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 OVERSIGHT AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio JERRY WELLER, Illinois KENNY C. HULSHOF, Missouri SCOTT MCINNIS, Colorado MARK FOLEY, Florida SAM JOHNSON, Texas JENNIFER DUNN, Washington	WILLIAM J. COYNE, Pennsylvania MICHAEL R. MCNULTY, New York JOHN LEWIS, Georgia KAREN L. THURMAN, Florida EARL POMEROY, North Dakota
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 February 14, 2001, announcing the hearing

U.S. Department of the Treasury, Joseph Mikrut, Tax Legislative Counsel

U.S. Department of Energy, John S. Cook, Director, Petroleum Division, Office of Oil and Gas, Energy Information Administration

Chautauqua County, NY, Frederick A. Larson

Independent Oil and Gas Association, Dennis Holbrook

Lindsley, Moira L., Sinclairville, NY

National Fuel Gas Distribution Corporation, Bruce D. Heine

Sosinski, Caroline, Westfield, NY

Universal Resources Holdings, Inc., John J. Nalbone, Jr.

Western New York Regional Council of Carpenters, Jeff Aiken

Accurate Prices Program, and Redefining Progress, Oakland, CA, Mark Glickman, and Kim Rodgers, joint statement

American Petroleum Institute, statement

Anchor Glass Container, Elmira, NY, Michael Sopp, statement and attachments

Brown, Helen D., Bath, NY, letter and attachment

California Independent Petroleum Association, Sacramento, CA, David S. Hall, letter and attachments

Coyne, Hon. William J., a Representative in Congress from the State of Pennsylvania

Dominion, Jane Lew, WV, Ben Hardesty, statement

Eaton, Patricia, Bath, NY, letter and attachment

Edison Electric Institute, statement

Hall, Mildred C., Bath, NY, letter

Independent Petroleum Association of America, and National Stripper Well Association, John Swords, joint statement and attachments

Lubrizol Corporation, Wickliffe, OH, statement

National Energy Marketers Association, Craig G. Goodman, statement

New York State Assembly, Hon. Catharine M. Young, Assemblywoman, statement

Slaughter, Hon. Louise M., a Representative in Congress from the State of New York, statement

House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Mayville, New York.

The Subcommittee met, pursuant to notice, at 12:16 p.m., at the Chautauqua County Legislative Chamber, Gerace County Office Building, Mayville, New York, Hon. Amo Houghton (Chairman of the Subcommittee) presiding.

[The advisory announcing the hearing follows:]

Mr. LARSON. I am Fred Larson. I am the Chautauqua County Attorney, and more significantly today, I am the Acting County Executive. And on behalf of our County Executive, Mark Thomas, who is in Washington today, and on behalf of the 140,000 people of Chautauqua County, it is a distinct honor and privilege for me to welcome Congressman Houghton, Congressman English, and Congresswoman Thurman here to Chautauqua County, New York.

It is appropriate that you are here. On the one hand, Chautauqua County is the largest gas and oil producer in the State of New York, and on the other hand, we obviously have a very long heating season here in Chautauqua County. We have all been shocked by the sudden, dramatic and largely unexplained increase in the cost of heating our homes and businesses this winter. We wish you the best in formulating thoughtful public policy that will foster both the efficient use of energy and the increased exploration and production of energy.

So on behalf of Mark Thomas and the people of Chautauqua County, welcome to Mayville and Chautauqua County, New York. Thank you.

Chairman HOUGHTON. Well, thank you, Fred, very much. I really appreciate it, and give Mark our best. Mark is in Washington. We are here. It just seems that something is wrong. But Fred, we are delighted and thank you for your gracious words.

Ladies and gentlemen, let me just try to explain a few things before we begin our hearing. I have got this great gavel. I will pound it in a minute.

First of all, thanks so much for being here. It really means a lot, because it means a lot to us, and it means a lot to the people, not only here in Chautauqua County, but also in the United States. But we are dealing with a really important issue. The concept of the hearing is that we listen to people who know something about this issue, and can give us information with which we then can make better decisions.

We are Members of the Ways and Means Committee, and the Ways and Means Committee is primarily involved in taxation because 100 percent of the revenues and 60 percent of the cost go through our particular Committee.

The work of Congress is done by committees, and many times the work of committees is done by subcommittees. And, we are the oversight Subcommittee here dealing with this particular issue on energy. We had a meeting a couple of years ago. Since then, obviously, energy prices have escalated, and there has been a lot of hurt around this country.

So what we are trying to do is take our hearing process out into the country, hear what other people have to say, not only experts in the field of energy conservation or production, but also people who, locally, are being affected by this energy crisis.

So that is the whole concept here. We cannot drill for oil. We cannot do a lot of different things that you would expect us to do, maybe such as Spencer Abraham in the Department of Energy might be able to do, but we can take a look at the overall issues and see where Congress, particularly through the Ways and Means Committee, can play its part. So that is what we are trying to do.

Let me just say, also, that there are pieces of testimony up here. Anybody that would like to pick up one of them, they can. Also, if you would like to put your name on a piece of paper -- I don't know where that piece of paper is, Mac. If you would like to get copies of the testimony, which is being produced here today, we would be glad to send it to you. We want you to be involved in this process, despite the fact that you really are observers here and the panels and the individuals are the ones who are going to be doing the testimony. So I just wanted to explain that.

We will try to keep this thing moving right along, and I hope it will be of interest to you. So now here goes, the gavel.

The hearing will come to order, ladies and gentlemen, and I would like to deliver a few brief remarks. Then I would like to turn the microphone over to Karen Thurman and Phil English.

Before I make my remarks, let me introduce these two individuals. Karen Thurman is a dear, wonderful friend. She and I have done a lot of things together. She is not only representing herself and her own feelings, but also Bill Coyne, who is the ranking member of this Subcommittee and hurt his shoulder and could not be here today.

Bill could not get here from Pittsburgh, but Karen got here from Florida. So I think we ought to give you a special Chautauqua welcome.

And the person on my right is Phil English, who I am very close to. We have been involved in a variety of different issues. Phil and I consider ourselves some of the middle of the roaders in the Republican Party and feel that we try to represent the best interests of northeastern United States, both in Pennsylvania and in New York. So, Phil, thank you very much for coming up here from Erie.

Now, I want to thank so many people. Also, I would like to thank Mac McKenney, who is the head of the -- he was head of the staff of the -- on the Republican side on the Ways and Means Committee for the Oversight Subcommittee, and also Beth Vance, who represents the Democratic side. Beth and I worked together for a long time, particularly when I was the minority member, when Jake Pickle of Texas, who was the Congressman -- famous Congressman who took over for Lyndon Johnson. So we have had a long, long history together. So I want to thank them very much.

You may be knowledgeable about this; I was not. That in 1821 in Fredonia, there was a man called William A. Hart, who drilled a 27-foot deep well in an effort to get a larger flow of gas from the seepage of natural gas. That was the first well, if I understand it, intentionally drilled to obtain natural gas in the country, and it was right here. So, this is really an appropriate place and an appropriate start for our hearing.

We are here, basically, because of the crisis. Oil and gas prices are too high, too high for people who are having trouble paying their heating bills, and also too high for many of the businesses that provide jobs in our community. There obviously is a shortage.

So, the new Bush administration has created an interagency task force -- that is a task force amongst the departments reporting to the President -- to look at the Nation's energy problems. It is being chaired by Vice President Dick Cheney, and he will make recommendations soon. I think it will be a serious report for a variety of reasons, and not the least of which is the fact that, as you know, Governor Bush comes from an energy -- not only consuming, but producing -- State, which is Texas.

In the meantime, the three of us here who serve on the tax-writing Committee, and we are here to learn more, as I mentioned earlier before, about the problem. Our particular assignment within the Congress is to write tax law. So we need to look at where our tax laws are going, and whether they are making matters worse or making matters better, or can be improved or help solve the problem.

There was great concern in Washington 2 years ago on incentives for oil and gas production, and we had a hearing at that particular time. Since then, things have gotten worse. The price of crude oil has increased threefold. The price of natural gas has gone up four times. In fact, it has increased over sevenfold in some parts of the country. And, the price of home heating oil has nearly doubled.

So it seems to us that we just cannot go along here and accept this. We have got to take a look at what we can do. So the people in the government can be working together. We cannot have American families choosing between heating their homes and buying food and medicine.

