COMMITTEE ON WAYS AND MEANS BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois E. CLAY SHAW, Jr., Florida NANCY L. JOHNSON, Connecticut AMO HOUGHTON, New York WALLY HERGER, California JIM MCCRERY, Louisiana DAVE CAMP, Michigan JIM RAMSTAD, Minnesota JIM NUSSLE, Iowa SAM JOHNSON, Texas JENNIFER DUNN, Washington MAC COLLINS, Georgia ROB PORTMAN, Ohio PHIL ENGLISH, Pennsylvania WES WATKINS, Oklahoma J. D. HAYWORTH, Arizona JERRY WELLER, Illinois KENNY C. HULSHOF, Missouri SCOTT MCINNIS, Colorado RON LEWIS, Kentucky MARK FOLEY, Florida KEVIN BRADY, Texas PAUL RYAN, Wisconsin	CHARLES B. RANGEL, New York FORTNEY PETE STARK, California ROBERT T. MATSUI, California WILLIAM J. COYNE, Pennsylvania SANDER M. LEVIN, Michigan BENJAMIN L. CARDIN, Maryland JIM MCDERMOTT, Washington GERALD D. KLECZKA, Wisconsin JOHN LEWIS, Georgia RICHARD E. NEAL, Massachusetts MICHAEL R. MCNULTY, New York WILLIAM J. JEFFERSON, Louisiana JOHN S. TANNER, Tennessee XAVIER BECERRA, California KAREN L. THURMAN, Florida LLOYD DOGGETT, Texas EARL POMEROY, North Dakota
Allison Giles, Chief of Staff Janice Mays, Minority Chief Counsel  SUBCOMMITTEE ON SELECT REVENUE MEASURES JIM MCCRERY, Louisiana, Chairman
J.D. HAYWORTH, Arizona JERRY WELLER, Illinois RON LEWIS, Kentucky MARK FOLEY, Florida KEVIN BRADY, Texas PAUL RYAN, Wisconsin	MICHAEL R. MCNULTY, New York RICHARD E. NEAL, Massachusetts WILLIAM J. JEFFERSON, Louisiana JOHN S. TANNER, Tennessee
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records of the Committee on Ways and Means are also published in electronic form. The printed hearing record remains the official version. Because electronic submissions are used to prepare both printed and electronic versions of the hearing record, the process of converting between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process is further refined.

Advisory of June 6, 2001, announcing the hearing

THIRD IN SERIES ON EFFECT OF FEDERAL TAX LAWS ON THE 
PRODUCTION, SUPPLY, AND CONSERVATION OF ENERGY

House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.

The Subcommittee met, pursuant to notice, at 10:05 a.m., in room 1100 Longworth House Office Building, Hon. Jim McCrery, (Chairman of the Subcommittee) presiding.

[The advisory announcing the hearing follows:]

Chairman MCCRERY. The hearing will come to order.

Today's hearing is a continuation of a series of hearings we're having on energy policy vis-a-vis the tax code in the United States. Yesterday we heard from about 20 members of Congress who brought to the Subcommittee various ideas for using the tax code as an incentive for increased production of oil and gas in the United States, for incentives for conservation of energy in the United States, and also some ideas for using the tax code for an incentive to produce new kinds of energy, alternative fuels, renewable fuels, and the Subcommittee was impressed with both the scope and the depth of the suggestions that were made by members of Congress.

Today we are going to hear from witnesses representing industry, business, interest groups that have concerns about the environment, about energy policy, so we look forward to hearing from these folks from outside the Congress to tell us what your ideas are about energy policy in this country and how the tax code might establish sensible energy policy.

And with that, I will turn it over to my good friend from New York, Mr. McNulty.

Mr. MCNULTY. Thank you, Mr. Chairman, and thank you again for holding these very important hearings. I am pleased to join with you in this, the third hearing conducted by the Select Revenues Subcommittee on tax incentives for the production, supply, and conservation of energy in our country.

As we consider energy tax issues, it is important to understand that the energy problem is not limited to the high cost of electricity on the West Coast. Indeed, this is a national problem and we should seek a national solution on a bipartisan basis.

The administration, in my opinion, is correct to develop a long-term plan to address our energy needs. However, it would be wrong to ignore the short-term problems of the West Coast and to focus all our attention on production initiatives. The problems of the West Coast can easily grow into the problems of my home State of New York, spreading up and down the East Coast across the Midwest and encompassing the entire country. We need a balanced energy program which reflects appropriate tax initiatives in the area of production, renewable and alternative fuels development, conservation and energy efficiency.

The testimony we will receive today from our distinguished private sector witnesses will be extremely valuable in analyzing and developing pending energy tax legislation. I look forward to this testimony and I welcome each of you.

Mr. Chairman, I also want to express my sincere appreciation for your including Mr. Roger Saillant as a witness. Mr. Saillant is the CEO of Plug Power, which is headquartered in my congressional district. Plug Power is an industry leader in fuel cell technology and is involved in exactly the type of energy saving innovation this Committee should be encouraging.

Now I just want to depart for a moment from my prepared statement to again thank you, Mr. Chairman, for holding these hearings and focusing on this issue. My friend Roger asked me before we started the hearing do I think we will actually do anything this year? And my answer is yes and the reason I gave a positive answer is because of your positive attitude and your focus on this issue. And I think we struck a good chord several times yesterday when we discussed specific legislative proposals by the members. We will have those issues that we disagree about on Arctic National Wildlife Refuge (ANWR) and price caps and all the rest but I was struck by the number of specific bills before this Committee upon which there is broad bipartisan support.

And I mentioned the old song; I think we ought to live by its words. "Accentuate the positive; eliminate the negative." Let us do what we can do. Let us do what we can agree upon and let us not hold meaningful reform hostage to some of these other issues.

So I think we have, Mr. Chairman, broad bipartisan support on a lot of these issues. I thank you and your members for the support that you have given to the fuel cell technology issue, which was voiced by many of the members who testified yesterday, and I look forward to working with you in the coming weeks to make sure that we do get a bill on the floor and we do accomplish something this year. Thank you, Mr. Chairman.

[The opening statement of Mr. McNulty follows:]

Chairman MCCRERY. Thank you, Mr. McNulty. And I do look forward to working with you and members on both sides of the aisle to accomplish some very positive things for energy policy this year.

This morning our first panel is composed of a number of distinguished representatives from the private sector. We have Joseph Cooper, who is president and CEO of Alliance of Automobile Manufacturers; Daniel R. Robinson, president and CEO of Placid Refining Company in Dallas, Texas; Roger Saillant, president and CEO of Plug Power, Inc. on behalf of the Fuel Cell Advocates, Latham, New York; Robert Murray, president and CEO of Murray Energy Corporation on behalf of the National Mining Association; and Howard Geller, executive director emeritus, American Council for an Energy Efficient Economy on behalf of the Sustainable Energy Coalition.

Welcome, everyone. Your written testimony will be submitted in its entirety for the record. We ask you though to summarize that testimony in five minutes. You will notice before you there is a little machine there that will light up in just a minute. As long as the green light is on, you are in good shape. When the yellow light comes on, start wrapping up. And when the red light comes on, we expect you to conclude.

So now we will proceed and begin with Ms. Cooper.

STATEMENT OF JOSEPHINE S. COOPER, PRESIDENT AND CHIEF EXECUTIVE OFFICER, ALLIANCE OF AUTOMOBILE MANUFACTURERS

Ms. COOPER. Thank you, Mr. Chairman. On behalf of the 13 members of the Alliance of Automobile Manufacturers, it is a pleasure to be here today to provide the Subcommittee with our position on the role of cars and light trucks in our national energy policy. Today I would like to make three basic points.

First, existing energy policies are not delivering anticipated results. That is why we are all sitting here today.

Second, to be successful, we must maintain a consumer focus because consumers determine fuel economy every day through their purchasing decisions on dealers' lots.

And third, with your help we can increase the fuel economy of the fleet and meet consumer demands by accelerating the introduction of advanced technology fuel efficient vehicles.

Let me expand. We are a mobile society. Today transportation accounts for nearly two-thirds of all oil consumption and is almost 97 percent dependent on petroleum. Federal fuel economy requirements are established by a 25-year-old regulatory program known as Corporate Average Fuel Economy or CAFE. In 1992 the National Academy of Sciences called CAFE a flawed program in need of review. At the direction of Congress, the academy is once again reviewing CAFE and will issue a report this summer. This report may well focus on how CAFE only addresses the supply side of the equation but I am not here to dwell on the inefficiencies of the CAFE program, which are well documented and included in my written statement.

I am not here today, either, to focus on the future of CAFE. Congress has already acted in that regard. Congress does not need to set new standards or change the structure of the CAFE program. Current law requires the Department of Transportation to promulgate new light truck standards; that is, fuel economy standards for pick-ups, sport utility vehicles, mini-vans and vans at the maximum level possible when considering certain criteria. We will be working with the department to ensure appropriate standards are set.

Meanwhile, we continue to work on increasing fuel efficiency. Auto manufacturers have consistently increased the fuel efficiency of their models since the 1970s. According to Environmental Protection Agency (EPA) data, fuel efficiency has increased steadily at nearly 2 percent a year on average from 1975 to 2001 for both cars and light trucks. This fuel efficiency is a measure of how effectively a vehicle uses energy from fuel.

While car and light truck fuel efficiency continues to increase, their combined fuel economy has stabilized for one reason: consumers are in the driver's seat when it comes to determining fuel economy. This is the demand side of the equation.

Today you are in the role of policy-makers but you are also consumers and like millions of consumers nationwide, you may also value advanced safety features, passenger room, towing capacity, cargo-carrying capacity, utility, comfort and performance when you buy a vehicle. In fact, most consumers want it all. In surveys, consumers indicate they want greater fuel economy but in their purchases they do not want to sacrifice size, safety, cargo room, acceleration or other vehicle attributes to get it.

Today manufacturers offer more than 50 models with fuel economy ratings above 30 miles per gallon. We also offer vehicles that get more than 40 miles per gallon or greater but these highly fuel efficient vehicles account for less than 2 percent of sales.

So here we are. CAFE only addresses the supply side of fuel economy and to be successful we must maintain a consumer focus, a focus on the demand side.

We all want greater fuel economy but how do we get there from here? The auto industry strongly believes that technology will allow us to address energy conservation goals and still provide consumers with vehicles that meet their family and their business needs. That is why we support the alternative fuel and advanced technology provisions in Vice President Cheney's national energy policy.

We also support the tax credit provisions in Congressman Camp's bill, H.R. 1864, which you all heard about yesterday, the Clean Efficient Automobiles Resulting from Advanced Car Technologies Act. The CLEAR Act would provide tax incentives for fuel cells, hybrid electric vehicles, battery electric vehicles and dedicated alternative fuel vehicles, along with alternative fuel and alternative fuel infrastructure incentives.

The CLEAR Act is timely legislation. New technologies have set the stage for transforming the auto industry. Today you can purchase alternative fuel vehicles from subcompacts to SUVs to pick-ups. Alliance members are developing and introducing hybrid electric cars, SUVs and pick-ups that can increase city fuel economy by up to 200 percent.

Mr. Chairman, we support consumer tax credits. As a result, the manufacturers can increase production and lower costs for consumers. Consumers will have more fuel efficient vehicles with the vehicle attributes that they desire, and the policy-makers will see increases in fuel economy.

In conclusion, let us not try to fix CAFE. Let the program as it stands continue. Second, as we go forward, we must maintain consumer focus. And lastly, tax credit will accelerate the market penetration of highly fuel efficient vehicles that consumers will buy. Thank you, Mr. Chairman.

