Statement of Robert W. Gee
Assistant Secretary for Fossil Energy
U.S. Department of Energy
to the
Committee on the Judiciary
U.S. House of Representatives
April 7, 2000

Mr. Chairman and Members of the Committee:

As virtually every American is aware, our economy has endured a new cycle of volatility in oil markets. It began in 1997 when the Organization of Petroleum Exporting Countries (OPEC) substantially increased oil production. At about the same time, global demand took a downward turn. Much of Asia lapsed into recession, and the world had two years of relatively mild winters. As a result, the availability of crude oil in global markets began to exceed demand, and oil prices plunged to historic lows.

In the spring of 1998, as Middle East nations watched oil prices plummet, both OPEC and non-OPEC oil producing nations proposed the first of three production cuts. As the consequences of continually falling prices became apparent to producing countries, they stiffened their resolve to hold to agreed production cuts. Just as these cuts took hold, world demand for oil began increasing. Tight world markets began to drive up prices and led refiners to draw down stocks worldwide to meet demand growth.

Crude oil and petroleum product prices rose rapidly, especially over the past 12 months. West Texas Intermediate crude oil, one of the U.S.'s benchmark crude oils, rose from about $12 per barrel in February 1999 to $34 a barrel in the first week of March 2000.

This dramatic swing in prices has largely resulted from an imbalance between world supply and demand of less than 3 percent. In a world that consumes 70-75 million barrels of crude oil per day, a two million barrel per day excess in supply caused oil prices to spiral downward in 1998; a two million per day shortfall in supply, coupled with low stock levels, caused oil prices to skyrocket upward in 1999-2000.

Low inventories leave little cushion to meet sudden increases in demand or decreases in supply, increasing the possibility of price runups. In particular, U.S. Northeast heating oil and diesel prices surged in January 2000, when cold weather and supply problems occurred at a time when petroleum product stocks were low. With little distillate stock cushion, local supplies were diminished, and prices spiked. Large volumes of distillate imports, warm weather, and increases in production have since resolved this supply shortage in the Northeast.

The nation's consumers, however, are now facing a very tight gasoline market. U.S. crude oil and gasoline inventories are at historically low levels. On top of low stocks, refineries need to increase crude inputs about one million barrels per day by mid summer.

U.S. Dependence on Petroleum. Today, the United States is still heavily dependent on crude oil, in spite of the growth in use of other fuels such as natural gas and coal. In 1998, petroleum supplied nearly 40 percent of our energy needs. Since 1985, domestic crude oil production has been declining, while domestic oil consumption has increased by more than 20 percent. The result is a growing reliance on oil imports. In 1974, net imports of crude oil and products supplied about 35 percent of U.S. consumption. In 1998, net imports supplied about 52 percent of U.S. consumption, the highest percentage ever.

Our sources of these imports, however, have changed significantly over the last two decades. Last year, we imported 4.85 million barrels of oil per day from OPEC, down 22% from the 6.19 million barrels of oil per day we imported from OPEC in 1977. Our imports now come from over 40 countries around the world. During this same period, OPEC's share of the world market has dropped from 49% to 40%.

In the past, oil shortages have taken a significant toll on the U.S. economy. The most recent price spikes, while still a threat to reignite inflation and dampen economic growth, have not had the major or immediate impact on the U.S. economy they might have had 10 or 20 years ago. Increased energy efficiency - in cars, homes, and manufacturing - has helped insulate the economy from these short-term market fluctuations. In 1974, for example, we consumed 15 barrels of oil for every $10,000 of gross domestic product. Today we consume only 8 barrels of oil for the same amount of economic output.

Thus, the Administration's policy of encouraging conservation has paid real dividends for the American people. In fact, had Congress fully funded our Conservation and Renewable Energy requests, over $1.67 billion additional dollars would have been committed to this effort.