Now, our first witness today will be a representative of the Treasury Department. He is also an old friend of the Ways and Means Committee, and Mr. Mikrut, we are delighted to have you here.

Then we are going to hear from the Energy Department, and then Assemblywoman Cathy Young, who I hope is here, who will tell us about the important work that is under way in Allegheny.

After that, we will hear from a number of men and women who live and work here in the southern tier and, of course, they are our most important witnesses today.

So I want to again say, I encourage anyone who is not testifying today, who would like to submit a statement for the record, to do so. And just make sure it reaches my office by the close of business on March 19th. We have got a little wiggle room there, but basically, we have some sort of discipline on the date. That may seem like an arbitrary deadline, but we have got to get our record printed so we can get it back to you.

So now what I would like to do is turn this over to Congresswoman Thurman for an opening statement.

[The opening statement of Chairman Houghton follows:]

Mrs. THURMAN. Thank you, Mr. Chairman. I actually will be reading what Mr. Coyne would have said had he been able to be here, since he is the ranking member. He, like Mr. English, have worked together over the years to address the concerns of Pennsylvania, which is where Mr. Coyne is from as well.

So I am not Mr. Coyne, but will read his statement in its entirety. I know he does send his regrets. I guess sometimes we get hurt and sometimes that happens.

"I am pleased to be here today to discuss an issue of critical importance to Americans nationwide. My constituents in Pittsburgh, Pennsylvania, know firsthand the impact of rising energy costs on their lives.

Experts and government policymakers say that the reasons for higher natural gas prices are varied and complex. This winter, we had colder-than-average temperatures. This followed two mild winters, which saw a drop in the demand for natural gas. As a result, the price producers could charge was lower. Gas producers had less incentive to drill new wells and supplies dropped. Then, when demand rose dramatically with our current cold weather, prices rose as well.

Many of us are beginning to face 50 to 100 percent increases in our monthly heating bills. Apparently, the utility companies are paying twice as much for the gas they deliver and passing the cost on to their customers.

As a short-term measure, I have cosponsored H.R. 683, the Emergency Energy Response Act of 2001. This legislation will help consumers cope with high energy costs through increased funding for the Low-Income Home Energy Assistance Program and State energy programs.

In the long term, however, it is necessary that the Subcommittee consider the role that the Tax Code plays in providing adequate incentives for fuel production and conservation. Tax incentives are being considered to assist the home purchase of energy-efficient furnaces, air conditioners" -- which is where Florida would really be interested -- "and appliances, and for energy conservation measures, such as improved residential insulation and weatherization. Also, tax incentives are being discussed to make marginal wells more profitable and to encourage appropriate oil and gas exploration.

I want to personally thank Chairman Houghton for scheduling today's hearing on this most important topic. I hope we can continue with additional hearings in Washington, D.C., and move forward with legislative recommendations on a bipartisan basis."

I submit his written statement for the record.

Chairman HOUGHTON. Thank you very much, Karen. Mr. English, would you like to make a statement?

Mr. ENGLISH. Thank you, Mr. Chairman. Just briefly. I want to thank you for bringing the Subcommittee to the North Coast to hear about the high energy costs that our constituents are facing, and to look at ways that the Tax Code can blunt the impact of those problems.

We know that we are going to consider an energy bill this year, and clearly the new administration is committed to putting in place a national energy policy. Given that, it is most timely that you have decided to have this hearing to focus on the effectiveness of some of the incentives built into the Tax Code, whether they are incentives for increased production or incentives for energy conservation.

This is one of the most important issues that we will grapple with in Congress this year, and I want to congratulate you particularly for being proactive and allowing a North Coast perspective to be entered into this national debate.

I have come here with an open mind, curious to find out what our role as Ways and Means can be in crafting this energy bill. So I am looking forward to the testimony. I appreciate the fact that we have had people to come in from Washington as well as Florida to participate in this hearing. I look forward to the comments of the witnesses, and, again, I thank you for allowing me as a Ways and Means Committee member who is a visitor to this Subcommittee to participate today.

Chairman HOUGHTON. Well, thank you, Phil, and thank you, Karen, very, very much. Now, I would like to introduce Mr. Joseph Mikrut, who is a Tax Legislative Counsel for the United States Department of the Treasury.

Joe, it is great to have you here. Thanks for making the effort to come up.

STATEMENT OF JOSEPH MIKRUT, TAX LEGISLATIVE COUNSEL, U.S. DEPARTMENT OF THE TREASURY

Mr. MIKRUT. Thank you, sir. Thank you, Mr. Chairman, Mr. English, Mrs. Thurman.

I am pleased to be here today to discuss with you the impact of current tax law on the cost and supply of energy, particularly oil, natural gas, and alternative fuels. As a Chicago native, I particularly enjoyed being in a part of the country today where people actually know how to drive in the snow. It is a rare treat.

Mr. Chairman, as you said in your opening remarks, what a difference 2 years makes. Treasury last testified before this Subcommittee in February, 1999, on energy policy. At that time the cost of a barrel of oil was approaching single-digit dollars, gasoline costs were routinely under a dollar a gallon, and home heating oil and natural gas supplies were relatively plentiful.

Mr. Cook, the representative of the Energy Information Agency, will later describe in detail the dilemmas caused by current energy prices. It is easy to see that the current prices have created crisises both for individual consumers as well as businesses.

This underscores the fact that energy, particularly oil, is an internationally traded commodity, and the U.S. Price is set by world supply and demand. Domestic exploration and production for oil is affected by the world price.

Domestic oil production has been declining since the mid-1980s. From the late 1970s, to the mid-1980s, oil consumption in the U.S. Has also declined, but in the last decade oil consumption has risen by 11 percent. The decline in oil production and the increase in consumption has led to an increase in oil imports. Net crude oil imports have risen from approximately 41 percent of consumption in 1988 to 55 percent in 1999.

The U.S. Has large natural gas reserves and was, essentially, self-sufficient in natural gas until the late 1980s. Since 1986, however, natural gas consumption has increased by more than 30 percent, while production has increased by only 17 percent. As a result, net imports as a share of consumption more than tripled from 1986 to 1999, rising from 4.2 percent to almost 16 percent.

The increases in energy prices over the past 2 years have focused attention on the impact of shortages and higher prices on individual consumers and businesses, and on the tax treatment of oil and gas producers.

Mr. Chairman, in your statement announcing this hearing, you have said, rightly, we have to find out where the Tax Code helps, where it causes problems, and where it needs to be changed.

Policymakers have long recognized the importance of maintaining a strong domestic energy industry. To that end, the Internal Revenue Code includes a variety of measures to stimulate domestic exploration and production. The tax incentives contained in present law address the drop in domestic exploration that has occurred since the mid-1950s, and the continuing loss of production from mature fields and marginal properties. Current tax incentives are generally justified on the grounds that they reduce U.S. Vulnerability to an oil supply disruption by stimulating increased exploration and production in oil and gas and development of alternative forms of energy.

Incentives for oil and gas production in the form of tax expenditures are estimated to total almost $10 billion for fiscal years 2002 through 2006. Over 40 percent of these expenditures, or $4.4 billion, are represented by the enhanced oil recovery credit. This is a 15 percent credit for costs associated with qualifying tertiary recovery methods. These methods generally involve injecting substances into an oil reserve to increase production that would otherwise not occur. The credit phases out at higher oil prices, but under current prices is fully effective.

The next largest expenditures are for the nonconventional fuel production credit, the section 29 credit, and the percentage depletion deduction. The section 29 credit is approximately $6 per barrel of oil equivalent for oil produced from shale and tar sands, gas produced from geopressurized brine, Devonian shale, coal seams, and biomass, fuel produced from coal. There is a $3 credit for gas produced from tight formations.

These credits are supplied so that oil and gas reserves that would otherwise not be put into production are put in production by way of a credit.

Percentage depletion allows independent producers to deduct a percentage of their oil and gas revenue, even if the total deductions for depletion have exceeded the cost of the revenue. It is, in essence, a reduction of the applicable tax rate. In most cases, the deduction is 15 percent of revenue, but marginal wells; that is, those wells that produce less than 15 barrels a day or produce heavy oil, can qualify for a higher rate up to 25 percent. This higher 25 percent rate, phases out when oil prices fall below $20 a barrel.