[The prepared statement of Ms. Cooper follows:]

Chairman MCCRERY. Mr. Robinson.

STATEMENT OF DAN ROBINSON, PRESIDENT AND CHIEF EXECUTIVE OFFICER, PLACID REFINING COMPANY LLC, DALLAS, TEXAS

Mr. ROBINSON. Thank you, Mr. Chairman, members of the Subcommittee. I appreciate the opportunity to be here today to testify about the outlook of the small refining industry in the United States.

I represent Placid Refining Company, which is a privately owned independent refiner, a small refiner with the capacity of 50,000 barrels per day. Our plant is located in Port Allen, Louisiana. We produce primarily gasoline, military jet fuel, and diesel fuel suitable for on-road use. I do not represent any other group of small refiners but due to our size, we are fairly representative of small refiners in the United States, which by some standards includes a group of up to 43 companies operating 57 refineries or up to 8.6 percent of our nation's capacity.

We have been seeing over the past 25 years an alarming rate of refinery closures in this country. We have had a loss of from up to 300 plants down to the current level of about 150. Most of these losses admittedly have come from small refineries owned by small refiners. In fact, Secretary Abraham is quoted as saying over 50 of these refineries have been lost in the last 10 years alone, the most recent being the one in Blue Island, Illinois.

The loss of this capacity has been replaced largely by the expansion of the remaining refineries in the country, primarily the larger ones. The smaller plants, however, have not participated to a great degree in expanding their capacities and we feel that they should be encouraged to do so. Certainly any impediments to expansion of small refineries need to be addressed wherever they are found.

One particular example of this can be found in section 613(a) of the Internal Revenue Code. That particular section provides that any independent producer stands to lose his status as an independent producer if he owns an equity interest in any refinery that refines more than 50,000 barrels per day of crude oil on any single day.

Placid has long opposed this particular test of any single day because it limits the flexibility of a refiner to produce more than 50,000 barrels per day on certain days of the year in order to offset production lost on other days of the year when it has to be shut down for maintenance. We alternatively support a change in this language so that the test would be made on an annual average basis rather than an any single day test.

This is not a new proposal. It has been around for a while. The Ways and Means Committee has considered this measure in 1999 when the 1999 tax bill was under consideration. The Committee adopted this proposal, incorporated it into the tax bill and, as we all know, it was later vetoed by President Clinton.

The measure continues to have broad bipartisan support. It has currently been readopted into two bills, Senator Murkowski's energy bill, S. 389, and Representative Thornberry's bill, H.R. 805, and we urge the Committee to once again give us favorable consideration on this issue when it comes before you.

But in light of the opinions stated by President Bush, Vice President Cheney, Secretary Abraham and others that we need to make a national priority of expanding refining capacity in this country, we think it is entirely appropriate now to address the 50,000 barrel issue itself. This standard was instituted in 1975 into the code and it has remained unchanged at that 50,000 barrel level for over 25 years. Other agencies on the Hill considered that higher standards are probably more reasonable for small refiners. The Small Business Administration, for example, uses a standard of 75,000 barrels per day. The Environment Protection Agency recently adopted 155,000 barrels per day as its standard for small refiners.

We urge the Committee to consider favorably any legislation that would come forward in the near future regarding the changing of these limits from 75,000 to higher levels, which will encourage small refiners to increase their production.

Before I close I would like to mention one other quick issue that is a particular concern to small refiners regarding Environmental Protection Agency (EPA's) current regulations to reduce sulphur limits in gasoline and diesel fuel dramatically. This is going to affect all refiners in the United States but in particular, small refiners are going to be particularly affected because the level of investments that are going to be required of these plants in some cases will exceed the entire market value of their refineries.

Given the fact that small refiners have limited resources, limited access to capital, and armed with the knowledge that investments that have been made traditionally in the past to produce cleaner fuels have yielded little, if any, return, there are going to be some very serious decisions that are going to have to be made in the board rooms of small refineries.

In order to soften the blow, some refiners have formed a loose ad hoc committee to explore whether tax credits or expensing of investments to meet these investments that are going to be required to produce these lower sulphur fuels might be appropriate. These proposals are currently being developed and being discussed on the Hill and there is not a particular proposal ready to go right now but we think that there will be one soon and we urge the Committee to keep in mind this need when any legislation that might come from these efforts will come before you.

We thank you very much for your patience today.

[The prepared statement of Mr. Robinson follows:]

Chairman MCCRERY. Thank you, Mr. Robinson. Mr. Saillant?

Mr. SAILLANT. Thank you, Mr. Chairman and members of the Committee. My name is Roger Saillant, CEO of Plug Power, Incorporated, a developer of fuel cell systems in Latham, New York, right outside of Albany. We are developing proton exchange membrane fuel cell systems for the stationary market, particularly for utilities, small businesses and ultimately, homes. We are testifying today on behalf of the fuel cell companies, suppliers, and other interested parties who have come together to support tax incentives for stationary fuel cell power systems. In particular, we are supporting House Resolution 1275 and its companion Senate Bill 828.

A fuel cell system is the cleanest fossil fuel generating technology available today and will be an integral part of the hydrogen economy of the future. Fuel cells are power generation systems that electrochemically combine hydrogen and oxygen--oxygen from the air and hydrogen readily available from fossil fuels. The benefits of fuel cell technology include higher efficiency and near-zero emissions of pollutants like oxides of sulphur and nitrogen and particulate matter. If widely deployed, fuel cells can address peak power demand and reduce the need for new central station power generation and power lines.

The fuel cell tax credit, if passed, would provide $1,000 per kilowatt for purchasers of fuel cell systems and would be available for purchase of all types and sizes of stationary fuel cell systems. It would be available for five years, January 1, 2002 through December 31, 2006, at which point fuel cell manufacturers should be able to produce a product at market entry cost. The credit does not specify fuel inputs, application or system sizes. Thus, a diverse group of customers can take short-term advantage of the credit to deploy a wide range of fuel cell equipment.

The credit will allow access to fuel cell systems by more customers now, when there is a serious need for reliable power in many parts of the country. Additionally, the credit will speed market introduction and create an incentive for prospective customers, thus increasing volume and helping to reduce manufacturing costs.

As with any new technology, low initial volumes keep companies from developing a manufacturing base of component and subsystem suppliers and therefore we cannot leverage better prices. For example, we have a control module in our fuel cell system that is similar to one we purchased when I was at Ford Motor Company. However, due to where we are on the learning curve and our volumes, we pay eight to 10 times more than does Ford for the same module.

Passage of H.R. 1275 will not only benefit fuel system developers but also customers and the public at large. Customers will be able to take advantage of the reliable and uninterruptable power that fuel cells provide, which is important to customers who are highly sensitive to power grid transmission problems.

Additionally, customers in rural areas or in load pockets will have reliable and secure power and will be able to have that power sooner and at a more affordable price with the passage of the tax incentive.

The public benefits are many. First and probably most important, fuel cells and the idea of distributed power lay the foundation for a truly different way to view energy generation and transmission. In other words, power becomes localized to the point of use, rather than centralized and distributed. The analogy is mainframe versus PC, cell phone versus conventional pole and line telephones.

Second, fuel cells minimize emissions. I have already mentioned NO_x sulphur and particulates.

Third, they are relatively small, quiet, and are easily sited in areas in and around people's homes.

Fourth, fuel cell systems as a distributed generation technology can address the immediate need for secure and adequate energy supplies while reducing grid demand and increasing grid flexibility.

Fifth, they avoid costly and environmentally problematic installation of transmission and distribution systems and siting issues surrounding central station power generation.

And finally, they provide a framework to move from a fossil fuel-based economy to a longer term truly sustainable energy system.

The tax credit introduced by Congressman McNulty and Congresswoman Johnson will help to bring fuel cell power systems to market more quickly and help address this country's power needs. The Fuel Cell Advocates encourage you to enact the legislation this calendar year. Thank you.

[The prepared statement of Mr. Saillant follows:]

Chairman MCCRERY. Thank you, Mr. Saillant. Mr. Murray.

Mr. MURRAY. Thank you, Mr. Chairman, members of the Committee. My name is Robert E. Murray and I am president and chief executive officer of the Murray Energy Corporation. It is a privilege to be here today on behalf of the National Mining Association. The National Mining Association represents 80 percent of the coal production in the United States and all of the uranium production. Murray Energy Corporation operates in the States of Pennsylvania, Illinois, Ohio, West Virginia, Kentucky, and Utah.

Mr. Chairman, I would like to request that my written statement be included in the record and, in the essence of time, I will discuss only two areas today of my testimony--the use of investment and production tax credits (PTC) to accelerate commercialization of clean coal technologies, both in existing and in new electric power generating facilities, and the elimination of the alternative minimum tax, which is adversely affecting the ability of the mining industry to attract capital for expansion.

Affordable, reliable electricity is necessary to maintain economic growth. By 2020, electricity consumption will increase 40 percent in our country. Yet the current electric generating fleet is not large enough to meet the demand. New electric generating plants will need to be built.

Coal is now the source for 52 percent of the electricity produced in the nation and many of the new plants should be coal. Coal is reliable, domestic, and affordable. It is the lowest cost way to generate electricity. And with new technologies, it can provide electricity with minimal impact on the environment. But new coal-based generating plants that would be capable of using this natural resource are not being built. This is largely due to the uncertainty about environmental regulations from the Environmental Protection Agency and also utilities are reluctant to assume the risk associated with large investments for advanced technologies, even when these technologies mean lower emissions.

We must do two things, Mr. Chairman and members of the Committee. First, we must expand the use of newer, more advanced NO_x and SO₂ control technologies in existing plants through retrofits. Secondly, we need to move advanced new technologies that have been proven at the demonstration stage to the commercial marketplace.

The National Electricity and Energy Technology Act, so-called NEET, has been developed to meet these challenges. The legislation has been introduced in the Senate, S. 60, and we expect that we will shortly have this bill introduced in the House. It is supported by coal producers, power generators, coal hauling railroads, the National Mining Association, Edison Electric Institute, Association of American Railroads, the National REAs, and the American Public Power Association.

As the subject of this hearing is specifically changes in the Federal tax code, we will limit our comments to those relevant provisions of the NEET Act.

For existing coal-fired generating units first, NEET provides a 10-percent investment tax credit on the first $100 million of investment in a qualifying system of continuous emission control retrofitted on an existing coal-fired generating unit. If an existing unit is repowered then a $0.0034/Kwhr production tax credit for the first 10 years of operation is provided. All units must meet improved efficiency targets to qualify for any tax credit.

The second portion of the NEET Act involves a tax credit for a new generation of technologies installed on new generating plants and just a limited number of plants. NEET proposes to amend the Internal Revenue Code to provide a 10 percent tax credit on variable, efficiency-based 10-year production tax credit investments in advanced clean coal technologies on a limited number of new and repowered units.

These technologies must meet improved design efficiency standards and there are limits on the amount of the capacity for each technology and this tax credit would go away as the technology becomes competitive.

Tradable tax credits are also provided for electric power cooperatives and publicly traded utilities.

It is expected that the revenue impact of the NEET Act would be between $1.7 and $2.2 billion for the first five years and $3.2 to $4.5 billion for the second five years. These incentives will offset the significant technical and financial risks associated with putting new technologies on line. In turn, these new technologies will allow greater use of affordable coal with lower emissions while keeping electricity costs as low as possible. This is a win for the environment, a win for the economy, a win for the lower income Americans who pay a far higher percentage of their incomes for electricity.