Let me take a moment to briefly outline the basis for our energy policy. Our energy policy is based on:

• Market forces -- not artificial pricing.
• Pursuing diverse sources of supply and strong diplomatic relations with energy producing nations.
• Working to improve the efficiency and environmental acceptability of production and use of traditional fuels through new technology development.
• Diversifying our energy sources through long-term investment in alternative fuels and energy sources.
• Investing heavily in increasing efficiency in the way we use energy.
• Maintaining and strengthening our insurance policy against supply disruptions - the Strategic Petroleum Reserve.

These are the foundations of the Clinton Administration's policies - and over the long-term they work to provide affordable, secure supplies of energy.

The Problem of Volatility. Extreme market volatility negatively impacts several sectors of economy - both for energy producers and consumers. The rapid increase in the price of home heating oil created hardship for many families in the Northeast and Americans living on modest incomes. High fuel costs have hurt independent truckers, small businesses that are energy intensive, and farmers.

Market volatility has also created difficulties for the nation's oil producers. When prices plunged in 1998-99, domestic production declined by more than 300,000 barrels per day. More than 30,000 oil workers - nearly 1 out of 10 - lost their jobs. Drilling rigs were scrapped. Even as prices rebounded, financial markets have remained cautious, money continues to be tight, and reinvestment in the domestic oil industry has not fully materialized. Some of the lost production may never come back on line.

In short, while $34 per barrel adjusted for inflation is still less than the $70 per barrel equivalent price seen in 1981, the extreme price volatility over the last year has created market dislocations. President Clinton and Energy Secretary Richardson have repeatedly urged policies that can help restore market stability by turning to markets and free market principles to set the future price of oil. At the same time, the Administration has recognized that actions must be taken to cushion the nation's economy and its most vulnerable consumers from future volatile swings in oil prices.

Aftermath of OPEC Decision. For several months, Energy Secretary Richardson engaged in numerous discussions with oil producing nations urging them to increase production in line with current market demands. These diplomatic efforts paid off when OPEC announced its decision on March 28 to increase production quotas by approximately 1.7 million barrels per day. Coupled with additional outputs from other oil producing nations, the production increases will help replenish low inventories and better meet current demand.

Typically, it takes 4 to 6 weeks for crude oil produced in the Middle East to reach the United States; however, markets often react well in advance of actual shipments.

As of Tuesday, April 4, the price of West Texas Intermediate (a benchmark domestic crude oil) for May delivery dropped to around $25.50 per barrel, down more than $8.50 from the posted price in February.

By March 27, 2000, the national average retail regular gasoline price had dropped to $1.508 per gallon, down 2.1 cents from the prior week but 42.6 cents higher than a year ago. This was the first decrease in the national average retail regular price since early January 2000. The national average retail diesel fuel price was $1.451 per gallon on March 27, 2000, down 2.8 cents from the prior week but 40.5 cents higher than last year.

Ultimately, as markets determine if the increased production levels are sufficient to meet demand and rebuild depleted inventories, we expect the downward trend of prices to continue.

Administration's Mitigation Measures. Beginning in January, the Administration took several steps to mitigate the impact of high heating oil and diesel prices.

These included the release of additional Low Income Home Energy Assistance Program (LIHEAP) funds to help low-income Americans pay their energy bills, along with a number of short-term actions intended to ease the immediate problems faced by truckers, heating oil distributors, and others. In all, nearly $300 million has been released to help low income families pay their energy bills. The President has also requested another $600 million in additional LIHEAP funds in the pending Supplemental Appropriations bill, and he is seeking an additional $19 million from Congress for low-income home weatherization in FY 2000.

Secretary Richardson also directed our Strategic Petroleum Reserve Office to renegotiate oil delivery contracts for the Reserve's royalty-in-kind program. The Energy Department has contracted for 28 million barrels of federal royalty oil from the Gulf of Mexico to be delivered to the Strategic Petroleum Reserve's storage facilities in Texas and Louisiana. About 10 million barrels of this oil have already been delivered. The Department has renegotiated contracts to shift the delivery of 5 million barrels of oil from this spring to later this fall and winter, when conditions are more favorable for putting crude oil in the Reserve. Postponing delivery dates until prices are expected to be lower also allowed DOE to negotiate greater than contracted-for quantities of crude oil.