Oil and gas producers are also allowed to expense their intangible drilling and development costs, or IDCs. In general, these are the costs associated with drilling and preparing wells for the production of oil and gas, and normally would have to be capitalized and recovered over time absent a special rule.

In the case of independent producers, a 100 percent deduction is allowed. Integrated major oil companies may deduct 70 percent of these expenditures up front and amortize the remaining costs over a 5-year period. This tax expenditure is estimated to cost $640 million over the 5-year period.

In addition, working interests in oil and gas production are largely exempt from the passive loss limitations of present law, and oil and gas activities have been largely eliminated from the alternative minimum tax by amendments made in the Energy Policy Act of 1992.

Incentives for energy efficiency and alternative energy sources are also essential elements of our national energy policy. The continuing strength of our economy over the past 2 years, despite oil price rises, underscores the dramatic improvements in energy efficiency we have achieved in the past quarter century. While the past oil shortages have taken significant toll on the U.S. Economy, the recent increases in oil prices have not affected the economy to the same degree.

Increased energy efficiency in cars, homes, and manufacturing have helped insulate the economy from the short-term market fluctuations. For instance, in 1974, we consumed 15 barrels of oil for every $10,000 of gross domestic product. Because of increased efficiency, today we only consume about 8 barrels of oil for the same amount of economic activity.

Tax incentives currently provide an important element of support for these energy efficiency improvements and the increased use of renewable and alternative forms of energy. Current incentives in the form of tax expenditures are estimated to total $1.2 billion for fiscal years 2002 through 2006. They include a tax credit for electric vehicles and expensing of fuel vehicles, credits for the production of electricity produced from wind or biomass and for certain solar energy property, and an exclusion from gross income for certain energy conservation measures provided by public utilities to their customers.

The administration's fiscal budget for the year 2002 will include additional tax incentives for renewable energy resources. The proposal will extend the credit for electricity produced from wind and biomass and expand eligible biomass sources. The proposal will also provide a new 15 percent tax credit for residential solar energy property, up to a maximum credit of $2,000.

We are currently developing the details and the revenue estimates for these proposals and will provide to Congress more details when the administration presents its budget later this month.

Mr. Chairman, this concludes my brief remarks. I ask that my entire statement be submitted for the record, and I would be happy to answer any questions that you and the other Members of the Subcommittee may have.

[The prepared statement of Mr. Mikrut follows:]

Chairman HOUGHTON. Well, thanks very much, Mr. Mikrut. I have just got a brief question. It is sort of a generic question, and then I will turn it over to Mr. English and Mrs. Thurman.

The problem I see is that one of the reasons we do not have more energy available is because the prices have been so low. Two years ago, it was something like $10 a barrel. I don't know what it is now -- if it is at $30.

So, you say to yourself, okay, so you give tax incentives to producers and the price is higher. Therefore, they can afford to invest. And that is good. But at the same time, what it does, it bumps up the price to the individuals and the users of this. So I see an almost incompatible scenario here. So that is the question number one.

The other question is, if we took all your incentives, we took all of the things that you were doing and put them together, would it make a major dent in the energy crisis which we face today?

Mr. MIKRUT. Those are two very good questions, Mr. Chairman. I wish I had two very good answers. As my testimony points out, the price of oil is set on a world market. So, there is very little one could do domestically to affect that market. Any increased production in United States can be offset by decreased production elsewhere in the world. Alternatively, should OPEC decide to increase production and drive prices even further down, that could discourage the production of U.S. Reserves.

As a result, what we saw 2 years ago when we testified before you at a time of very low energy prices was a request by domestic oil producers to have some sort of a floor or stopgap measure, such that if they knew that should oil prices fall below a certain floor, then credits would kick in to encourage continued production.

The rationale was that with respect to certain properties, particularly marginal wells, that once prices drop and it becomes too expensive to operate that well, then the producer shuts down the well. That represents an almost permanent loss of production, in that it may be very difficult, if not impossible, to restart an oil well that has been capped or very expensive to do so.

Your question points out the tension here. You want to ensure a certain level of domestic production, and that is what our current code attempts. It tries to provide an incentive for current production, and yet you want to somehow ensure that those benefits flow through to consumers so that oil producers themselves are not the only ones benefitted by the incentives, and that is the part that is difficult to do.

And, again, as you mentioned, Vice President Cheney has a task force that is developing a comprehensive energy policy strategy for the United States, and it is in light of those forthcoming recommendations that I think you will have to reexamine the tax provisions.

This may not be a very satisfying answer to your original questions, but again it is one that the tax policy writers have been wrestling with for a long time along with the energy policy writers.

Chairman HOUGHTON. Okay. Thanks. Mrs. Thurman?

Mrs. THURMAN. A lot of what you talked about was things that are already happening today. And based on your answers to the chairman, are you involved in putting together this policy that the Vice President is working on? As far as from the tax writing part of it and the implementation of what is going on with the White House and with Treasury, are you all communicating? And if so, what kinds of things are you offering to an energy policy that you believe, if implemented, would help this situation?

Mr. MIKRUT. Mrs. Thurman, again, this is an interagency task force. Treasury is and will be involved. I am not at liberty to discuss the specific details at this time. I can tell you what has already been decided, what will be in the President's budget proposal with respect to energy incentives. There would be a new 15 percent investment tax credit for residential solar energy systems. Under current law, as you know, businesses have a 10 percent solar credit and this credit is proposed to be expanded for residential purposes.

There will be a proposal extension of the 1.5 percent per kilowatt hour tax credit for the production of electricity from wind and biomass, and a proposed expansion of the sources of biomass. Under present law, the biomass that qualifies for the credit only can be what is called "closed loop biomass," which are crops grown and dedicated solely for burning. There is going to be an expansion of the eligible biomass sources.

Mrs. THURMAN. Like potentially hydrogen and some other areas?

Mr. MIKRUT. Potentially.

I think some of the expansions that have been mentioned in the past have been mixing biomass sources with coal generation, the use of wood chips and other waste wood products, items that can be burned, which would otherwise go to waste, but now could be burned and generate electricity.

Mrs. THURMAN. And for folks out here, the issue involves a fight that is kind of going on between coal producing States and those who use coal, dealing with Tax Code section 29. I have written a letter to Treasury Secretary Summers, and I feel compelled to bring it up now, is any conversation going on concerning section 29 that specifically looks at whether coal dust can be reused for section 29 purposes in our area, like some of our electric companies are doing? Do you see any help coming from Treasury on this at all?

Mr. MIKRUT. Certainly, Mrs. Thurman. And for a little background for the members of the audience who are not as familiar with the section 29 credit as you are: section 29 allows a credit, which is essentially equivalent to, I think, $25 a ton for coal, for the production of synthetic fuels from coal.

As you mentioned, in the past synthetic fuel producers have used coal fines, which are waste coal products that otherwise would be thrown out or thrown into settlement ponds, and created an environmental hazard, in essence. And what producers were able to do by way of the credit was to dredge out the coal fines, reconstitute them, generally with an oil/petroleum based product, to make a briquette, which can then be burned, and generally for electricity generation. And the Service has ruled favorably in a lot of those cases.

We have heard through Members of Congress, governors of States, and some of our trading partners, that certain producers have taken steps away from a coal fine process where they may be using run-of-the-mine coal, mixing it with oil, and claiming the credit. We were asked to study this issue further.

So in late October, we announced that the IRS would not be issuing any private letter rulings in this area, except for those involving the use of coal fines, and that we would study the issue. We asked for public comments. The comment period ended right around Thanksgiving. Several groups have asked to come in and speak to us further on this matter. All of this is a matter of the public record. And what we hope to do is study all the comments we have received and then develop a ruling policy as to exactly what kind of coal production qualifies for the section 29 credit and release that in the short term.

Mrs. THURMAN. This is the last question, and then back to the tax issues. I know that Mr. Matsui and I and some others actually produced a piece of legislation last year on alternative energy sources. Do you know if the proposals in the bill are going to be a part of the dialogue that is going on with the administration right now?

Mr. MIKRUT. Yes, I believe--

Mrs. THURMAN. I am not asking you to tell me exactly the final answer. I just kind of want to know if a piece of this bill is going forward.