The second area of my presentation involves the corporate alternative minimum tax. As we know, Representative English has proposed that it be eliminated in earlier legislation and indeed the House enacted legislation to have historical corporate AMT taxpayers, such as mining, utilize accumulated AMT tax credits to offset prospective AMT tax liability, as proposed by Representative Hayworth. Unfortunately, this was vetoed by President Clinton.

Most mining companies are not profitable according to accepted accounting principles, yet we all pay the alternative minimum tax. This is a disincentive to investment in mining, a disincentive in coal, the lowest cost form of electricity generation in America.

Finally, we believe that mining companies should be provided with the opportunity to fully expense exploration and development costs, as does the oil and gas industry. The current limitations on expensing such exploration and development costs result in mining companies being forced to capitalize a percentage of these costs. This is a disincentive to open new mines.

Mr. Chairman, this concludes my remarks. I would be pleased to answer any questions.

[The prepared statement of Mr. Murray follows:]

Chairman MCCRERY. Thank you, Mr. Murray.

I advise the members of the Subcommittee that I am going to go forward with Mr. Geller's testimony. At the conclusion of his testimony we will recess to go vote. However, any member wishing to leave and go vote and come back is welcome to do that, but we will recess following Mr. Geller's testimony. Mr. Geller?

Mr. GELLER. Thank you, Mr. Chairman. I am testifying today on behalf of the Sustainable Energy Coalition, a coalition of over 30 national business, environmental, consumer and energy policy organizations. I appreciate the opportunity to appear before the Subcommittee.

The Sustainable Energy Coalition supports a broad array of tax credits for innovative energy efficiency and renewable energy technologies. Adopting these tax credits will help manufacturers justify mass production and marketing and help buyers offset the relatively high first cost of the new technologies, thereby expanding sales and market share. Once the new technologies become widely available and produced on a significant scale, costs should decline and the tax credits can be phased out.

The Sustainable Energy Coalition supports tax incentives for a limited time period, typically for five years, for the following energy efficiency and renewable energy technologies.

High efficiency appliances. We support a tax credit of $50 to $100 for manufacturers of highly efficient clothes washers and refrigerators with a cap on the total credit per manufacturer. This proposal has been introduced by Representatives Nussle and Tanner, H.R. 1316, and also S. 686 in the Senate.

Highly efficient building equipment. We support a 20-percent investment tax credit with caps for innovative building technologies, including very efficient furnaces, stationary fuel cell power systems, gas-fired heat pumps, and electric heat pump water heaters. This proposal is included in S. 596 in the Senate. The coalition also supports H.R. 1275 mentioned by Mr. Saillant.

Combined heat and power. We support either a 10-percent investment tax credit or seven-year depreciation for combined heat and power systems with an overall efficiency of at least 60 to 70 percent. This proposal is included in S. 389 and S. 596 in the Senate, as well as H.R. 1045 and H.R. 1945 in the House.

High efficiency commercial buildings. We support a tax deduction of $2.25 per square foot for highly efficient commercial buildings and multi-family residences. This proposal is included in H.R. 778 introduced by Representative Cunningham and also S. 207 introduced by Senator Bob Smith in the Senate.

Hybrid electric, battery electric and fuel cell vehicles. We support tax credits of up to $5,000 for hybrid electric vehicles, up to $6,000 for battery electric vehicles, and up to $8,000 for fuel cell vehicles to stimulate introduction and purchase of these innovative fuel efficient technologies. This proposal is included in the CLEAR Act, H.R. 1864, in the House and S. 760 in the Senate.

Energy efficient new homes. We support a tax credit of up to $2,000 for highly efficient new homes. Versions of this proposal are included in S. 207, S. 389 and S. 596.

Next, renewable energy electricity production. We support extending the existing credits for electricity generated from wind power and closed loop biomass for five years. Also, this credit should be expanded to include electricity produced by agricultural and forestry residues, geothermal energy and incremental hydropower. These provisions in part or full are included in a Filner bill, H.R. 269, Foley bill, H.R. 876, Herger-Matsui bill, H.R. 1657, and the Dunn bill, H.R. 1677 in the House, as well as a number of bills in the Senate.

Residential solar energy systems. We support a 15-percent investment tax credit capped at $2,000 for residential solar electric and water heating systems. This proposal has been introduced by Representative Hayworth, H.R. 2076, also Senator Allard in S. 465.

And finally, small scale wind turbines. We support a 30-percent investment tax credit for wind turbines 75 kilowatts and below. This proposal is included in the Bingaman-Daschle bill, S. 596, in the Senate.

As you can see, virtually all these proposed tax credits have bipartisan support. A number of them, specifically for hybrid and fuel cell vehicles, combined heat and power systems, and renewable energy technologies, are included in President Bush's energy plan.

The administration estimates its clean energy technology tax provisions will cost the Treasury about $7 billion over 10 years. We estimate that our full set of recommendations would cost the Treasury around $10 to 14 billion over 10 years. This is a relatively modest cost considering the broad scope and importance of these technologies for addressing our long-term energy needs.

In summary, the Sustainable Energy Coalition urges the Congress to make adoption of tax credits for innovative energy efficiency and renewable energy technologies a high priority. By enacting tax credits on a broad set of energy efficiency and renewable energy technologies, the Congress can pave the way to a cleaner, more secure and more affordable energy future for all Americans. Thank you very much.

[The prepared statement of Mr. Geller follows:]

Chairman MCCRERY. Thank you, Mr. Geller.

There is a vote on the floor, gentlemen and lady. If you would just hold tight for a few minutes while we go vote, we will be right back and then allow members of the Subcommittee to ask questions. Thank you.

The Committee stands in recess.

[Recess.]

Chairman MCCRERY. The Committee will come to order. The witnesses will take their seats. We apologize for the interruption but occasionally we have to vote on the floor.

Ms. Cooper, I will start with you. If the new hybrid and alternative fuel vehicles save money in the long run through greater fuel economy, despite their higher up-front costs, why do not consumers consider those factors when they are making new vehicle purchases? Why do we need an added incentive?

Ms. COOPER. Well, I think the key, Mr. Chairman, is that as you know, when you develop a new technology vehicle it is in many cases much more expensive than the conventional vehicles with which these new technology vehicles would compete. So as the vehicles gain consumer acceptance and production volumes increase, the cost differential between these two advanced technology vehicles and conventional vehicles will be reduced and, in fact, even eliminated over time.

So we think it is really important to balance that gap between the incremental cost in a way that makes it easier for consumers to try a new technology. So that is really why we support these tax credits for the consumers because the real value is to deliver the benefits that these vehicles will obtain into the overall fleet and we have to get--that is the challenge we have, is to get consumers to purchase these vehicles.

As I said in my testimony, we currently make a lot of vehicles that are very fuel efficient, 30 to 40 and above 40 miles per gallon, but they represent a very small part of what consumers buy. So what we really have to do is deliver the technology and put it in an array of vehicles that deliver all of the attributes that people are looking for, if it is towing capacity, if it is added passenger capacity, other features, because consumers really want everything. And when they say they want fuel economy, we want to be able to deliver that without sacrificing safety and the other features that consumers look for.

So getting it up front and beginning to build the market penetration so that we get the volumes up, we think that is the best way over time to really begin--as we said, we are on the cusp of real change in the automobile industry and that truly is what we are trying--we are trying to bootstrap ourselves. We are trying to sort of give ourselves a leg up in the process and doing it through incentives that get the consumers, really help the consumers.

Chairman MCCRERY. Well, let us assume that Congress passes Congressman Camp's bill and the up-front credit to the consumer is in law. How many more fuel efficient cars do you estimate would be sold, say, in five years than if no credit were available?

Ms. COOPER. We cannot really give you that estimate at this point in time. We think, based on all of our companies looking at their product plans and the like, that there would probably be a dozen or more models or vehicles that would incorporate these new advanced technologies but I cannot tell you. All the companies are looking at what the time line would look like and what an accelerated schedule would look like. So I cannot give it to you but we can work to get a number back to you so that we can give you a better idea of what it would mean in the overall fleet.

Chairman MCCRERY. Yes, that would be helpful if you could get us some idea of what this credit would mean in terms of enhanced vehicle sales. And also, once you get that number, give us some idea of the reduction in gasoline use in the country with those new cars on the road.

Ms. COOPER. Well, we think that as this program is laid out, you do get credit for the technology itself being incorporated and then, as we believe a performance bonus for the fuel savings and the efficiency or economy that you would achieve. So we will work with you to provide some better estimates. Clearly they will be estimates, as I say.

Chairman MCCRERY. Thank you.

Also, I would like for you to get the Committee in writing the changes in Congressman Camp's bill that you think are necessary. You say in your written testimony that your coalition would suggest minor changes and some technical changes.

Ms. COOPER. Yes.

Chairman MCCRERY. In H.R. 1864. If you could get those to us in writing, that would be helpful.

Ms. COOPER. We would be glad to do that, glad to do that.

Chairman MCCRERY. Thank you.

Mr. Robinson, with respect to the 50,000 barrel a day limit, can you expound a little bit on the problems that causes? In current law if you go over the 50,000 barrel limit even one day during the year then you lose your status as an independent. And you are suggesting that we go to a 50,000 barrel average per day, which would give you some flexibility. And then, of course, you suggest that we go even higher than that but let us stick right now to the question of a single day occurrence versus an average day output.

What is the difference? Why is that better for you?

Mr. ROBINSON. Mr. Chairman, thank you for the question. I did not have a chance to address it much in my testimony.

This particular rule, of course, as you expounded, if the refinery produces 50,001 barrels of crude even on one day during the tax year, the code provides that the independent producer owner of that refinery loses his status for the entire tax year. As such, that requires that the refiner that is owned by such producers have to be very careful in monitoring their day-to-day operations. We have to essentially run well below 50,000, maybe 49,500 or something like that, so that we do not have an inadvertent measuring error or metering error or something like that and inadvertently break this limit. That is for every day during the year.

Our refinery, on the contrary, we believe is capable of running more than 50,000 barrels a day, although because of this limit we have never really tested that.

Also, there are many days during the year when the refinery has to be closed or operations have to be scaled back because of routine maintenance, either scheduled or unscheduled.

If we remove this on-any-single-day test and replace it with the concept of an annual average, in other words, the refinery will run 50,000 barrels per day or less on an annual average, that will permit any surplus capacity we have to be used on certain days when we can run greater than 50,000 in order to offset those days when we cannot but yet we would still achieve over a year, stay within the intended limit of 50,000, which we think is still in accordance with the spirit of what the code is attempting to achieve here.

Chairman MCCRERY. Thank you. It sounds like to me this is just common sense. If you want to limit an independent producer to refining no more than 50,000 barrels a day, you ought to average it out to give you some flexibility for your maintenance needs and, of course, to eliminate those extra costs in monitoring every single day of the year to make sure you do not go over that. It just sounds like common sense. So thank you for your response.

Mr. ROBINSON. That is correct. And, by the way, Chairman, thank you for your support on this issue in the past and your concern for all the issues of the refining industry in this nation.

Chairman MCCRERY. Mr. Saillant, I understand how economies of scale help bring down the per-unit cost of new technologies, such as fuel cells. In fact, in your testimony you noted that already the cost per kilowatt of energy produced by fuel cells has come down by a factor of 10 over the past five years.

Based on your look at this, if we were to adopt the tax credit proposal that you propose, how much further could we expect the cost per kilowatt hour to come down, say, in the next five years?

Mr. SAILLANT. Thank you. The economies of scale will really only kick in when we start getting into higher volumes, probably really outside the coverage of this bill. I am talking 100,000 units a year. So I would like to keep the economy of scale idea out of there for the moment as being impacted by this bill.

