by creating a certain market.

FEA regulations originally attempted to provide encouragement by allowing an imputed base price for refiners who did not market unleaded gasoline on May 15, 1973, of one cent a gallon above the price of the nearest leaded grade of gasoline that the refiner sold on the base date. Refiners may charge a price for gasoline equal to the base price plus a pro rata volumetric share of increased costs incurred since that date. Prices have not been permitted to increase, however, to reflect any per gallon profit contained in the May 15, 1973, price or imputed price. Since the actual costs of making unleaded gasoline are probably more than one cent above the comparable leaded grade, FEA attempted to provide further encouragement by permitting refiners to reallocate gasoline costs to unleaded gasoline. A shift to relatively higher refiner prices for the unleaded grade was noted immediately after this provision was installed early in 1977.

However, the limitation on allocating increased costs to gasoline on a pro rata volumetric basis now seems to be a barrier since some of the increased costs actually incurred to provide more unleaded gasoline are probably assigned to some other product. Therefore, we are currently considering an amendment, commonly called the “gasoline tilt," that would permit the allocation of increased costs to gasoline on greater than a pro rata volumetric basis.

The regulations classify increased interest and depreciation as allowable increased costs. To the extent that investment in new refinery capacity increases these costs, gasoline prices are permitted to reflect these increased costs. The current regulations do not provide for the passthrough of an amount representing an increased return on additional investments.

There is no specific statement in the law prohibiting the passthrough of a return on investment. However, a major restructuring of the regulatory system would be required to provide the necessary incentives for investment in gasoline production facilities, and any correction of the regulatory system would still necessitate continuation of the allocation system and the anti-competitive effects that flow therefrom.

Question 4. Assuming gasoline prices are decontrolled, what other incentives are needed to provide adequate capacity to produce unleaded gasoline?

Answer. We know of no other necessary incentives that need to be created specifically for gasoline manufacturing capacity. A study currently underway by the Office of Policy and Evaluation concerning domestic refining policy may shed further light on this in connection with the problems of handling of heavier, sourer crude slate. Of course, the creation of new disincentives of the type engendered by existing regulations should be avoided.

Question 5. Will the present concentration on gasoline supply result in a shortage of home heating oil? Will the Federal Government be required to grant entitlements to importers of home heating oil this winter?

Answer. Notwithstanding the present effort to improve gasoline supplies, DOE does not foresee any shortage of home heating oil. As of December 15, 1978, distillate stocks were at 219 million barrels, which is 33.5 million barrels below 1977 levels for the same week. However, 1977 distillate stocks were unusually high. Current stocks are 16.0 million barrels higher than the average stock level for the same week over the 3-year period stock level for the same week over the 3-year period 1974–1976. Should distillate demand show unexpected increases from December through February 1979, options are available to marketers and DOE, including the importation of foreign distillates, and the ordering of shifts in refinery yield to produce more distillate (although this could exacerbate a gasoline problem if one exists). Based on current high stock levels, DOE currently does not anticipate the granting of entitlements to importers of home heating oil this winter.

Question 6. Will the spread between leaded and unleaded gasoline be influenced by the removal of Federal controls on gasoline prices?

Answer. DOE price regulations do not directly control the differential between leaded and unleaded gasoline. There may be some measure of indirect control at the retail level if price regulations are restraining some retailers' prices of un. leaded regular but we have no way of estimating this.

Our estimates of the probable effect of decontrol and the range of possibilities are contained in the Draft Environmental Impact Statement (pages IV-16 to IV-23). In summary, at present, the na average price differential is 4.4 cents per gallon between leaded and unleaded gasoline. Based on the historical relationship between increases in retail unleaded gasoline prices and average retail price increases for both leaded and unleaded gasoline (and assuming the supply/demand relationship for leaded and unleaded gasoline remains the same as now), DOE projects that the price differential between leaded and unleaded gasoline will increase from the present national average of 4.4 cents per gallon to a national average of 5.3 cents per gallon in the event of deregulation.

Question 4. What domestic refinery capacity additions do you project for 1979, 1980, 1981 and 1982? Will these capacity additions be sufficient to keep up with the growth in demand for unleaded gasoline, particularly high-octane unleaded gasoline?

Answer. Following is a list of refiners' projections of capacity additions for 1979 and 1980. There is very little reliable data available for the years after 1980.