Mr. MIKRUT. Again, Mrs. Thurman, I think you have to see how all the pieces fit together. What the administration is trying to develop is a comprehensive energy policy, and I think the tax portion will be one of the last pieces considered. You may want to see exactly what proposals will be set forth with respect to the Department of Energy, and some of the other departments that are more directly involved in energy policy, and then, just as the chairman is doing today, see how tax law either inhibits or encourages those policies.

Chairman HOUGHTON. Okay. Mr. English.

Mr. ENGLISH. Thank you, Mr. Chairman. Mr. Mikrut, building on that line of questioning, I was wondering, has Treasury conducted any detailed studies of the efficiency, in general, of tax incentives for production? And you understand what I mean by efficiency. Does the tax policy provide the incentive necessary for changes in production on the margin, necessary to increase production? Are these tax policies efficient from a tax standpoint or not?

Mr. MIKRUT. We do that all the time, Mr. English. As you know, many of the tax incentives in the Internal Revenue Code are what are known as the "expiring provisions."

Mr. ENGLISH. Right.

Mr. MIKRUT. Like the section 29 credit, the percentage limitation on percentage depletion, and some of the others. So they expire from time to time and therefore the Congress and the administration have to revisit those policies. Together we have to make the determination on whether the policy is following through on what it was intended to do.

Most of the policies, especially with respect to the tax credits, are trying to provide an incentive for activity that would otherwise not occur. In studying the section 29 credit, as we have recently, what we have found is that there has been a lot of research and development done with respect to the production of coal into synthetic fuel that probably otherwise would not have taken place without the credit.

And this research has given rise to benefits such as lower ash content from burning, which is very important to electricity generation as well as to the steel industry. There is less coal dust, which is an environmental and a safety hazard in factories. We have also seen that there may be less pollution with some of these processes.

These are some of the things that we have found have happened. The difficulty, though, and what faces policymakers all the time, is how do you quantify those benefits versus how you quantify from what you are giving on the tax side? And that is the analysis that Congress and the administration follow up on all the time in deciding whether or not to extend these credits.

Mr. ENGLISH. Particularly on that point, the part that we are focusing on today, or one of the things we are focusing on today, is the production. Is it Treasury's finding that tax incentives have significantly increased production in the context of an energy situation where, until recently, prices were coming down? So the incentives coming from the marketplace were not to expand production?

Mr. MIKRUT. I think you have hit the nail on the head, Mr. English. The thing that creates the greatest incentive for production is price. Clearly, if someone knows that the commodity is going to sell at a high price, they are going to want to produce.

One of the problems in providing tax incentives, or incentives for production through the Internal Revenue Code is that generally producers do not pay very much tax when prices fall. So it is very hard to give them a tax benefit. For instance, when the Treasury last testified before the Subcommittee on this matter, it found that in a period of, I believe, relatively moderate prices, 75 percent or more the firms engaged in oil and gas production did not pay any income tax because of the cost they had versus what they were generating in revenues.

So it is hard to give an industry that pays little tax incentives through the Tax Code. You probably have to do it elsewhere, and that is why the administration currently is trying to develop a more comprehensive approach to energy policy to ensure continued domestic policy.

Mr. ENGLISH. That is a good point. If I might do a follow-up question, Mr. Chairman.

Chairman HOUGHTON. Yes.

Mr. ENGLISH. This is particularly a useful point, because the income from this particular industry has varied considerably. You need to have significant income and revenue in order to make full use of these tax credits.

On the other side, the tax breaks for conservation tend to extend, in a sense, more broadly across the economy. Has Treasury studied the relative efficiency of those tax breaks for conservation?

Mr. MIKRUT. Not in as great a detail, Mr. English. It is much easier to gather data on a specific industry, which we have for the oil and gas producing industry, or the coal industry, or for industries involved in energy production or distribution. The conservation measures are, as you said, much broader and are of a more recent vintage. So it is much harder to study those effects.

I do know, for instance, that the current law exclusion for conservation measures that utilities to their customers, at one time applied to both businesses and individuals. And the Congress and the administration together decided, I believe in 1996, to repeal the exclusion that applied to businesses because it was not as viewed as efficient as the provision that applied solely to individuals.

So, again, this was an instance where current law was being reevaluated on an ongoing basis and a policy decision was made.

Mr. ENGLISH. If I could, Mr. Chairman, and thank you for your tolerance, I have two other very quick questions. The first being, you had raised, Mr. Mikrut, the fact that some of these provisions are expiring provisions that were revived on an annual basis. Has Treasury studied whether the incentive effects of these provisions have been reduced because these are temporary tax provisions?

Mr. MIKRUT. In general.

Mr. ENGLISH. And would making them permanent improve their efficiency?

Mr. MIKRUT. In general, Mr. English, what we try to do, and what Congress has tried to do in designing these provisions, is to say that they apply for a relatively extended period of time. For instance, the extension of the section 29 credit applied to property placed in service in 1998, and for 10 years. So that gave those producers trying to make that investment decision a fairly wide window in order to make the investment and be sure that the credit would be there for 10 years.

I think, then, at the end of the 10-year period, it is appropriate for Congress to say, well, you had a credit for 10 years. What have you done? What benefits have we seen and has this industry stabilized to such an extent that it can go forward without the credit?

So, with respect to the energy provisions, the credits have been relatively long-lasting to give producers a sufficient lead time to make their investment decisions. With respect to some of the other credits that have been extended on an annual basis; for instance, the research and the experimentation credit mentioned before, taxpayers come to expect those to be enacted on an ongoing basis, so that incentive effect may be somewhat diluted. But, again, with respect to the energy provisions, I think Congress has wisely given the producers a long enough credit period so they can make those investments.

Mr. ENGLISH. Thank you, Mr. Chairman.

Mrs. THURMAN. I think Mr. English is exactly on target on those issues. I found that continued incentives are important to production, particularly the incentive for research and development. The wind energy tax credit actually expired for about 6 or 8 months before it was put into effect again. And so we are finding that some of these energy sources have not been able to fully develop because of the unavailability of incentives.

So as a kind of follow-up, have you looked at the impact of having the research and development expire?

Mr. MIKRUT. Again, not to the extent that we have on the cost items, Mrs. Thurman. But when we looked at the section 29 credit, we heard about research capabilities. It also is an issue that we have been exploring on an ongoing basis with respect to the production of electric vehicles and clean fuel technologies for automobiles.

As you know, as the years go on, we gather more and more information on how credits and other tax incentives could be more targeted to invigorate the next technology, as opposed to giving tax benefits for the last technology, which is activity that will be happening anyway. So those discussions have been ongoing with industry and Treasury, yes.

Mrs. THURMAN. Thank you.

Chairman HOUGHTON. Well, thank you very much. I certainly appreciate you being here.

Ladies and gentlemen, let me just explain, the key relationship which the Ways and Means Committee has with the administration is through the Treasury Department. We will be talking to somebody from the Department of Energy. We can talk to somebody from the Department of Justice or whatever the issue is, but this is the key.

So you can see the issue that we are wrestling with here. So, Mr. Mikrut, thank you very much for being here. You are a great asset and a great citizen and a great American.

Mr. MIKRUT. Thank you, Mr. Chairman. It has been a pleasure to be here.

Chairman HOUGHTON. Okay. Thank you. What I would like to do is call John Cook. Mr. Cook is -- is Mr. Cook here?

Mr. MCCOY. Yes, he is here.

Chairman HOUGHTON. Okay. Great, Mr. Cook is the Director of the Petroleum Division of the Office of Oil and Gas, Energy Information Administration in the U.S. Department of Energy.

So, Mr. Cook, we are delighted to have you here and you can proceed with your testimony and can submit any other pieces of information that you want outside your oral testimony.

Mr. COOK. Thank you, Mr. Chairman.

Chairman HOUGHTON. You want to turn your microphone on?

Mr. COOK. Is that it?

Chairman HOUGHTON. Yes.

STATEMENT OF JOHN S. COOK, DIRECTOR, PETROLEUM DIVISION, OFFICE OF OIL AND GAS, ENERGY INFORMATION ADMINISTRATION, U.S. DEPARTMENT OF ENERGY

Mr. COOK. Again, thank you, Mr. Chairman. I apologize for being a bit tardy. My only excuse, a weak excuse, is that United canceled both of its early flights this morning. That, and some rental car problem. Do not ask me any other questions.

Anyway, I would like to thank the Committee for the opportunity to testify today on behalf of the Energy Information Administration. I will begin with an overview of recent crude oil and natural gas trends and some of the factors underlying those trends. I will then address our near-term forecast.