What this bill does, it enables us to incentivize the purchaser at the high end who can afford a more costly device while we are working on getting the size of the device, the fuel cell system, down, while we are getting the weight down, while we are getting the reliability up and we have to go through a number of design iterations for that to happen.

The biggest single cost right now of a fuel cell system is related to fundamental design, fundamental design in the sense that the science is known, and the application engineering is unknown. So what we are trying to do is to bridge that gap and get units in the field so that utilities, commercial users can begin to have experience with it and give us feedback on how to redesign in order to get into the volume regime that we think will open up in the $1,000 to $2,000 per kilowatt target area, market area.

Is that helpful?

Chairman MCCRERY. Yes, sir, very much so. In other words, you think you need the tax credit to help you basically research the practical application of the fuel cells in the market.

Mr. SAILLANT. Do the practical application, the bridge. You are exactly right. It is beyond research but it is into the early adopter phase where we need the incentive.

Chairman MCCRERY. Okay. If Congress were to approve the fuel cell tax credit, how quickly do you think we could see or we would see a substantial increase in the amount of national energy demand met by fuel cell technology?

Mr. SAILLANT. Our company's estimate right now, in collaboration with other companies in this space, we think that we could begin to have a significant impact in year 2005, 2006. And by that I mean 2, 3, 4 percent, which may not seem like a lot but in terms of peak shaving and back-up, it is very, very significant.

[The following was subsequently received:]

Plug Power Inc.
Latham, New York 12110
June 15, 2001

The Honorable Jim McCrery
Chairman
Select Revenue Measures Subcommittee
Committee on Ways and Means
U.S. House of Representatives
Washington, DC 20515

Dear Chairman McCrery:

Thank you for the opportunity to testify at the June 13^th hearing on the effect of Federal tax laws on production, supply and conservation of energy. You had asked me during the witnesses questioning about the ability of fuel cells to reduce demand for electricity. For the record, I wanted to clarify the verbal response I provided to you at that time.

Alan Greenspan is correct: the short-term market for stationary fuel cells (the term of H.R. 1275) is relatively small. The fuel cell industry has estimated that fuel cell systems can provide 500 megawatts of electricity during that five-year time frame. According to data supplied by the Department of Energy, the average annualized electric demand in the United States is 440,000 megawatts. Further, data supplied by the DOE’s Energy Information Agency indicates that the increase in average energy demand is growing at a rate of 7,200 megawatts per year.

Accordingly, while the impact of the fuel cell tax benefit during the five year term, will be relatively small percentage (0.114%) of total demand, it can account for approximately 1.4% of the new megawatts needed over the next five years. By 2020, the U.S. Department of Energy estimates that distributed generation, including fuel cells, will account for 20% of the energy mix of the country. In addition, fuel cells and other distributed generation technology have the capability to address load pockets and peak demand a very targeted manner, thereby making a significant contribution in certain geographic locations.

The importance of the fuel cell tax credit is not necessarily found in megawatt demand reduction during the term of the actual tax incentive, but rather supports the production and deployment of a cost-effective product that will increasingly offload megawatts of electricity capacity over the next two decades and beyond. Without passage of H.R. 1275, many of the companies in the fuel cell industry today will be unable to sustain themselves long enough to provide the desired public good of reducing our central station power demand.

Thank you again for the opportunity to testify and the opportunity to clarify my answer.

Sincerely,

Roger Sallant

Chairman MCCRERY. That is more significant than the estimates that we have heard in this Committee from the Congressional Budget Office (CBO), for example, for all of alternative sources, not just fuel cell. And I will tell you, too, I heard Chairman Greenspan the other day, in responding to a question from a member, say not to expect too much from fuel cell technology in the near future. So you might want to get some of your research over to the Fed.

Mr. SAILLANT. I might want to add to that. When I talk about fuel cells I am including 250 kilowatt units, for example, from International Fuel Cell, Fuel Cell Corporation, Ballard, and so forth. I am not necessarily talking about the small fuel cells in the 5 kilowatt area.

Chairman MCCRERY. Thank you.

Mr. Geller, in your written testimony you describe several types of new technologies and say we ought to be supporting those through the tax code. Do you think that without the tax incentives we will be unable to achieve commercial success for some of these technologies?

Mr. GELLER. I think it varies from technology to technology. Some of the technologies are already available and are being sold on a limited basis. For example, wind power, there are wind farms going up virtually on a weekly basis in different parts of the country and it used to be only in California. Now it is the Great Plains, the Northwest. There are wind farms going up in New York State, also.

Other technologies are a bit down the road and are not commercially available yet, like fuel cell vehicles, for example. And I think the idea across the board here is to help, as previous witnesses have said, help manufacturers and help consumers to bear the higher cost for these new technologies for a limited time period to help them get well established, to help get the bugs worked out and get the economies of scale happening so that we have these technologies in hand.

This is not going to help us much in the short run; let us be honest. This is not going to do anything in the next year or two, these advanced technologies. The objective is to get them well established in the marketplace by 2005 so that we can be well prepared to address our energy needs over the long term. This is about thinking in the medium and long term. I think there are lots of other things we should be doing for the short term, given the energy problems that our nation is facing, but I think this is part of the mix, to support these innovative technologies so that they are produced on a larger scale, to help the manufacturers make that decision to go into production. There is uncertainty and risk and the tax incentives will help overcome these obstacles.

I think without the tax incentives some of it will happen but a lot less. I mean we have a couple of hybrid vehicles being produced today, for example, but I think we will have a lot more if the tax credits in the CLEAR Act are adopted.

Can I just add a comment on your initial question to Miss Cooper?

Chairman MCCRERY. Sure.

Mr. GELLER. I was involved personally in the development of the CLEAR Act and the discussions with the auto companies that developed it and we estimated that there might be something like 1 million to 1.5 million hybrid vehicles, just talking about the hybrid vehicles, vehicles that would get the credit over the time period. I think it is a six-year time period through 2007. About 1.5 million hybrid vehicles would qualify for the credit and the Treasury Department uses a similar number for their estimates of the cost to the Treasury.

That is not a lot of vehicles, considering the market is about 15 million passenger vehicles sold per year, 1 million over six years, but the whole idea again is not to get a lot of impact from the credits directly but to get the technologies well established, get the products well established. I think if this is successful, the potential market by 2010 and the decade after 2010 could be millions of vehicles per year providing major energy savings down the road. I would encourage you to look at it in that perspective, that it is not about how much do we save from the products getting incentives.

I do not think there is enough money available to incentivize a large fraction of the market for any of these technologies. It is more important to get them introduced, support the earlier adopters, get them beyond a niche product to where they are a couple of percent of the marketplace, and then phase out the credits and allow the market to work after that.

Chairman MCCRERY. Thank you. Mr. McNulty.

Mr. MCNULTY. Thank you, Mr. Chairman. As usual, you have done a good job of covering all the salient points. Let me just take a moment before I yield to our other colleagues to try to elicit a few more of the Saillant points with regard to fuel cells.

Roger, you and your colleagues have succeeded in getting me interested and even excited about the future application of fuel cells to address our energy needs but it is my view that probably most of my constituents and probably most Americans do not really have a clue about what fuel cells are. And you have described them very ably in your testimony today but I was wondering if you could expand a little bit more on the future practical application.

I know these would be guesses but how long do you think it would be before there would be a widespread use of fuel cells in residential homes? And would you have a guess as to how much a unit would cost and how long it would last before it had to be replaced, practical things like that?

Mr. SAILLANT. The general industry belief is that the automobile will be the largest single user of fuel cells in the 2020, 2025 type of frame of reference. In order to do that, it has to be $35 a kilowatt. The price volume sensitivity is real.

Before you can get to the automobile, we believe you will come to what we call the John and Jane Doe market. That market, we think, is somewhere in the neighborhood of $350 to $500 a kilowatt. We think that that market will begin to be real in probably the 2008 to 2010 or so time frame.

Before that market there is a market where it will be $2,000 a kilowatt, which will be back-up power, telcoms, utility substations, small commercial, whether it is a 7-Eleven or a Mobil gas station, and so forth. That area will probably be entered, and I think incentives would help that, somewhere between 2004, 2005, 2006 and 2007.

We have just recently acquired a sale of 75 units with a single utility and it is not necessarily public but the point really is they want to work with the technology to understand how to use them in back-up power and how to integrate them into their already-existing grid network, creating microgrids, and so forth.

So specifically back to your question, it is price-sensitive. It is probably two decades before we begin to see general widespread usage.

I would say that thing that you are doing in this market area by incentivating is different than regulating. When I was in the auto industry, we regulated emission controls and brought about expenditures in excess of tens of billions of dollars for automobiles over a 10- or 15-year period, cars and trucks, to go from unemissionized to emissionized.

One thing that I can see in parallel to this area is the seriousness with which the world is facing the CO₂ problem. That may lead to regulation. All this work is really about preparing ourselves in converting from a fossil fuel CO₂-based economy to one where eventually you can actually have total renewables. So I look at this money as very well spent, and a better alternative to going the regulatory route in a crisis.

Mr. MCNULTY. Thank you very much.

And Mr. Chairman, one of the reasons I asked that question was because I do not think that you should be too concerned about Mr. Greenspan's comments because, first of all, he was talking about in the short term and obviously here we are talking about the long term.

And the other thing is that I have tried to figure out for many years why, for instance, the stock market does what it does. A lot of people think it is based upon Greenspan's comments and it has been my experience, because I have been tracking this, that the stock market also goes up and down based upon whether or not Alan Greenspan has had a bad hair day.

So I really would not worry too much about his comments with regard to fuel cells. Thank you.

Chairman MCCRERY. Thank you, Mr. McNulty. Mr. Brady?

Mr. BRADY. Mr. Chairman, I came in a little late so on this panel I am clueless, not that the two are always related but in this case it is, and I will wait for the next panel. Thank you.

Chairman MCCRERY. Okay, thank you very much.

I want to thank all the members of the panel for your excellent testimony and your being patient with us, staying to receive our questions, and now we will excuse you and invite our second panel to come forward.

In the second panel we have Tom Ed McHugh, the executive director of the Louisiana Municipal Association, Baton Rouge, Louisiana on behalf of the American Public Gas Association; Charles N. MacFarlane, assistant general tax counsel, Chevron Corporation on behalf of the American Petroleum Institute; Vince T. Van Son, manager, business development, Alcoa Energy Division, Alcoa Inc.; and Mr. David S. Hall, manager of taxation, Berry Petroleum Company from Taft, California on behalf of the Independent Petroleum Association of America.

Gentlemen, the Subcommittee is pleased to have all of you with us today. I am particularly pleased to have an old friend of mine, Tom Ed McHugh from Louisiana, whom I have gotten to know over the years and have a great deal of respect for. He is a former mayor of the second largest city in our State, Baton Rouge, did a great job there and is now continuing to assist the municipalities all over the State through the Louisiana Municipal Association. And Mr. McHugh, we will begin with you. You may proceed.

STATEMENT OF TOM ED MCHUGH, EXECUTIVE DIRECTOR, LOUISIANA MUNICIPAL ASSOCIATION, BATON ROUGE, LOUISIANA, ON BEHALF OF THE AMERICAN PUBLIC GAS ASSOCIATION

Mr. MCHUGH. Thank you, Mr. Chairman, Mr. McNulty and members of the Subcommittee. I am delighted to be here.

I am in support of H.R. 1986 by Congressman Mac Collins and this legislation's purpose is to clarify the treatment of tax-exempt bonds used to fund long-term prepaid contracts for natural gas. The reason for this clarification is to deal with the problem created by the IRS that has effectively prevented the use of tax-exempt bonds, a privilege granted to the municipal and state governmental entities by Congress.