President's Actions to Strengthen Oil Reserves and Domestic Supplies. On March 18, President Clinton announced additional steps to strengthen America's energy and economic security. They included:

1. Reauthorizing the Strategic Petroleum Reserve, our emergency crude oil inventory;
2. Enacting a comprehensive tax incentive package, balanced between incentives to support domestic oil production, continue diversifying our energy supplies, and increasing the energy efficiency of our economy.
3. A call to Congress to draw up legislation establishing a regional heating oil reserve with an appropriate trigger mechanism to help protect consumers in the Northeast and New England;

Reauthorizing the Strategic Petroleum Reserve. The Strategic Petroleum Reserve is our "first line of defense" against the threat of energy shortages that can cripple our economy; however, the organic authorities for the Reserve in the Energy Policy and Conservation Act expired on March 31st. Congress extended EPCA for only six months last September. Although the Senate has passed a 4-year extension last September, the House has not taken action since that time.

It is critical that the Congress extend EPCA as soon as possible to ensure that the president maintains the ability to use all available tools to respond to the needs of the United States economy.

Enacting a Comprehensive Tax Incentive Package. To insulate the economy from the effects of future price increases, the President has called on Congress to enact a comprehensive and balanced package of tax incentives.

The President is proposing new steps to support new domestic exploration and production, and to lower the business costs of producers when oil prices are low. These tax proposals will cost less than $1 billion over ten years. They include:

• Expensing of Geological and Geophysical Costs: The President is proposing to support domestic exploration and production by adjusting the treatment of the costs of exploration and development -- geological and geophysical costs -- in the tax code. Under current law, geological and geophysical costs may be deducted if the related exploration activity was unsuccessful but must be capitalized if the exploration activity was successful. By allowing the industry to expense these costs, we will be encouraging the discovery of new reserves.
• Allowing Expensing of Delay Rental Payments: A "delay rental payment" is an amount paid by a lessee to the lessor of a petroleum resource when the lessee does not begin producing commercial quantities of oil or natural gas as soon as was agreed. The delay rental payment is intended to compensate the lessor for the royalties he does not receive while production is delayed. Currently, the federal tax code requires delay rental expenses to be capitalized under some circumstances. Allowing producers to expense delay rental payments in the year incurred will lower the cost of doing business and allow more dollars to be invested in finding and producing new domestic oil reserves.

The Administration will also continue to examine measures to preserve marginal well production. Domestic marginal wells (which produce 15 barrels of oil per day or less) account for more than 20 percent of onshore oil production in the lower-48 States. An estimated three-fourths of these wells are owned by smaller, independent producers. The Administration will continue to evaluate whether a tax credit for selected marginal wells that could be activated under specific market conditions should be proposed as a "safety net" to help these wells maintain their economic viability during periods of low oil prices.

Expanding the Nation's Diversity of Fuel Supply. In his March 18 announcements, the President again stressed the need to diversify our energy supply by starting "down the right path toward real, long-term energy security." The President believes that any tax package to improve the energy security of the country must include incentives to improve energy efficiency and promote the use of renewable energy. In his proposal, therefore, the President also included (1) tax credits for electric, fuel cell, and qualified hybrid vehicles, (2) tax credits for efficient homes and buildings, and (3) tax credits for efficient, non-petroleum based sources of power. He also reemphasized the importance of Congressional passage of his FY 2001 budget request which includes more than $1.4 billion to accelerate the research, development and deployment of alternative energy sources and more efficient end-use technologies.

The President also directed the Department to conduct a 60-day study on converting factories and major users from oil to other fuels, to determine whether this will help to free up future oil supplies for use in heating homes.