A combination of factors contributed to the sharp increases in both oil and gas prices experienced in the past year or so. On the demand side, strong economic growth through the first half of last year lead to increased oil and gas consumption. Additionally, the winter started out very cold, unlike the previous three or four winters, which were much warmer than normal. November and December were very cold in certain parts of the country, requiring significantly more energy for home heating than in recent winters.

On the other hand, supplies of both oil and natural gas in 2000 did not keep pace with demand growth, especially given the need to rebound from low inventory levels. This left the market situation ripe for higher prices. For natural gas, strong demands in the residential sector combined with continued growth in gas fired power generation occurred at the same time that production stagnated.

Low oil and natural gas prices in 1998 and early 1999 sharply curtailed drilling and discouraged vigorous exploration and development of natural gas. As a result, gas production actually declined in 1998 and 1999 before rising by a modest 1 percent in 2000. With demand outpacing supply, natural gas inventories dropped to low levels. For oil, supply been the most significant factor. Although the cold winter, robust economy, and some fuel switching from natural gas to oil, has an impact on oil demand, it was action taken by OPEC that has greatly elevated oil prices since early 1999.

OPEC dramatically reduced crude production in 1998 and again early in 1999, so that even after the four increases seen last year, inventories remained at extremely low levels. Scarce crude supplies encourage high near-term prices relative to those several months out. This situation is referred to as backwardation, and it discourages maximum refinery production and inventory holding. With low crude and product inventory, there is little flexibility to adjust to market conditions, and the stage is set for price volatility.

I would like to turn next to our short-term forecast, beginning with crude oil. On January the 17th, OPEC reduced its production quotas by approximately a million and a half barrels a day effective at the beginning of last month. This decision by OPEC is expected to maintain a tight balance between global supply and demand, resulting in continued low inventory worldwide, especially in the developed countries of the OECD. You can see this in figure 2 in my testimony.

Given low stock, the EIA expects the price of OPEC's basket of crude oils to remain toward the high end of the OPEC target range of $22 to $28 a barrel at least for the remainder of this year. You can see that in figure 1.

Given its higher quality, West Texas Intermediate, which is the U.S. Benchmark crude oil, tends to run about $3 to $4 a barrel higher than the OPEC price basket. This puts our forecast for the remainder of this year for WTI at about $30 again this year, before easing several dollars by mid next year.

If we look at gasoline next, with crude oil prices rebounding from their December 2000 lows, and with gasoline stocks currently low and expected to be low ahead of the summer, we look for gasoline prices to rise from the current levels by at least a dime. And this is assuming that we see no further disruptions this summer like those seen in California and the Midwest last year. In other words, with low inventories and everything flowing smoothly, we will see prices average this summer about the same $1.50 that they did nationwide last year.

On the other hand, with low inventories, the stage is again set for regional supply problems that could bring about price spikes. The prospect of these regional problems is increased by the differing regional gasoline product requirements, which arise from Federal and State air quality programs which limit the distribution system's flexibility.

Regional problems can also arise from temporary or permanent losses in refining capacity and pipeline disruption. Nevertheless, it is expected with a year's experience behind them the refining industry's ability to make the new phase 2 reformulated gasoline, required for the first time last summer, should be somewhat enhanced.

Turning to distillate fuel, with the heating season nearing its end, it is likely that retail prices have peaked. Because of relatively warm weather in the Northeast during the last half of January and for stretches in February, coupled with high distillate imports and high refinery production, inventories did not decline in January and February like they normally do. This means that for heating oil anyway, stocks have now returned to their normal range.

Nevertheless, while retail heating oil prices have declined some accordingly, they still remain relatively high on a historical basis. Thus the average bill for the consumer heating with oil in the Northeast this winter is expected to be nearly $1,000, compared to $760 last winter and under $600 the previous two winters.

Although consumers have not faced the price spike they saw last winter, consumption is expected to be over 11 percent higher due to colder weather and high natural gas prices, sparking fuel switching. High consumption levels, lower initial stock levels, and high crude prices have combined to push the average price of heating oil up 18 percent this winter. Together, these increases in consumption and price are expected to raise the winter bill by over 31 percent.

Looking at natural gas, spot prices last summer averaged more than $4 per thousand cubic feet during the normally low-priced season. They remained above $5 per thousand cubic feet last fall, and more than double the average the year earlier. We see this in figure 3.

In January of 2001, the spot price averaged a record $9 per thousand cubic feet as noted earlier. Such high prices are due largely to demand out stripping domestic production, causing very low volumes to be injected into storage as happened last winter, figure 4.

Looking ahead and assuming normal weather, we project continued low storage, resulting in an average annual wellhead price this year of about $5, an increase of well over $1.50 from last year's already high average. On the positive side and in response to these higher prices, drilling for natural gas in the 48 States increased over 45 percent last year, and therefore we expect some moderate growth in production to continue this year and next. See figure 5.

Thus, by the summer of 2002, we expect storage to return to the low end of the normal range. This should drive wellhead prices back down under $5.

Finally, increased consumption and higher prices this winter are expected to yield heating bills for homes using natural gas in the Midwest, which is the region most dependent on gas for heating also, of approximately $1,000. This represents something like a 75 percent increase from last winter. This sharp increase in prices has had particularly severe impact on low-income consumers using gas to heat.

In recent months, 5 million consumers have applied for Federal and State government assistance to pay their heating bills, which is an increase of over 1 million from last year. A short description of our forecast for electricity is included in my written testimony. This concludes my remarks, and I will be happy to answer any questions.

[The prepared statement of Mr. Cook follows:]

Chairman HOUGHTON. All right. Thank you very much. That is great. You know, it just seems to me that there is something out of sync here. You say the consumption is up, expected to be 11 percent more than last year, and if you followed the law of supply and demand, that maybe you can see the prices being up 11 percent or maybe 15 percent, but not two, three, four, five, six, seven times. What is going on here?

Mr. COOK. Well, certainly those kinds of price increases we are seeing in California in gas and power markets I don't believe they are that high nationwide. The data that we have show gas prices approximately 50 percent higher, and the bill maybe double. But certainly in the West where supplies have been very constrained with the disruption in the El Paso pipeline into California, and combined with a very strong economy out there, certainly that balance is very tight. And when the market is resolving a situation like that, prices do not rise proportionately. They tend to rise to whatever will clear the market. Then the individual who just has to have supplies--

Chairman HOUGHTON. You mean whatever people will pay? In other words, will be forced to pay; is that right?

Mr. COOK. Unfortunately, that is correct, sir. In economics, back when I took the course 30 years ago, I think the professor talked a little bit about the glass of water. How much you would pay for it in the first hour you are in the desert, which is not very much. As you walk farther and get hotter and thirstier, then the amount you are willing to pay for it, assuming you can, rises geometrically. I am not here to offer excuses or apologies, or suggest, you know, solutions to the problem. I can only tell you what has happened.

Chairman HOUGHTON. Oh, no, and I understand that. And you know, you are new, I assume, in the Department of Energy.

Mr. COOK. No. I have been there--

Chairman HOUGHTON. You have been there what?

Mr. COOK. Longer than I want to remember.

Chairman HOUGHTON. So we can lay it on you a little harder; right?

Mr. COOK. Give me your best shot.

Chairman HOUGHTON. I don't want to give anybody a shot. What I am trying to do is to understand what the dynamics are here, and the-I mean, I think, you know, we live in a -- we live in a democracy. It is not only a political, but economic democracy and we live by competition. And that is why our economy is virgin. That is why it has grown so much faster than other economies around the world.

At the same time, I do think there is a responsibility for somebody, either doing on a voluntary basis or government, to take a look at what are the discrepancies here. Could next year the prices go up another seven times, or another seven times after that? I mean, what responsibility do you think that we have, as all Federal employees have, to be able to give the best and fairest deal to the people who are consuming?

Mr. COOK. Well, again--

Chairman HOUGHTON. That is my best shot.

Mr. COOK. You are pushing me into the policy arena, which is not my agency's mission. You would have to talk to the policy folks at the Department. EIA just does the forecasts, and in this case, provides the unpleasant facts. And along those lines, all I can say is that, although -- well, I will give you an example in the heating oil arena.