As background, the American Public Gas Association and municipal gas systems, APGA, is a national association representing 570 members in 36 states across this great nation, of the nearly 1,000 systems that serve 4.8 million customers or 5 percent of the national gas market.

The Louisiana Municipal Gas Association is comprised of 62 members of the 109 systems throughout the State of Louisiana and it is managed by the Louisiana Municipal Association, an association of 303 municipal governments across the entire State of Louisiana and one parish, or county that you might be more familiar with.

Municipal-owned gas systems are not-for-profit entities, public entities owned and accountable to the citizens that they serve, generally serving a mixture of residential, commercial and industrial customers. Reliability of service is paramount. As a practical matter, service can never be interrupted, heating our homes, our hospitals, and our schools.

Let us review for a minute the important issues that bring us to where we are today. The Federal Energy Regulatory Commission in 1993 restructured the natural gas industry. Municipal local distribution companies, LDCs, could no longer buy direct from interstate pipelines. They now are required to acquire a reliable gas supply and arrange transportation in order to serve the members across their districts.

In response to this new changing marketplace, joint action agencies or authorities were created to help the LDCs to assure a supply of competitive price natural gas. Joint action agencies or authorities looked at options. They, in effect, tried to form business plans. They looked at options such as pay-as-you-go, drilling wells, operating buying production, long-term prepay, both taxable and nontaxable bond issues, and other business plans in order to meet the requirements of a reliable service of long-term prepaid and as we went through that business process, it became absolutely clear to us that the prepay was a substantial business response to the needs that we had.

And based on the risk factors--credit issues and good public policy--we had no commercially reasonable alternative. In August of 1999 the IRS, in an unrelated matter, raised some questions and asked for public comments and threatened the potential of a retroactive clause in the issuance of the prepaid tax-exempt bonds.

In January of 2000 they had a public hearing. No other action has resulted from that public hearing and the action or the lack of action has effectively prevented the issuance of tax-exempt bonds to fund long-term prepaid contracts for natural gas. By no action, IRS, since January 2000, have basically overturned a privilege granted by Congress.

If we review the current law, prepayment does not result in prohibited arbitrage if prepayment is made for a substantial business purpose other than investment returns. And the issuer has no commercially reasonable alternative.

This is precisely the case with prepaid natural gas contracts for municipal gas systems. Our substantial business purpose is the duty to protect the general health and welfare of the citizens that we serve. We must deliver gas that heats our homes, our schools, our hospitals, our businesses and our factories. Prepay allows long-term contracts that have severe penalties for failure to perform. The overriding business purpose is to secure delivered supplies of gas on a competitive price basis. Prepaid transactions are designed to meet these goals and they become a clear business purpose.

As previously mentioned, other transactions, such as pay-as-you-go, drilling, and others, are not reasonably commercial alternatives. Although municipal gas systems clearly have a substantial business purpose and no commercially reasonable alterative, IRS's failure to clear up this matter in line with the current law has eliminated this most efficient tool available to public gas systems to secure long-term reliable supplies of natural gas. Congress must step in and enact legislation clarifying this law.

Mr. Chairman, this concludes my prepared testimony. Thank you for this opportunity.

[The prepared statement of Mr. McHugh follows:]

Chairman MCCRERY. Thank you, Mayor McHugh. I might add, too, Mayor McHugh is ably assisted by another old friend of mine, former State representative Robert Adly from Louisiana, who was also a floor leader for our governor in his days in the legislature, so they come well prepared. Thank you both for coming. Mr. MacFarlane.

STATEMENT OF CHARLES N. MACFARLANE, ASSISTANT GENERAL TAX COUNSEL, CHEVRON CORPORATION, SAN RAMONE, CALIFORNIA, ON BEHALF OF THE AMERICAN PETROLEUM INSTITUTE, DOMESTIC PETROLEUM COUNCIL, AND U.S. OIL & GAS ASSOCIATION

Mr. MACFARLANE. Thank you, Mr. Chairman. My name is Charles MacFarlane and I am assistant general tax counsel at Chevron Corporation. I am appearing today as a witness for the American Petroleum Institute, the Domestic Petroleum Council, and the U.S. Oil and Gas Association.

The United States today finds itself at a crossroads. Natural gas price increases last winter and higher gasoline prices this spring are in large part the inevitable result of our nation's past failure to address its long-term energy needs. According to the Department of Energy, energy demand in this country will only continue to grow, with demand for oil and natural gas expected to rise 33 percent by the year 2020.

The oil and natural gas industry stands ready to do all that we can to meet the dual challenges of satisfying increased future U.S. energy demand while at the same time maintaining a clean environment. In the short run, our industry is working flat out to produce the gasoline consumers need. With eight consecutive weeks of record production, refinery utilization is up to 97 percent. However, securing our nation's long-term energy future will take time and will require an incredible amount of capital investment.

U.S. tax policy significantly impacts our industry's ability to compete and will play a pivotal role in determining whether the needed capital investment will be made. It must be remembered that oil and gas projects require large amounts of capital and are high risk, long lead time ventures. The tax treatment of the financing and structuring of these ventures is one of the essential elements of decisions whether to proceed.

In 1999 the united oil and gas industry proposed a series of tax changes designed to spur domestic oil and gas production--expensing of geological and geophysical costs, expensing of delay rental payments, relief from the alternative minimum tax, a marginal domestic oil and natural gas well tax credit, and eliminating restrictions on percentage depletion for independent producers. In addition, expanding the enhanced oil recovery and a heavy oil production credit would help to increase domestic production.

Finally, recent events have demonstrated that it is equally important that we maintain an adequate refining and pipeline transportation infrastructure. Modifying the depreciation lives for refinery assets, oil and gas pipelines, and storage tanks by making them more consistent with other manufacturing assets will help promote the tremendous investment that is needed in these areas.

While the United States has a strong strategic and economic interest in maintaining a vibrant domestic oil and gas industry, we also need a wide diversity of international supplies. The U.S. taxation of foreign source income imposes a substantial burden on all U.S. multinational companies by exposing them to double taxation and significant compliance costs. Significant additional tax restrictions are imposed on the oil and gas industry that place us in a less favorable position than U.S. industry in general.

In order to survive, the industry must operate where it has access to economically recoverable reserves. Since access to domestic opportunities has been substantially foreclosed, the tax treatment of international operations is critical to the industry's ability to supply consumers' energy needs.

Tax measures that would enable U.S. oil and gas companies to better compete in the global oil and gas market include the repeal of the separate oil and gas foreign tax credit limitation and other items enumerated in my written statement.

In summary, we support tax provisions that will encourage the needed capital investment in our nation's refining and distribution infrastructure. Further, our industry strongly supports efforts to encourage increased petroleum and natural gas production activity in the United States through more equitable tax rules that will facilitate the use of new technologies for exploration, development, and production.

It is clear that despite our best efforts, U.S. demand for oil and natural gas cannot be met solely through increased domestic production. While U.S. reliance on imported oil can and should be reduced, maintaining the global competitive position of the U.S. oil and gas industry will be crucial to ensuring that U.S. consumers continue to enjoy a readily available supply of affordable fuels.

Thank you for the opportunity to present our views.

[The prepared statement of Mr. MacFarlane follows:]

Chairman MCCRERY. Thank you, Mr. MacFarlane. Mr. Von Son.

Mr. VAN SON. Mr. Chairman and members of the Subcommittee, my name is Vince Van Son and I am manager of business development for the Energy Division of Alcoa Inc. of Pittsburgh, Pennsylvania. I appreciate the opportunity to appear before you today. My comments today are a summary of written testimony submitted to the Subcommittee for the official record and are made on behalf of Alcoa Inc. My responsibilities at Alcoa include the procurement of electricity and the development of additional energy assets.

Alcoa is the world's leading producer of primary aluminum, fabricated aluminum and alumina. Its activities include mining, refining, smelting, fabricating, and recycling. Since the cost of energy to support some of these activities represents up to 25 percent of total production costs, Alcoa takes considerable interest in all energy and electricity developments. The total size of Alcoa's energy expenditures, coupled with Alcoa's ambitious environmental goals, makes Alcoa keenly interested in both measures to improve energy efficiency and conservation, and the growing market potential of clean and renewable energy sources.

Consistent with these interests, Alcoa is a member of the World Resources Institute's Green Power Market Development Group. The group consists of Alcoa and nine other large U.S. companies interested in promoting the development of 1,000 megawatts of renewable and clean energy sources by 2010 through directed purchasing and investment. My remarks today are based on my direct experience with renewable energy markets and my involvement in the Green Power Market Development Group's activities over the last 12 months. Through this effort Alcoa has been looking at renewable energy supplies not only from the perspective of contributing to environmental protection and sustainable development but also as a viable business proposition.

An integral part of a corporate or national energy strategy is to ensure energy is used as efficiently as possible. Extending energy efficiency and conservation can be orders of magnitude more cost effective and quicker to implement than extending supply. Efficiency and conservation of resources are integral to the Alcoa business system and Alcoa's values and therefore a natural part of Alcoa's overall energy management strategy. A national energy strategy would be incomplete without a keen focus on conservation and efficiency.

In addition, recognizing that additional generation capacity is inevitable to meet growing energy demands, Alcoa believes that there is a significant role for green power technologies within the nation's future energy mix. Green power technologies, including solar, wind, landfill gas, cogeneration and fuel cells, offer a number of environmental advantages. Consequently, Alcoa feels that renewable and clean energy technologies should be given an explicit place and support in the nation's future energy strategy.

Typical of many new technologies, renewable energy technologies currently face several obstacles that limit their growth. The primary obstacle Alcoa and the Green Power Market Development Group has encountered that currently inhibits more aggressive demand for green power and corresponding development is its relatively high delivered cost. The cost of power from renewables is often greater than the market price established by more common sources of generation for several reasons, more details of which are given in my written testimony.

Some factors relate to the relatively high capital cost of still-developing technologies. Other factors relate to the particular characteristics of some renewable technologies, such as the intermittency of wind power or the location specificity and size of landfill gas to energy projects, which present challenges to energy developers and purchasers alike.

One key factor for green power's current competitive disadvantage is that no monetary value is placed on the superior environmental attributes of green power technologies. In making decisions about new generation capacity, developers and purchasers are not presented with comparable life cycle costs and profitability that reflect environmental attributes.

In short, renewable energy sources are not competing on a level playing field with traditional energy sources. While technological and market developments will help us overcome some of the obstacles currently facing renewables, policy solutions are also needed.

A national energy strategy should provide incentives for energy conservation and accelerated development and deployment of renewable and clean energy sources. An ideal framework would ensure that after a certain future date, monetary values were placed on environmental benefits and included in all new energy investment decisions, whether conservation measures or investment in new generation. Such an outcome could be achieved through the introduction of comprehensive emission credit programs. Such programs would lead to increased development of renewables and clean energy sources. Furthermore, by extending the credit programs beyond power generation activity to include other sources of emissions, larger gains in energy efficiency could be achieved.

We recognize that a broad system of incentives cannot be designed and implemented immediately. In the meantime there will have to be bridging policies that encourage the development of renewable and clean energy sources. We believe that specific short-term tax provisions can play a vital role in encouraging investment decisions that support a more sustainable environment. In particular, we support the immediate renewal of the section 45 production tax credit for wind and closed loop biomass. In addition, we support the extension of the PTC to include a broader range of biomass technologies, such as landfill gas and combined heat and power or cogeneration applications. We would also strongly encourage incentives such as accelerated depreciation of capital investments in equipment that reduces energy use and associated emissions from industrial processes.