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Our analysis indicates that these additions will be adequate to meet 1979 and 1980 unleaded gasoline demand, but barely so if demand is at the high end of the expected range. It will probably not be adequate to meet unleaded gasoline demand beyond 1980, and new investments will be required.

Although there are few announced additions beyond 1980, unannounced improvements could be brought on stream in 1981. There is a continuing need for investment in future refining capacity because, among other things, of the increase in demand for unleaded gasoline. By 1985 unleaded gasoline is expected to increase to 78 percent of the gasoline pool.

Question 8. Are the new domestic automobiles of 1979–85 projected to require high-octane gasoline to operate without knocking ? If so, how will this affect your projections about the balance between gasoline supply and demand ?

Our supply and demand forecasts assume that new vehicles will generally operate satisfactorily on unleaded regular gasoline with a research octane number (RON) of 92.3 and pump octane (research plus motor octane divided by 2) of 88.2—the current average for unleaded regular. In an alternate assumption, which assumes a reduction of leaded premium sales and transfer of that demand equally to leaded regular and unleaded premium, RON is set at 91.5 and pump octane at 87.0 (the EPA minimum for unleaded regular).

The latter assumptions are based on auto industry expectations for 1980 model cars, and assume that car design will continue in a mode which will permit generally satisfactory performance on 87.0 pump octane. This topic is difficult, and complicated by several factors :

There is a difference in octane requirements among the same model cars coming off an assembly line. This is a function of minute manufacturing differences within the engineering tolerances allowed. A typical pattern for 1979 model cars is that 91 plus percent will be satisfied by 91 RON gasoline, but the others will show trace knock at that octane level. We do not know what percentage will show trace knock at our alternate assumptions of 91.5 and 92.3 RON, but the percentage is probably very small at the latter level.

There are wide differences among car owners' abilities to discern and recognize trace knock. Slight knocking may continue indefinitely unrecognized without engine damage. Some drivers may recognize it and solve it by changing grades or brands of gasoline. Others may demand engine tuning changes. There are substantial differences in octane policies among refiners. Some set octane relatively high, to achieve a high percentage of car satisfaction; others set it low and rely on other marketing techniques to maintain sales. These policies change over time.

The EPA permits on-road fuel economy tests to be run on gasoline which is higher in octane than the average unleaded regular. Detuning routines are then permitted for customers who experience knock on unleaded regular, and minor losses in fuel efficiency result from this detuning. This testing practice may affect demand for unleaded premium, and accordingly affect

supply capabilities. It may also be a contributing factor to fuel switching. In making a forecast for 1980 supply and demand we have not had to assume anything about post-1980 model car requirements. We do know from informal conversations with car manufacturers that the public's buying habits, which favor larger cars more than exnected, add to manufacturers' difficulties in meeting overall fuel efficiency standards, and that this creates an auto industry interest in increased compression ratios as a solution. This would increase octane demand.

We have not yet made projections of supply beyond 1980. Supply after that year will be significantly influenced, in our opinion, on decisions that will be made in the near future regarding improvenient or elimination of the present regulatory program.

Question 9. What does DOE assume is the gap between on-road performance and EPA mileage tests for new domestic automobiles? If this gap increases by 10–20 percent, what will be the effect on the balance between gasoline supply and demand ?

Answer. DOE's assumptions are described in the attached Energy Information Administration Analysis Memorandum, "1980 Motor Gasoline Supply and Demand," pp. 10–19. In summary, the low conservation case assumes that new cars will perform in the same relationship to projected average EPA test mileage as did 1977 model cars' actual experience (0.65 X EPA Test + 2.98) and the high conservation case assumes new car performance in the same relationship to EPA tests as 1976 model cars' actual experience (0.74 X EPA Test + 2.32). A further 10 percent degradation in the relationship used for the low conservation case (which produces the highest level of total demand) would reduce the low conservation estimates from 250 MB/D to 230 MB/D in 1979, and from 430 MB/D to 395 MB/D in 1980. Thus, this degradation would increase the high demand estimate by 20 MB/D in 1979 and 35 MB/D in 1980. The reduction in the high conservation estimates (and increase in the low demand estimates) would be smaller.

This assessment was derived manually without running the Light Duty Vehicle Fuel Consumption Model.

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