We had the spike in January of 2000, and as a result, lots of heating oil imports flowed in from Russia and from Europe, unfortunately too late to avoid paying the higher price for it, but it did help stabilize the market some. With the continuing relatively low inventories this summer into last fall, heating oil prices were reasonably elevated compared to normal. But they never spiked, even though the weather was colder and stocks were low, unlike the year before when stock were normal and the weather was warm, and yet prices spiked.

This year, there was enough concern early on in the market that it brought in the imports early and prompted refiners to produce at much higher rates than they normally do in the wintertime. You could almost say the heating oil market was flooded in January and February. It was very tight and very high priced in November, for November. But that did bring in, again, lots of imports from Russia and from Europe, and refiners ran their refinery units at, at times, 500,000 to 800,000 barrels a day, higher levels than they had the year before.

To give maybe a little better example, inventories in January and February usually drop between 10 and 15 million barrels each month. They actually climbed, which means the market was oversupplied by 30 million barrels during that period. So it does work. It is just that sometimes, when it gets out of balance, it can be very painful in the recovery process.

Our testimony is that the same situation is occurring in the natural gas market. We have had real strong growth for 4 or 5 years. The low prices in 1998 and early 1999 curtailed drilling. We are paying now for the very low prices and the very low bills that we saw in 1997 and 1998, because that dampened production just when gas demand was beginning to take off, and yet you could not see it because the weather was so warm when gas demand peaks in the wintertime.

So this year we get a little more normal weather and the gas bill goes up. Part of it is just because the weather is more like a typical winter and, in particular, because the prices shoot up dramatically with the tight balance between supply and demand, that all of a sudden it has been revealed in the wintertime by the weather.

So we are going to have to have a lot more gas production; and, fortunately, these high prices have shot drilling for natural gas, exploring for natural gas, to record levels. We are seeing just enormous amounts of drilling going on scrambling, as I am sure you are aware, to consider the best way to bring more in from Canada, maybe even Alaska.

So, you know, within a year or two, I think we will be back out of the woods. But it is difficult now. All I can say is, the winter is over, and if the LIHEAP program, which has been funded additionally, can help the low-income families with their bills, hopefully, we will not have to go through this again next winter.

Chairman HOUGHTON. Okay. Thanks very much. Mrs. Thurman?

Mrs. THURMAN. Mr. Cook, is there any concern in your internationally forecasting about production because of a conversation going on in this country about the slowing down of our economy? Will that have any effect on any of this over the next couple of years?

Mr. COOK. Do I think our conversations about alternative sources--

Mrs. THURMAN. Or a slowing of our economy. Will less use have any effect on future considerations by those that we are dependent on?

Mr. COOK. Well, if you are referring to OPEC--

Mrs. THURMAN. That is probably who, yes.

Mr. COOK. It is hard to say. OPEC probably does not know what it is going to do at its meeting this month on the 16th. They stated that they are going to watch the U.S. Economy closely; and if it does look like it is sliding closer to recession and that oil demand is slipping further, which, you know, the data may show by then.

That is a tricky question, because half of that camp wants to increase supply, or at least leave supplies where they are, so that inventories can rebuild and prices can fall and help stimulate demand. But the more hawkish element within OPEC wants to keep cutting supply as demand falls to keep the price higher, which just spirals the situation downward. I really do not know which way they are going to go on this. I would hope that we will see some signs of stabilization in the economy that will convince them to leave supplies and prices where they are, if not maybe bring inventories up some.

Mrs. THURMAN. The other question is about how the different States operate. I don't know what happens here or in Pennsylvania, but obviously the big concern to the consumer is the same. Are the costs that get shifted to the consumer more than needed and a way to make profit on the other end? Is there conversation at all about this? I don't know if you can answer this since you are not doing policy. In Florida, for example, we have a Public Service Commission that sets rates. Sometimes the utility companies come in and ask for rate increases. When we find out that maybe they have had too much of a rate increase, we can actually reduce the rate. We go through a hearing of some sort and actually the consumer gets money back. Are we looking at those kinds of options at the Federal level or just at the State level which, quite frankly, is where it should probably be handled. I am just curious to know how overall the State have worked and whether they been successful in helping the consumer in what are really tough times for them?

Mr. COOK. I really can't comment on that. We not only skirt that area, but we don't collect State-level data and work at that level. National, regional to some extent, but certainly not State level. I don't know that FERC, for example, has the same role that you outlined for the States.

Mrs. THURMAN. I just thought it might be interesting to gather that forecasting information to see what is happening individually in the States and to see if there is some over charging in one part of the country because of high demand. What has been happening in other parts of the country may kind of even out the number a little bit, helping more consumers that way.

Mr. COOK. Well, okay. Indeed, those kinds of regional disparities in supply and demand, again, we don't have the resources to work the data at the State level, but it is our responsibility to provide that kind of regional information to the policy makers, so they can anticipate and promote better production policies in those regions.

Mrs. THURMAN. Okay. Thank you.

Chairman HOUGHTON. Mr. English.

Mr. ENGLISH. Briefly, Mr. Chairman.

Mr. Cook, the thing I find alarming about your testimony is that you are predicting that there is no immediate way out of this box. What you have suggested is that, for a substantial period of time, we are going to continue to have shortages of natural gas and that in the near future we can anticipate the prices at the gas pump of petroleum are going to go up for automobile drivers.

Now, I am particularly concerned, because I recently went to a local steel company, McGuinness Steel in Erie, Pennsylvania, and they showed me on a chart how their gas prices for their forge have gone up 400 percent since September. Do you feel that is an atypical impact, and does that figure surprise you?

Mr. COOK. Again, I don't have data at that kind of a local level, and the data that we have don't show 400 percent increases. That is stunning, and there may be local conditions causing that where that occurs.

Mr. ENGLISH. So this may be, in part, a local supply problem. It was particularly striking to me, because this region is a gas-producing region, and I would have thought there would be an opportunity for supplies of local gas that could bring those costs down.

You identified the lack of refinery capacity correctly as one of the sources of high gasoline prices last year, and our refinery capacity has been contracting over the years. This is wandering a little bit in the policy realm, but how much of this side of the problem should we focus on in designing tax incentives? If we can find a way of incentivizing investment and refinery capacity, could that help address the problem?

Mr. COOK. Possibly, yes. Again, I would like to steer a little clear of that area. Certainly refinery capacity right now is part of the problem, especially in the summertime when, again, it is run at virtually 100 percent in the Gulf Coast and on the West Coast.

On the other hand, the rest of the year, refining capacity utilization is not at its maximum like right now, and over the last year or two, it has been more an economic problem. So even if you have more capacity you probably wouldn't have a lot more production than what we have had. The reason again for that is tight crude oil supplies. It goes back to OPEC, crude oil cuts, and crude oil high prices, and you have this causing backwardation. Given this, refiners don't want to run their plants at maximum levels. They want to supply just their known contracted customers. They don't want to speculate on independents showing up, demanding increased supplies, and being able to sell this commodity on down the road a couple of months to them, because they may not get their money back with lower prices projected for the future. So it certainly would help to have more refinery capacity.

Mr. ENGLISH. But that is only a temporary problem typically during a certain time of the year.

Mr. COOK. At the moment it is. On down the road 5, 6, 7 years, our projections show it continuing to get tighter and tighter and the clean fuel rules exacerbating that trend.

Mr. ENGLISH. Mrs. Thurman brought up the point, and I have echoed it in my earlier questions about new technologies. Has the Department studied the extent to which new technologies like coal bed gas reclamation could create new supplies of natural gas, and to what extent is this potentially part of the new supply and part of the solution?

Mr. COOK. Yes. There has been work going on in that area. In the short term, I wouldn't expect a whole lot to result from that.

Mr. ENGLISH. A final question, and this is particularly relevant because we are just outside of Westfield, New York, which, of course, was the homestead of Governor Seward, who was the Secretary of State that brought Alaska into the United States. But to what extent does the Department estimate new supplies in Alaska could be a significant addition to our national energy supply?

Mr. COOK. Well, as you probably know, ANWR has been estimated to -- the median estimate is for about 10 billion barrels, which would supply about 1.3 million barrels a day.

Mr. ENGLISH. Relative to what is our known reserve nationally?

Mr. COOK. Well, I like to compare it as 1.3 million a day to roughly what we import from Saudi Arabia.

Mr. ENGLISH. Very good. Thank you.