In conclusion, we hope that the Federal Government can instigate the development of broad emission credit programs open to sectors beyond just power generation. Until such programs are firmly established, the PTC will continue to be a vital support for near-term development and application of renewable energy and clean energy technologies. The PTC and other investment incentives are needed to bridge the gap between the cost of generation between renewable and clean energy sources and the cost of generation from the technologies and sources that the nation has historically adopted.

Thank you for the opportunity to testify. I look forward to your questions.

[The prepared statement of Mr. Van Son follows:]

Chairman MCCRERY. Thank you, Mr. Van Son. Mr. Hall?

Mr. HALL. Mr. Chairman and members of the Committee, I am David Hall, manager of taxation for Berry Petroleum Company of Taft, California and a member of the Tax Committee of the Independent Petroleum Association of America.

Today's hearing examines the effect of Federal tax laws on energy. To put this issue in a clear perspective we can turn to the 1999 National Petroleum Council's Natural Gas Study. This study concluded that the U.S. demand for natural gas would increase by over 30 percent during the next 10 years. The report also identified general areas that must be addressed to assure that this clean burning fuel will be adequately supplied to American consumers (IPAA).

The Federal Government and the tax code play a significant--if not pivotal--factor in two areas:  (1) access to capital, and (2) access to resource base. Federal tax policy has historically played a substantial role in developing America's oil and natural gas. But the converse is equally true, such as the Windfall Profits Tax and the AMT that have sucked millions of dollars from the exploration and production of oil and gas. These changes have discouraged capital from flowing toward this industry. And, without capital, the ultimate result is lower production.

The independent producers are now recovering from the low prices of 1998 and 1999 that starved the industry of funds to maintain existing production and to generate new production. Today we have a domestic industry ready to find and produce new energy for the nation's consumers, but this inherently risky industry must compete for funds against other more appealing investments and the lure of lower costs to produce foreign oil.

Hearings throughout Congress have echoed with the statements of members from both producing and consuming states alike that more must be done to increase the domestic production. The question is how, and much of that answer lies within this Committee.

In the near term there are a number of actions that can be taken. In fact, there has been wide agreement on these actions between Republicans and Democrats alike. These include: (1) allowing expensing for G&G costs and expensing of delay rental payments, (2) creating a marginal tax credits, (3) suspending or eliminating the net income limitation on percentage depletion for marginal wells, and the 65 percent net overall taxable income limit on percentage depletion, (4) and providing for an extended period for net operating loss carry-back or for the carry-back of carried-over percentage depletion.

Equally important, these changes must be crafted in a manner to assure that AMT does not nullify the benefits that would be created. The mistake of 1986 should not be repeated.

For the future, the country needs to look towards tax policies to encourage domestic production. The AMT remains the constriction, which should be addressed. Some of the future focus need to be directed to getting more out of existing resources. For example, the Enhanced oil Recovery Tax Credit does not consider technologies that have been developed in the last 20 years.

Equally significant, policies need to address encouraging more new development. For example, the section 29 tax credit for unconventional fuels proved to be a strong inducement to developing those resources, and was addressed in an earlier hearing.

Fundamentally, the question facing the nation is how to marshal the capital to develop its domestic resources. The '99 natural gas study estimates that an additional $10 billion will need to be invested annually in domestic production over the next 15 years to meet the expected demand. One source is the capital markets, but it has significant drawbacks. First, the capital markets have yet to show a strong interest in the E&P industry, despite the recent high prices in both commodities. Second, where the capital markets are likely to focus their attention will be on large companies. So, while some large independents may derive some of the capital from these markets, it will only be a portion and smaller independents will need to look elsewhere. Third, there is no guarantee that such capital will go to domestic production.

The next source of capital will be from the revenues generated by higher production and higher prices. First, the magnitude of this capital may be overstated, because just as prices for oil and natural gas have increased, prices for drilling rigs and other costs are also increasingly squeezing the capital that is available. Second, this capital also will be directed to the most promising projects, so there is no guarantee that it will be invested domestically. Third, this revenue will be significantly reduced by taxes.

The challenge then is to create a mechanism to direct the capital to domestic production. One such approach would be to create a "plowback" incentive that would apply to expenditure for domestic oil and natural gas. This type of proposal would encourage capital formation and development of domestic wells provided it was immediately beneficial. It would address a compelling need to improve natural gas supply as well as reduce the growing dependency on foreign oil. It must also apply to both oil and natural gas because they are inherently intertwined, and often found together. A healthy domestic natural gas industry cannot exist without a healthy comparable oil industry. The IPAA has been evaluating two approaches. The first would be a deduction against gross income of wells drilled domestically after 2001. The second would be an investment tax credit applied to domestic investment made after 2001. One of these could provide a substantial in-flow of capital for domestic production.

In conclusion, if Congress wants to see more domestic oil and natural gas production, it must recognize that Federal tax policy plays a critical role in whether capital will flow toward this industry and production of these resources. There are immediate actions that can and should be taken. The time is right as the nation is seeking a more stable energy supply, and Congress should act. Thank you very much.

[The prepared statement of Mr. Hall follows:]

Chairman MCCRERY. Thank you, Mr. Hall.

Mr. MacFarlane, I want to talk about the part of your testimony dealing with our foreign tax provisions in the tax code because I think probably that is an area that is just not familiar to a lot of people, including some members of the Ways and Means Committee, so I would like for you to expound a little bit on that.

Particularly, tell us what benefits would be derived from the changes you suggest in terms of domestic jobs, the economic benefits. Tell us why we should change our foreign tax rules to benefit the people here in the United States. How does it benefit us?

Mr. MACFARLANE. Sure, I would be happy to. We support increased domestic production but I think we all realize that that alone will not be enough and that we are going to have to have access to oil from outside the United States, oil and gas. And the foreign tax credit system and the U.S. tax system that applies to U.S. companies is a little different than it is for some of the other competitors that we face in the international arena.

Non-U.S.-based companies typically have a tax system that is a territorial system, so they would only tax income which arose in their country, or they may have a credit system like we do, but it may be more fully effective.

What we have in the United States is a credit system where the worldwide income of U.S.-based companies is taxed and it comes back into the U.S. tax return and you are allowed a foreign tax credit against that for the taxes that are paid to foreign governments.

There are some limitations in that system that are not suffered by our competitors that are not U.S.-based companies and we feel that there are several reasons why it is important for U.S. companies to be involved in the development of foreign oil reserves and production.

One is that the more different sources of oil that you may have, the better the security situation is because you can look to a variety of sources and this allows you to compete in more places. It also helps that U.S. companies are involved in this. It creates jobs back in the United States, people supporting these efforts creating technical expertise and bringing that to bear to produce oil in the foreign locations. And it is better that the U.S.-based companies be involved in that than leave it to others from outside the United States.

Chairman MCCRERY. So in other words, some of the foreign tax provisions in our tax code make American companies less competitive with foreign companies doing the same business overseas.

Mr. MACFARLANE. That is correct. When we look at an oil and gas investment--exploration, production, development--these are long lead-time high risk ventures, so we look very carefully at what we anticipate the returns would be on these investments. And if we suffer costs from additional compliance or the foreign tax credit system not working as well as it might, then the return that we can get is not equal to that of our foreign competitors and therefore we can lose the business.

Chairman MCCRERY. Thank you for expounding on that.

I want to let you talk and Mr. Hall talk about the AMT. A lot of the provisions that you all talked about and previous panels have talked about, we are going to try to get in a tax bill. They do not cost much, frankly, so we think we might be able to squeeze some of the incentives for production of oil and gas, some of the incentives for alternative fuels, renewable fuels, some of the incentives for conservation into a tax bill and get it through to the president, but when you are talking about the AMT, you are talking big bucks.

However, when I go home to Shreveport, Louisiana and talk to small independent producers, they tell me the thing that just kills them is the AMT.

I will start with you, Mr. Hall, since you represent the independent producers. Can you explain why my guys complain so much about the AMT? Explain it to the Subcommittee.

Mr. HALL. If I can say it in such a manner that everybody understands, depreciation is probably the big issue. As we invest back into the industry and do more exploration and development, we incur depreciation. That depreciation limits the ability we can take our credits, and so forth. So having more credits does not always benefit us. If we have alternative minimum tax that puts a threshold to not being able to utilize those credits. So we cannot monetize our credits, which means we cannot put that money back into the ground because as Berry Petroleum, we take our money internally from what is generated from our production and put it back into our development program. So if we are--

Chairman MCCRERY. So number one, it discourages reinvestment.

Mr. HALL. That is correct.

Chairman MCCRERY. Okay, what is number two? What if you have a bad year?

Mr. HALL. Well, bad year, you may still have AMT involved because you may have production from the prior year. So the first 2 to 3 years of depreciation limits your ability to claim credits before the AMT turns around and works to your advantage. So if you are constantly on a drilling program and moving forward on a constant basis, you never get to that third year. You have to have two or three bad years in a row and then you have other problems.

Chairman MCCRERY. So the AMT is a rather perverse--

Mr. HALL. Big-time problem for the small independent producer, big-time problem.

Chairman MCCRERY. What about the big guys, Mr. MacFarlane? Is it for them, as well?

Mr. MACFARLANE. We also find AMT to be a problem. I think Mr. Hall said it well. The problem is that some of the incentives we are talking about here, you do not get them if you are subject to AMT. The other problem is that AMT tends to hit you the hardest in the bad years. It has the effect of making you pay taxes when basically you do not have the income that would warrant it. So it is a difficult situation to deal with when you are trying to encourage investment.

Chairman MCCRERY. Well, that is the third point, getting outside investors to even look at financing an oil and gas deal. When they can put their money into bonds or something that is safe and get a fairly good rate of return, they look at the oil and gas deal and say well, even if the deal works, if the price goes down we have a bad year, we do not make money, we are still going to have a tax liability. Not a real good selling point.

So I am hopeful that this Congress will finally come to grips with the alternative minimum tax, not just for the oil and gas industry but for our whole economy it is a relic of past tax policy; it has no place in our tax code today. Yes, it is going to be expensive to do away with it but we ought to do that. But we will particularly look at the effects on additional incentives that we put in the tax code, trying to at least insulate those from the effects of the AMT. So I appreciate your testimony.

Mr. McNulty?

Mr. MCNULTY. Thank you, Mr. Chairman. I have no questions. I just want to thank all the witnesses for their testimony. I especially want to thank Mr. Van Son for his focus on renewables and I certainly hope that legislation with regard to those issues will be included in our final legislative package. Thank you, Mr. Chairman.

Chairman MCCRERY. Mr. Brady?

Mr. BRADY. Thank you, Mr. Chairman.

First, Mayor McHugh, I know that the Internal Revenue Service's job is to collect revenue but I am always constantly amazed at how good a job they do. When organizations work hard to try to get the most efficient, the most affordable cost for their customers it has to be frustrating to have a Federal agency step in and negate those very gains you have made for your own customers. So I am hopeful that we can help in that area.

For Mr. Van Son, you put a big emphasis on conservation. I appreciate the point you make, too, which is it is not either conservation or supply; it is not either conservation or technology. We have to have all three in a balanced approach--some help short term, some help long.

But the main point that you make, the Green Power Group supports immediate renewal of section 45 and the expansion of it; is that included in the president's energy proposal?

Mr. VAN SON. I'm sorry; could you please repeat the second half of your question?

Mr. BRADY. The section 45, your main proposal, immediate renewal of 45, the production tax credit for wind and closed loop biomass and then the extension of it. Is that included in the president's plan?