Support for Establishment of a Regional Heating Oil Reserve. The President remains concerned about the effect that future shortages of heating oil may have on consumers, particularly in the Northeast and New England. To reduce the likelihood that future shortages will harm consumers, the President is:

• Supporting the Establishment of a Regional Reserve: The President supports the creation of a two million barrel heating oil reserve in the Northeast with an appropriate trigger to combat future product shortages. In the event of heating oil shortages, heating oil can be sold from the reserve to increase the supply on the market.
• Directing DOE To Undertake Necessary Environmental Reviews: The President has directed the Department of Energy to begin the appropriate environmental reviews for the creation of the heating oil reserve.
• Calling on Congress to Establish a Reserve Through Legislation: The President has called on Congress to pass legislation that authorizes creation of a regional heating oil reserve and includes an appropriate trigger. The President has reserved his right to establish a reserve under his existing authority in the event that Congress fails to act.

Investing in Better Technology to Boost Domestic Oil Exploration and Production. If we hope to avoid the roller coaster fluctuations of oil prices 10 or 15 or more years into the future, we must invest in better oil exploration and production technology today - and most importantly, sustain that investment in the coming years.

It has been the steady pace of technology that has helped keep the domestic industry viable. In the 1970s, an exploratory well had about a 14 percent chance of finding producible hydrocarbons. Today, those odds have more than doubled. An exploratory well in the 1970s, on average, added about 10,000 barrels of oil in new reserves. Today, an exploratory well adds four times that amount, more than 40,000 barrels in new reserves.

Major technological advances in oil exploration, such as three- and four-dimensional seismic drilling, are helping us to find more oil at greater depths, both on- and off-shore. At the same time, these technologies have reduced the environmental footprint left by exploration and production to 1/10th the size it was 25 years ago.

Research and development partnerships between government and industry have become increasingly important in recent years. The domestic petroleum industry of the 21^st century is not the industry of the 1970s or even the 1980s. It no longer is dominated by "Big Oil." Increasingly today's modern-day domestic oil industry is an industry of independents - an industry of smaller companies. Independent producers now drill 85 percent of all new wells in this country. They account for almost half of the crude oil produced in the lower 48 States and two-thirds of the natural gas. They are the ones that can benefit most from new technology -- especially technology that resolve production problems in the older, more complex U.S. fields -- but they are the ones least able to afford research and development. Eighty percent of these companies employ less than 20 workers.

Our petroleum technology efforts at the Department of Energy fit into two primary categories:

• One is to maintain access to the resource through the transfer of existing and improved oil and gas production technologies into the hands of domestic producers, especially the smaller independents.
• The other is to develop the longer-range technologies that can ultimately produce the full potential of that resource.

If we don't maintain access to the resource - or in other words, if we don't find ways to forestall the abandonment of still-productive oil fields - developing longer-range technologies will be of virtually no benefit. Most of the resource will be lost before these technologies are ready.

When domestic wells are plugged and abandoned, the surface infrastructure - pumping units, gathering systems, storage tanks, and other equipment - that has been installed and financed over decades is dismantled. The capital investment necessary to restore this infrastructure can be so large that few of today's companies - especially the smaller ones - can obtain the necessary financing no matter the price of oil. The resource is, for all intents and purposes, no longer accessible under any reasonable price or technology scenario.

That's why we have placed a high priority on keeping oil fields facing imminent abandonment in production through such efforts as:

• The Reservoir Class Field Demonstration Program. Eight years ago we began a program to cost-share field tests of technologies that could prolong the economic life of fields threatened with imminent abandonment, yet known to contain considerable quantities of remaining oil.

  The program achieved some major successes - revitalizing production in places like Utah and Michigan. It gave producers the opportunity to apply innovations that didn't exist a decade ago in fields that no longer were of economic interest to many of the larger companies.

  In February 1999, Secretary Richardson announced that he would restart the Reservoir Class Field Demonstration Program. In October, we selected 10 projects to receive $23 million in Federal funding, all of which involve independent producers.

  These efforts have the potential to keep nearly 650 million barrels of domestic crude oil from being abandoned.