Chairman HOUGHTON. I just have one other question. We have asked the Secretary of Energy -- we asked Bill Richardson to come up at one time, and now we have asked Spencer Abraham to come up here. Now I am going to throw a tough question at you. If they come, what is the key question we should ask them? And this will not be a resignation speech on your part.

Mr. COOK. Well, let's see, with respect to Secretary Richardson, since he is--

Chairman HOUGHTON. No, he is out now.

Mr. COOK. He is out. I would be safe there. I guess one might ask a tough question like what exactly is the Department and Federal Government doing to ease in the short to midterm the crude oil, in particular, and the natural gas supply shortfalls? Aside from jawboning here and there and sending people like me up here to sit in the hot seat, what are we exactly doing here?

Chairman HOUGHTON. All right. That is fair. That is a fair question.

I do have one other. I understand the whole conservation issue is really not being explored appropriately. I don't know what the numbers are, but somebody told me that if people just tuned up their cars and blew up their tires, that it would save an enormous amount of gasoline. Is that worthy of some action on our part in terms of tax incentives?

Mr. COOK. I don't know how you would do it. Practically speaking, it would probably be difficult to do that. Yes, it certainly would help some. It would conserve some energy. I am not an optimist that that is the way to do it. I think you need more supply. You need to address both sides, the supply and the demand side here. But just blowing up your tires is not going to get you where you need to be.

Chairman HOUGHTON. Thank you. You are very nice. I appreciate it, and I hope United has a flight back for you.

Mr. COOK. They said they did, but they--

Chairman HOUGHTON. I don't trust them. Find out.

Mr. COOK. When I get back, I am going to see if I can switch to USAir.

Chairman HOUGHTON. Okay. Thank you very much. We certainly appreciate you being here.

Now, we were going to have Cathy Young, who is the Assemblywoman from New York, and she can't be here. Neither can Mike Sopp, who is General Manager of the Anchor Glass Container Corporation in Elmira. But we do have other members of the panel, and I hope that they will come up now, so they can provide their testimony.

Moira Lindsley of Sinclairville; Caroline Sosinski of Westfield; Jeff Aiken, Council Representative for Western New York Regional Council of Carpenters, Randolph, New York; Dennis Holbrook, who is a member of the Board of Directors, Independent Oil and Gas Association out of Buffalo; Bruce Heine, Assistant Vice President, National Fuel Gas in Buffalo; and John Nalbone, President of Universal Resources Holdings of Dunkirk, New York.

Ms. Lindsley, would you like to begin your testimony?

Thank you very much, all of you, for being here. You can go ahead.

STATEMENT OF MOIRA L. LINDSLEY, SINCLAIRVILLE, NEW YORK

Ms. LINDSLEY. Thank you for the opportunity to be here today. I am a little nervous.

Chairman HOUGHTON. Don't be nervous.

Ms. LINDSLEY. I am a single mother of a 14-year-old son; and I am the head of the household, the only wage earner in my family. I have a 94-year-old mother who is living with me -- she will be 94 in June -- and a sister who is 72 diagnosed with Lou Gehrig's disease.

I have two businesses at this time, and I also have a part-time position at Jamestown Community College. My average workweek is approximately 70 hours. My son is very active in sports and in school activities, and I try, as a single parent, to be there for hockey games and music programs. Obviously, it doesn't leave many more hours in a day to put any more work hours in. Also, both of my businesses require that I drive considerably, approximately 700 miles a week. So I am affected twofold. I am affected at home with my heating oil and also with my gasoline.

My mother and sister were living together. My father passed away approximately 5 years ago, and because of their age and their handicap it was becoming very difficult for them to be alone. I chose not to put them in a nursing home and not to have them live with assistance. So my son and I brought them into our home, and there is plenty of room there for them.

I heat with fuel oil, and I live in the country. Niagara Mohawk is our power source. We sat down to do a budget before they moved in to see what needs we had, and at that time we felt comfortable with what we were earning to be able to support the energy needs that we had.

They moved in in August of 1999, and in September we needed to purchase fuel oil for the first time. The first bill we had was -- we had averaged $150 a month for budgeting our first bill, and the total was $300. Obviously, it put a real big nick in our budgeting. We struggled through that winter. My mother now has congestive heart failure, and her circulation is very poor. So she needs to be warm. Seventy-eight to her is cold. We tried to adjust with, you know, clothing and whatever. We did get through last year, but it really put a crimp in the budgeting, and I continued to work more hours, stressful, everything that we are trying to do to keep going.

I have two alternatives. I could feed them and keep them warm, or I could pay my mortgage. Obviously, the one that is going is the mortgage; and mortgage companies don't want to hear that. They really don't care about the energy problem.

I looked during the summer. We had a relatively cold summer, also, so I had heat -- normally, I wouldn't be heating through the summer, but at times we had to have heat on for my mother and for my sister. In the fall I had locked into $1.349 for fuel oil, and I received -- again, October was our first delivery. We had been averaging $600 a month from that point on because of the cold winter and need for my mother to stay warm.

I went to several agencies to try to see what I could do. I never had assistance. I have always been an entrepreneur. I have had businesses in this area for many years, and it was very difficult for me to go get assistance, but I had to do something. One of the problems that I had was now getting any response from agencies. I was put off from one to the other to the other, and I thank Mr. Houghton's office for coming to my rescue, so to speak.

I was told from one agency that I didn't qualify, Office of the Aging. I was head of household, my mother wasn't, various situations. I did apply for HEAP, and because of my income being too high I didn't qualify, but we did look at a self-employment worksheet to get the expenses to balance that. So I am getting some assistance from HEAP, and again it is very difficult for me. I am embarrassed to go there, to ask for this assistance. I have to keep my mother warm. There was no other alternative.

So we looked at sources, other sources that may be less expensive, and we did put in a propane heater in her end of the House. At that point, propane was less expensive. However, after we put the equipment in, the propane increased, also. So we are struggling with the cost of equipment, the cost of the increase in the propane, and then the cost of increase in fuel oil.

Right now I am not certain what we are going to do. We are looking at a foreclosure on our house, so I might be not worrying about any of these problems pretty soon. I hope not. We are looking at reorganizing. What I saw as a consumer was that no one seemed to be interested in the fact that we had energy problems, that our prices were going up. I looked around and, you know, what is the average person supposed to do? I thought maybe it is just me who is suffering. After talking to other organizations and people, I found out, no, it is not just me. There are many people in my situation that have to make a choice. Do we feed and keep our older people warm, or do we make our mortgage payments? And we are making the choices that we have to.

I thank you for your time.

[The prepared statement of Ms. Lindsley follows:]

Chairman HOUGHTON. Thank you so much. That was a wonderful, wonderful message.

What I thought we would do is just go through the panel, and then we will have questions and general afterwards. Ms. Sosinski.

STATEMENT OF CAROLINE SOSINSKI, WESTFIELD, NEW YORK

Ms. SOSINSKI. Thank you, Congressman Amo Houghton and Members of the Ways and Means Committee, for coming to Chautauqua County, and thank you for allowing me the opportunity to speak to you on the energy crisis.

I live in a small mobile home, 12 by 82. I keep my thermostat on 60 to 65. Still, my gas bill was $194 a month. On the budget plan, I was paying $62 a month and was warm. Now I pay $99 a month, and I am cold.

I cannot and will not pay such high prices. The raise we received in Social Security doesn't begin to cover the fuel raise. Then there are also all the other raises to consider, medicine, food and doctor bills.

I am a volunteer with the county HEAP program, and I see many of the seniors applying for HEAP who have to choose whether to keep warm or eat well. Unfortunately, either choice is not a healthy one. So many times I would suggest that they go for food stamps, but they refuse that. They don't want to be shamed. Medications for some can run over $200 a month, even with a prescription plan. There are some who have to forgo medicine they need in order to pay fuel bills.

The really hard part for me is when I have to deny someone HEAP when I knew it was needed. If they are just a few pennies over income guidelines, you have to deny them. They tell you how much they have to pay for medication and other essentials, but because of government rules it makes no difference. I believe it should make a difference, and I believe you, Congressman Houghton, and other congressmen here today do, also, or you would not be here. But we need help now.

While doing volunteer work in January, a 90-year-old lady was telling us she had an $800 gas bill. She didn't know how she was going to pay it. What do we do in America about someone like her? At her age, she needs to keep warm. Even some with arthritis like me feels the cold more than others, and it affects our health.