Mr. VAN SON. Yes. Actually, many of the comments I said today are consistent with what is outlined in the national energy policy document recently published. In particular, the extension of section 45 should include landfill gas to energy projects for both the production of electricity, as well as direct use applications by conversion to a BTU credit as in some cases it is more efficient to route the methane directly to a boiler or other application.

Mr. BRADY. Sure, thank you.

And Mr. MacFarlane and Mr. Hall, it seems to me that the issue of energy security is more than just economics; it is a matter of national security. And as long as our country continues to rely on foreign sources for more than half of our daily needs, we are vulnerable. It also seems like as one of the most prosperous nations in the world, there is no responsible reason we ought not be taking more care of our own energy needs.

From the national security standpoint, because no one pays much attention to you when oil is $10 or $12 a barrel but part of your effort at encouraging domestic supply in a consistent and affordable manner, does that not contribute to our national security efforts, just to have more control over our own daily energy needs so that we again have more strength when dealing with circumstances that are beyond our control? Either one of you may answer.

Mr. MACFARLANE. Certainly I would agree. It is important to produce what we can from this country. I think it gives us more options from a security point of view and it is important. I do not think it is the total answer but I think it is a very important part of it.

Mr. HALL. Coming from the independent producer side of it, the issue becomes when you have low oil prices and you stop producing, you have these marginal wells that may be shut in on a permanent basis, which means you have lost that reserve for a long period of time, if not forever. They may not come back. They may not be brought back ever.

So every barrel that we import, every barrel we do not produce internally, or domestically we have to import from someplace else, which means there are a lot of environmental issues, as well, by bringing tankers in and everything else. So there are multiple facets to that issue and we do concur with you. That its a National Security issue as well

Mr. BRADY. Right. Well, thank you to the panelists and thank you, Mr. Chairman.

Chairman MCCRERY. Thank you, Mr. Brady. And thank all of you for your testimony today. We appreciate your helping us to try to craft a national energy policy that makes sense.

Now we will go to our third panel. Jerry D. Williams, general manager and CEO of Claiborne Electric Co-op, Homer, Louisiana on behalf of the National Rural Electric Cooperative Association; John Tiencken, president and CEO of South Carolina Public Service Authority on behalf of the American Public Power Association; Greg Nelson, vice president and tax counsel, Ameren Corporation, St. Louis, Missouri on behalf of the Edison Electric Institute.

Welcome to all of you, gentlemen, and a particular welcome to Mr. Jerry Williams, who is from north Louisiana and my congressional district and I have worked with him on electric co-op issues for quite a number of years. He always brings a load of expertise and common sense to our discussions so I welcome him particularly. And Mr. Williams, since you are from my district, you get to go first.

Mr. WILLIAMS. Thank you, Mr. Chairman and members of the Committee. I am Jerry Williams, the general manager and CEO of Claiborne Electric Co-op in Homer, Louisiana. I appreciate the opportunity to appear before you today to discuss tax law changes that are needed to ensure adequate power supplies and to facilitate fair competition for all electric utilities in the move towards a more competitive marketplace.

Mr. Chairman, my verbal testimony will summarize Rural Electric Co-op's strong support for the bipartisan legislation H.R. 1601 introduced by Representative Scott McInnis and John Tanner, and please refer to my written statement for background information and an explanation on the need to provide rural electric co-ops with tradable tax credits.

As you are aware, electric cooperatives have a different tax status. Because cooperatives are not-for-profit businesses, they are owned and operated for the benefit of consumer owners. It is particularly important that in an era of restructuring that tax policy adjust to keep the cooperative business structure viable. All three sectors of the utility industry agree that legislative tax fixes are needed to keep pace with the changes occurring in the industry.

An electric cooperative is tax-exempt as long as 85 percent or more of its annual income comes from members. Even though tax-exempt, income derived from business lines unrelated to the co-op's tax-exempt purpose is still taxed under the unrelated business income tax. If restructuring were accompanied by a loss of the tax-exempt status of electric cooperatives, the prices cooperative members face might rise as a result of it.

The 85/15 percent test posed few problems for cooperatives prior to retail competition, mainly because cooperatives, like all electric providers, had exclusive service territories. But with retail competition, the very nature of the business is changing. The 85/15 percent test was enacted in 1924 and has not been substantially altered in 75 years.

To compute a co-op's income, the tax code currently ignores two type of revenue. H.R. 1601 proposes eight additional exclusions from the income test. The first exclusion is income earned by a subsidiary is fully taxed at the subsidiary level and would not be counted in the 85/15 test until paid to the co-op.

Secondly, in order to operate on an at-cost basis, rural electric co-ops are required to assign and distribute capital credits, also called patronage dividends, to their members. These capital credits represent the difference between revenue received from a member less the operating cost to serve that member. In a competitive market, certain members may be willing to forego their capital credits in exchange for lower rates and the donated capital would not be considered for the 85/15 test.

And third, for competitive reasons, a rural electric co-op may need to sell electricity below fully allocated cost and at a price based on incremental cost in order to meet market rates and such income would be excluded from the 85/15 test. An example of this, Mr. Chairman, would be the rates that Claiborne Electric offered Con-Agra to build a poultry plant near Farmerville, Louisiana.

And fourth, the nuclear decommissioning investment income would also be excluded. As the Nuclear Decommissioning Fund grows over the life of a nuclear power plant, investment earnings on the fund could cause the co-op to fail the 85/15 test.

Fifth, condemnation income would not be considered. Nationwide, rural electric cooperatives suffer the condemnation and annexation of their service territories by municipalities. This would not limit a municipality's right or authority to condemn territory.

Sixth is prepaid income that would not be considered income to rural electric co-ops. This is a clarification that is important because approximately 20 percent of all the rural electric cooperatives have prepaid their debt to the RUS. Because the present value payment is a discount from the par value of the debt, the IRS presently considers the discounted amount to be nonmember income.

And seventh, H.R. 1601 excludes contributions in aid of construction by members or nonmembers to build new lines or improve electric service from the 85 percent member income test.

And eighth, H.R. 1601 provides that if a rural electric co-op enters into a mutually beneficial agreement to sell, lease or swap service territory or other assets, the capital gains from that transaction are excluded from the 85/15 test.

In addition to the exclusions from member income that I have just described, four other types of income would be considered member income under H.R. 1601. In general, this is income that was member income prior to restructuring.

Those four are first, wheeling income and, as an example, Claiborne Electric may be required to transmit or wheel electricity through our lines for other utilities or third parties.

Second would be regional transmission organization income. It is quite likely that either a statute, regulation or market condition would force the rural electric co-ops to participate in regional transmission organizations.

And third is unbundled income and electric energy sales income. The income of co-ops may be unbundled and charges for things like billing, collecting, et cetera may be broken out and these transactions with or for our members would be considered member income, even if we actually collected it from a third party.

And then fourth, replacement electric energy sales income. If a rural electric cooperative loses kilowatt-hour sales in an open market, the co-op would be allowed to replace those sales with an equal amount of outside sales.

Mr. Chairman, the bill also provides generally the same relief for taxable co-ops.

In conclusion, 75 years ago when the 85/15 percent test was established it was impossible to contemplate what is going on in the industry today. We respectfully request that Congress recognize the changing market and revise the 85/15 percent test to ensure that cooperatives are part of the future competitive landscape of the electric industry.

Thank you for the opportunity to appear before you today.

[The prepared statement of Mr. Williams follows:]

Chairman MCCRERY. Thank you, Mr. Williams. Mr. Tiencken.

Mr. TIENCKEN. Thank you, Mr. Chairman. My name is John Tiencken and I am president and CEO of the South Carolina Public Service Authority, also known as Santee Cooper. I am here today on behalf of the American Public Power Association, which represents more than 2,000 publicly owned utilities across this nation, and also on behalf of the Large Public Power Council, which represents 21 of the nation's largest publicly owned utilities.

I would like to address certain aspects of H.R. 1459, which deal with tax-exempt bonds, which public power has traditionally issued to build its facilities. This tax-exempt debt is subject to a strict set of Federal tax rules which limit the amount of power that can be sold to private parties and the amount of transmission service that we can provide to private parties.

Now these rules, which perhaps made sense in a regulated noncompetitive world, are problematic in the world in which we now do business and are a barrier to our ability to deliver electricity at a time when our nation is experiencing power shortages.

I want to emphasize that the private use rules are a real-world problem. They are one that weaves its way into the fabric of our decisionmaking at our utility and I wanted to give you a few examples of that, to describe how we run into this very frequently during our business transactions.

Private use rules restrict public power systems from opening up our transmission to use by all parties and even though the 2001 IRS temporary regulations permit public power to participate in transmission open access without creating private use on existing lines, the regulations are only temporary and will expire in three years unless extended or made permanent.

Now public power cannot make a long-term commitment to open access when the door may be closed in a 3-year time frame. I will also point out that we cannot build new transmission lines with tax-exempt debt if we participate in open access.

Another limitation on our ability to provide open access is that public power is restricted by private use rules from joining regional transmission organizations. Although the 2001 temporary tax regs again provide some relief, that relief is, in fact, limited to only a time frame of 3 years and may expire in 2004.

Private use rules also limit our ability to sell surplus power into wholesale markets. My utility, for instance, is a net power purchaser now but at other times may be selling into the wholesale market. Under the 2001 temporary regulations, we may only make wholesale sales which are less than one year in duration. However, long-term contracts are, in fact, favored in the electric industry now and you do not have to look much further than California to see the value of long-term contracting for electric supply. The proposed bill will also allow longer-term sales under certain conditions.

Finally, I want to address the complexity of private use rules and the lack of clarity in their interpretation and how this creates a challenge to us and a chilling effect on our ability to do transactions. As an example, Santee Cooper, along with a number of other public power entities, formed an organization by the name of The Energy Authority to market and purchase power for us. The sales that The Energy Authority makes are sales which are governed by the private use rules.

Now what is not evident to most folks is the amazing complexity of these private use rules. I was a tax lawyer in a former life and I can tell you that this area is as complex as any that I have had to deal with in my tenure. To give you an example, I have been on the phone with five tax lawyers and bond lawyers to try to determine whether we could do a specific transaction for The Energy Authority. You can imagine that there is going to be a difference of opinion in whether or not that can be done.

So what you find is that the complexity and the lack of clarity in this set of arcane rules makes us seek the lowest common denominator among the divergent opinions, so you end up with in many instances not being able simply to do a deal.

What H.R. 1459 does and will do is provide us with clarity and it will enhance our ability to provide open access and compete in the new competitive world. So I appreciate your consideration and thanks for your time.

[The prepared statement of Mr. Tiencken follows:]

Chairman MCCRERY. Thank you, Mr. Tiencken. Mr. Nelson.

Mr. NELSON. My name is Greg Nelson. I am vice president and tax counsel of Ameren Corporation in St. Louis, Missouri. Ameren is a public utility holding company that owns utilities that serve customers in Missouri and Illinois. I am speaking today on behalf of the Edison Electric Institute, the trade association of shareholder-owned utilities. We serve 90 percent of the customers served by shareholder-owned utilities in the United States and roughly 70 percent of all electric customers in the United States.

I am particularly pleased to testify in support of H.R. 1459, along with Mr. Tiencken from the public power trade organizations. The provisions of that bill are the product of a long negotiation between our respective groups to try to find a way to fairly balance the interests of our respective constituencies in light of the changing situation, both on the regulatory front and with the electric energy supply situation.

The context of the bill is the energy supply situation. We are all familiar with the developments in California. We also are familiar with the fact that the crisis in California threatens to spread to the rest of the country if something is not done. There is a wide range of opinion as to what went wrong in California and why. I think a consensus among people with different opinions is that energy supply is a big part of the problem. There are policy-makers now at the Federal level and the state level looking for ways to solve energy supply issues.