• Technology Assistance to Independents. Also to maintain access to reservoirs, we have set aside funding to assist the smallest of our independent producers solve specific field production problems. Since this program began in 1995 and was restarted last year, 45 companies have received targeted grants to apply innovative solutions that have kept many wells in production.
• The Preferred Petroleum Upstream Management Practices Program. We are also kicking off a new effort we call the "Preferred Petroleum Upstream Management Practices Program" (PUMP) program. Our plan is to find out where geologic, regulatory or other factors have combined to hold back production, and then develop an integrated set of "best practices" that can get production back up quickly. This month, we will issue a competitive solicitation to begin this program. We will be looking for proposals that identify these "best practices," show how they can be used to overcome regional production constraints, how they can improve the bottom line, and how they can be transferred to other producers.

These are some of the efforts that keep oil flowing that might otherwise be shut in. If we are successful, we can halt the decline in domestic production during this decade. This will preserve access to reservoirs and provide time for better technology to be developed that can extract even greater amounts of crude oil from the Nation's reservoirs.

The potential for improved oil technologies is enormous. Many people are surprised to know that for every barrel of crude oil produced in the United States in the history of the domestic oil industry, nearly two barrels have been left in the ground. Technological improvements can help U.S. producers recover a much greater portion of the oil that is currently beyond the capabilities of today's exploration and production processes.

• Examples of Longer-Range Potential of Technology. Already, the same technology used by Steven Speilberg to create the dinosaurs of Jurassic Park is being used to image the flow patterns of oil reservoirs. 3-D seismic became a more widely used tool when advances in computer technology brought down the cost of digital processing. And that has helped boost exploratory well success rates to as high as 50 percent. Now companies are adopting 4-D seismic - adding time to the data set - and beginning to see new production benefits. One company has seen recovery rates jump to 70 percent.

  Artificial intelligence is just beginning to make its mark in the industry. That, combined with micro-technology - perhaps one day, nano-technology - could lead to a new generation of "smart" auto-drilling systems that can reduce the costs and increase the success rates of future drilling.

  A complete "logging and chemical laboratory-on-a-chip" might be in the industry's future. This technology would analyze for hydrocarbons near the bottom of the hole while drilling is underway. Fiber optics, perhaps embedded in composite drill pipe, could bring about quantum improvements in the way data is transmitted from the bit to petroleum engineers on the surface.

  In the future, new polymers and other chemicals, along with different types of gas injection (including greenhouse gases such as carbon dioxide), could offer better ways to force previously unmoveable crude oil through the tight pores of reservoir rocks and to production wells. It may also be possible to use naturally-occuring microbes that live deep in reservoirs to produce substances that can aid in the future recovery of crude oil.

These are some of the examples of technology that begins to maximize production - that allows us to tap the true potential of the considerable oil wealth that remains in this country.

Conclusion

It will take a combination of actions - both near- and long-term, both to encourage additional domestic oil production and to increase the efficiency in our future use of oil - to give the United States a more stable energy future.

The problem of market volatility will not be solved overnight. It will take continuing dialogue and a common understanding among both consuming and producing nations that stability in oil markets is a shared and desirable goal. Much of Secretary Richardson's recent success in discussions with energy ministers and key global leaders was the availability of data which showed global petroleum stocks at extremely low levels. This kind of data will continue to be important, and a goal of the Department is to improve the quality and accuracy of international data.

A fully responsive and capable Strategic Petroleum Reserve is also a key element of a more secure energy future, and we will continue to work with Congress to pass its reauthorization as soon as possible.

Also given the hardships imposed by fluctuations in home heating oil prices to many low-income families in the Northeast, we will continue to work with Congress to establish a regional arm of the Strategic Petroleum Reserve that will provide heating oil to help cushion future price swings.

Finally, we will continue to make investments in technology that can increase the amount of crude oil that can be produced in the future from our own domestic resources. If these programs are successful, we may be able to halt the decline in U.S. oil production by the mid part of this decade and begin to slow our growing dependence on imported oil.

These steps are key elements of a sound, comprehensive energy strategy that has helped sustain the longest economic expansion in American history. They will enhance America's energy security, create jobs, protect the environment, and produce long-term savings for consumers.

This concludes my prepared statement, Mr. Chairman. I will be pleased to answer any questions.