Energy supply has two components. First is the generation component, making sure that we have adequate generation facilities in the country to produce the electricity that we need. But secondly and very important to this bill is the need for adequate transmission; that is, delivery of the electricity from the plants to the population centers and industrial centers where electricity is needed.

Mr. Tiencken covered the private use rules, the part of the bill that affects tax-exempt bonds of public power. I would like to cover three items and basically all three items, deal with removing tax barriers to energy supply expansion and modern restructuring developments.

The first is to remove barriers to the formation of independent transmission companies. The Federal Energy Regulatory Commission (FERC), which has jurisdiction over interstate sales of electricity, is essentially requiring electric utilities to join regional transmission organizations. These are defined in roughly 1,000 pages of FERC orders and regulations and FERC Order 2000 as having several characteristics, including sufficient size and scope to have a regional-type presence or concentration of transmission and also independence from the present transmission owners themselves.

The ultimate business model that most utilities are moving toward is a transmission company; that is, a company formed for the purpose of owning transmission and being motivated to improve and upgrade and keep the transmission system where it needs to be, given our energy supply needs.

There are two hurdles right now in the tax code that limit the ability to form independent transmission companies. The first is just the normal rule. If we as the utility sell transmission to a transmission company, we have to pay a tax on the increment of the value over the tax basis. That is an impediment right now to selling assets to a transmission company.

The second transaction to get to a transmission company is a spin-off, and the problem is that if we were to spin off transmission assets we would need to subsequently combine with other spun-off companies to form a transmission company with sufficient scope to meet the FERC guidelines. Under tax law, section 355(e), the so-called anti-Morris trust provision, that would trigger a tax event, as well.

So what 1459 would do, number one, is to provide tax relief in both of those situations to promote the formation of transmission companies.

The second item is to restore in general the pre-1986 Act law on contributions in aid of construction in an effort to ensure that contributions to utilities by customers are not taxed and that we do not have a tax impediment to the expansion of our infrastructure.

Finally, 1459 would update the Nuclear Decommissioning Fund provisions by removing the tie to regulated rates that the Code section 468A has going back to 1984 and by facilitating the transfer of nuclear plants from one owner to another by providing for accelerated funding of decommissioning if a regulator approves it or if a transfer occurs.

I see my time is running out. I would be happy to take questions and I appreciate the opportunity to speak.

[The prepared statement of Mr. Nelson follows:]

Mr. HAYWORTH. [Presiding.] And Mr. Nelson, we thank you for your testimony and being mindful of the time, as have the other two witnesses. Thank you very much.

Mr. Tiencken, let me turn to you first if I could. As I understand it, if a utility is in a state that has restructured its electricity industry, it may experience some loss of customers to competition. Is it true that if private use rules remain in place, that utility could find it difficult to sell the excess power created by these losses to new customers on a long-term basis, even though some parts of our country may urgently need that power?

Mr. TIENCKEN. That is correct, Mr. Hayworth. The current private use rules restrict our ability to sell into the open market. We can sell to retail customers currently to our existing customer base, but without the relief that is represented by your bill, we will have difficulty in competing in a competitive world and being able to remarket that power without impacting our existing tax-exempt debt.

Mr. HAYWORTH. Mr. Tiencken, we have all heard about the problems associated with inadequate supply but also in getting that supply to the customer through the nation's transmission grid. It appears that private use rules actually inhibit municipal utilities from allowing their own transmission lines to be utilized by others without jeopardizing the tax-exempt status of the bonds used to build the assets.

Will you explain how changes in the private use rules could enhance the use of the transmission and distribution systems to deliver more power?

Mr. TIENCKEN. Yes, sir, Mr. Hayworth. The reality is that we are impaired dramatically in our abilities to be able to join regional transmission organizations and, in fact, to be able to offer our transmission assets for use in open access regimes. We have problems with that.

What your bill does is provide us with substantial ability to have certainty in opening up to transmission access. In moving power from one region to another it allows us to place our assets in play in the transmission grid and have those assets utilized by all parties without fear of our tax-exempt bonds becoming taxable. And that is a big issue for us in the public power area, particularly those who own a substantial amount of transmission, as does my utility.

Mr. HAYWORTH. One final question for you, Mr. Tiencken. The Treasury Department has reissued temporary regulations related to tax-exempt bonds in private use. I have heard from some of my constituent utilities that while these temporary regulations help, they are by no means totally adequate. Could you explain why that is the case?

Mr. TIENCKEN. Yes, sir, I can explain. Congressman, the temporary regs are, in fact, just that--temporary. They expire within their three-year time frame. They also do not offer full relief. New transmission cannot be funded with tax-exempt bonds any longer. And in addition, transmission that was funded with tax-exempt bonds recently may not now be placed into an RTO or into open access without jeopardizing all of those bonds that have been issued for that particular entity's transmission assets.

So the rules that the IRS has proposed as temporary are not going to resolve our problem for the long term and that means we cannot do a substantial amount of planning based on a three-year window that might close on us.

Mr. HAYWORTH. Mr. Nelson, in your statement you suggest that shareholder-owned utilities complying with FERC orders to transfer their transmission assets are likely to choose a limited liability corporation model. I really have a two-part question for you, sir.

Why would they choose such a corporate form? Are there advantages and disadvantages you could describe? And are you aware of any instances where this has occurred?

Mr. NELSON. Yes, Mr. Hayworth. The reason that a shareholder-owned utility right now would choose an LLC structure is that by choosing a more direct structure, an outright sale or a spin-off with the consolidation to follow, both of those other structures would involve the imposition of a tax and a very substantial tax.

The LLC model allows the assets to be contributed to an LLC to satisfy the FERC requirements that control the transfer to a separate entity but ownership stays with the utility to avoid imposition of a tax. So it is really a tax-driven structure where a utility can comply with the FERC rules but avoid taxation.

That really goes to the advantages and disadvantages, as well. The advantage is that you avoid a tax; the disadvantage is that you have a fairly cumbersome structure, as opposed to a more direct sale and movement toward a transco.

In terms of the prevalence of the use, my own company is a member of the Alliance RTO, which stretches from our service territory in Missouri all the way east to West Virginia. It covers the States of Illinois, Indiana, Michigan, parts of Virginia. We are using an LLC structure in that RTO. In addition, I know there is an RTO in Wisconsin that is using an LLC structure; also, in Florida. Frankly, I do not know of any examples of RTOs that are not using the LLC structure.

Mr. HAYWORTH. Thank you, sir, very much. Let me turn to my good friend, the ranking member from New York.

Mr. MCNULTY. Thank you, Mr. Chairman. I have no questions of this panel and I thank you and the chairman for conducting all three of these hearings and I look forward to working with you in developing a consensus on reform legislation to serve our energy needs in the future. Thank you.

Mr. HAYWORTH. Thank you, sir. Does my friend from Texas have any questions?]

Mr. BRADY. No, it was excellent testimony. I know the groups have worked hard to work out some solutions and it shows. So thank you.

Mr. HAYWORTH. I look down the dais and I see my good friend who has labored on this issue with me, the gentleman from Pennsylvania.

Mr. ENGLISH. I thank the chairman. First of all, I would like to salute the chair for all of his groundwork in moving toward a legislative compromise between a couple of parties interested in this issue and he really has been the leader on this and I want to thank him for his efforts, both on behalf of public power and investor-owned utilities.

I would like to ask Mr. Nelson a couple of questions. You described in your testimony the corporate form that your company has adopted in response to the issues you have outlined. How much of the corporate structure you have adopted is a function of tax liability, potential Federal tax liability?

Mr. NELSON. I hate to use the word all but I would say most, mostly driven by the need to avoid a tax that is built into these assets under current law.

Mr. ENGLISH. Can you describe it advantages and disadvantages that drove your decisionmaking in that regard?

Mr. NELSON. Certainly. FERC Order 2000 is essentially forcing us to join an RTO, to put our assets into an RTO. We also have a merger order which requires us to do that. We have found that the only structure that accommodates the FERC requirement that there be independent control of the transmission assets, while we still retain ownership and avoid the triggering of a tax, is the LLC structure.

The disadvantage is that we separate ownership from control. We own assets but we do not control them. The RTO will control them. They will tell us what to do with those assets in terms of maintenance, improvements, et cetera. They can call capital from us to do things to the assets. That is a cumbersome and awkward way to own an asset.

Mr. ENGLISH. Looking at the provisions of H.R. 1459, how do they compare with Congressman Weller's bill, H.R. 1702?

Mr. NELSON. This is dealing with the nuclear decommissioning components and they are virtually identical in substance. The only difference is that Mr. Weller's bill has an earlier effective date than does Mr. Hayworth's bill.

Mr. ENGLISH. With regard to interconnection as you have described it in your testimony, why do you propose that interconnection be nontaxable?

Mr. NELSON. There are really two contexts that we have the interconnection issue. The first is where the merchant generation plant is being built and the first thing they need to do is arrange for transmission.

The IRS for a very long period of time had a ruling posture that would have allowed that generation plant to make a tax-free interconnection payment. Recently the IRS has declined to rule and to give us the comfort that we need that these transactions are not taxable.

These transactions are happening and the problem is that we have a situation where the IRS is not interpreting the law the way that we believe it should be interpreted. This legislation will clarify that and make sure that a generation plant, when it makes an interconnection payment, does not get what turns out to be a 30 to 35 percent increase in the cost of that interconnection facility. The policy reason for that is not to saddle these transactions with an incremental cost that is not warranted.

The second context is the situation where developers are connecting housing developments and new electric customers to the system. The reason to change the law in that context is simply to reduce the cost of improving our electricity infrastructure given the situation we have right now with an energy supply problem in our country.

Mr. ENGLISH. And can I finally ask you to elaborate? You had mentioned tax policy considerations. I could understand why some of these tax changes would benefit investor-owned utilities but can you elaborate on the tax policy justification for your position? You know, from a standpoint of tax policy principles, can you elaborate on why you think we should go in this direction?

Mr. NELSON. May I assume that the context of your question is in the 1033 and the 355 context?

Mr. ENGLISH. Yes.

Mr. NELSON. The analogy there really is to involuntary conversion. The tax code already provides for tax deferral in the context of involuntary conversion. Our proposal analogizes the situation where we are being obligated to turn over our assets to an RTO. It analogizes that situation to the involuntary conversion context and it is consistent with the tax policy in the involuntary conversion context.

Mr. ENGLISH. Thank you, Mr. Chairman.

Mr. HAYWORTH. I thank you. And the chair would note the outstanding work done by the gentleman from Pennsylvania as we took a look at some differences in this and reached across this vital industry to reach an accommodation and come up with some common-sense solutions. The chair also welcomes the very constructive comments of the ranking minority member but I would be remiss if I did not state for the record the very genuine energy and policy challenges that were overcome by the work of my good friend from Pennsylvania. I am very appreciative of the fact that we were able to team up on this.

Mr. ENGLISH. I thank the chair and I am always very much obliged for the opportunity to follow in your path of leadership. Thank you, sir.

Mr. HAYWORTH. Well, I think we are walking side by side and that is quite a spectacle, as we know. From time to time we have been referred to as tag team partners and I am glad to have you on my side, Mr. English.

I would like to thank the witnesses. Again, Mr. Williams, the Chairman, as he was going out to vote, was very happy to have you here from his district. We appreciate you representing the co-ops.

And for all our witnesses today, thank you very much for your time and attention on these matters and this third hearing of the Select Revenues Subcommittee is hereby adjourned.

[Whereupon, at 12:25 p.m., the hearing was adjourned.]
[Submissions for the record follow:]