I honestly do not feel there is any justification for raising prices so high. I may not understand business, but I truly believe someone is making a big profit at our expense, and it could be dangerous to some.

As my friend, Mac McCoy, who is a senior advocate in our county, said to me, there are many older people who will need the whole year to pay off this huge increase in their gas heating bills, and it will set them back for a long time. But they go without to pay their bills, because they are responsible citizens. So many of these people receive no assistance and are living on a restricted, fixed income.

All of us living here in Chautauqua County and throughout our great country will continue to work hard to pay our bills. I thank you for coming here today. I ask you to please let them know in Washington that America needs to find a solution to this problem. Tomorrow is already too late for so many of our older citizens, and that is very sad.

[The prepared statement of Ms. Sosinski follows:]

Chairman HOUGHTON. Thank you very much, Ms. Sosinski. Mr. Aiken.

STATEMENT OF JEFF AIKEN, COUNCIL REPRESENTATIVE, WESTERN NEW YORK REGIONAL COUNCIL OF CARPENTERS, RANDOLPH, NEW YORK

Mr. AIKEN. Good afternoon.

Once again, like the rest of the panel, thank you for having a labor representative here. I can't speak for labor across the country, only on the local level that I deal with. I also want it noted that whatever affects industry also affects labor, and industry is feeling the pinch here.

We in southwestern New York live in what would be classified as a rural area. There are several small cities and municipalities within this area which have a reliable and inexpensive although subsidized source of power. But, by and large, most people live and work outside these areas; and the majority of citizens, manufacturers and businesses cannot avail themselves of the less expensive source of power. Not only do they end up on an uneven playing field locally, but on a national average we pay more for energy in this area than other areas.

We are in a national and global market that is very competitive, and in order to compete for their share of this market, industry must find ways of cutting costs. Where does industry begin? Usually the first place to start is cutting workers' wages for producing the same product that is produced in other parts of the country at a higher wage. By not offering health insurance and pension benefits or not offering a package that requires a monetary contribution on behalf of the employees is another cost savings so the manufacturer can better compete with industries in other parts of the country.

However, this creates another problem. When workers here know that they can earn a better living for themselves and their families elsewhere, they leave for greener pastures. Consequently, and this is proven by census figures that show a steady decline in population in western New York, it turns out that this area's most valuable export is its workforce. We find our best and brightest young people leaving the area to make their homes and careers elsewhere.

As population declines, fewer working taxpayers are left to support our economy, schools, and maintain our needed infrastructures. Our residents are doing this with a dollar that is already stretched too thin.

Previously, I mentioned the fact that this is basically a rural area. This means that many workers travel great distances to get to their place of employment. As you can see, I have an attached chart. We are now paying at the pump a significantly higher price for fuel than the national average. Plant closings, layoffs and shutdowns require workers who once lived close to their work to either travel long distances or go from job to job in ever-increasing numbers.

In effect, if nothing is done, what the high cost of energy has created for New York is a death spiral. Industries that offer good-paying jobs leave the area. Our sons and daughters leave the area seeking a better life. What we are left with is an aging workforce that is being forced to do with less and less while we sit back and watch the rest of the country prosper. Far too many of the workers I talked to are forced to forgo braces for their children, needed medical treatment, and college savings plans because so much is spent on paying utilities, taxes and getting to work.

Perhaps if energy rates in this area for both residential and commercial entities were more in line with the rest of the country, families and industry would find western New York an attractive place in which to live and work. Thank you.

[The prepared statement of Mr. Aiken follows:]

Chairman HOUGHTON. Thank you very much, Mr. Aiken. Mr. Holbrook.

STATEMENT OF DENNIS HOLBROOK, MEMBER, BOARD OF DIRECTORS, INDEPENDENT OIL AND GAS ASSOCIATION, BUFFALO, NEW YORK

Mr. HOLBROOK. Good afternoon, Mr. Chairman, members of the panel. On behalf of the Independent Oil and Gas Association of New York, we appreciate this opportunity to come here today and to hopefully provide some of the solution to the problem that has been identified here today.

IOGA of New York has 130 members. We represent the vast majority of both the large and the small independent producers operating in this State. Large by New York State standards is clearly not large when you compare it with some of the majors you would think elsewhere in the country or world, but we try and do our part.

I personally bring many years of experience, dating back to the early 1970s in the energy industry when I worked on the staff of Senator Buckley from New York. At that time, Senator Buckley was concerned that government policies were interfering with proper market signals for energy development, particularly for natural gas. Much has changed in the nearly 30 years since that time, and yet in many ways the issues are the same.

Current policies of the Federal Energy Regulatory Commission that was referred to earlier today, commencing with order 636 the early part of the past decade, in the early 1990s, allowed interstate pipelines to charge nearly all of their costs in the form of a demand charge. Basically, the charge was assessed up front for the cost of transportation, bringing gas from the southwest and bringing gas in from western Canada. You couple that experience with the nearly 20-year contract terms associated with most of those contracts that the local distributors were engaged in, and it created a tremendous hindrance on local gas development in this region.

If you compare the time period just prior to that FERC order and the time period following that, you find a significant difference. I mean, we are talking on an order of magnitude of more than a 50 percent reduction in drilling activity since that time period. What this region basically lost was the geographic advantage they should have had associated with being relatively close to the market.

The typical local distribution company pays, on average, $1.50 per 1,000 cubic feet to bring gas in from western Canada and the western part of the U.S. Our point is, it may seem like a minor amount when we talk about relatively large dollars here today, but even if one-third of that, just 50 cents, was assured to the local producer on a consistent basis and the other dollar returned to the consumer, we believe that that would be a tremendous encouragement in terms of local drilling activity.

Now, I appreciate that this panel's focus is on tax policy, but the question posited for today's hearing and as recited by Chairman Houghton at the beginning of this meeting was, why are prices rising in the manner that you described, and what can we do about it? So we point that out, that we believe there are government policies, some of which you may have direct control over, some of which you may not, that do have a significant influence over the supply side of this business.

The current high prices, I will submit to you, are a reflection of an inefficient marketplace where price signals are not consistent. The current high prices are a reflection of shortage. Shortage is a reflection of the lack of drilling activity, and the lack of drilling activity is due to an inability to accurately predict prices. The unusually low prices that were alluded to earlier today associated with recent mild winters discouraged drilling activity, and the high prices we are seeing this winter are a reflection of that reduced activity.

The irony in all this is even today's high prices won't necessarily support renewed drilling activity. Now, I know it was mentioned earlier today that we saw an upsurge in drilling activity. There is no question that people get excited on my end of the business when prices get high, but what needs to be appreciated is that there is a healthy degree of skepticism associated with that activity as well, and all you need is to see the downturns that we have experienced in recent years for that drilling activity to dry up once again. Keep in mind that the vast majority of natural gas wells drilled in this country are drilled by independent producers.

Another point I think is worth mentioning is that while it seems like there would be a windfall out there right now for the producers associated with in some cases the tripling or quadrupling in prices when compared with earlier years, many producers, based upon their historic experience of having a relatively flat or downturn in the market, went out and hedged. They basically sold their product in advance when the price got a little bit better because it was so much better than what they had experienced in recent years.

As a result, much of what has now been the fly-up in prices is not being experienced by the producers that you are looking to, to go out and help correct some of this problem by going out and increasing the supply. Marketers, brokers, other parties that are engaged in the energy industry are either winners or losers depending on how they hedged and how they sold product.

But I think it is important to keep in mind that short-term swings, such as what we are seeing now, while they are very severe, and I appreciate what we are hearing here today on this panel, in terms of the economic impact on individuals, they don't always do much to encourage the very activity we are looking for to ultimately correct the problem.

What I would suggest to you is that, given the lead time, the significant lead time, that is needed with drilling activity, the activity of going out, developing a prospect, raising the money necessary to drill for that product, and then to ultimately bring it to market, it is critically important for energy producers to have a minimum threshold of what I call predictability.

You heard prices out here associated with upwards of $10 per thousand cubic feet that has been charged in the marketplace last winter. Most producers that I am familiar with have expressed the view that if they could consistently anticipate a price, even in the middle $3 range, for what they could expect for their product, they could go out, borrow money from the bank, go out and raise the necessary funds to go out and drill and provide a consistent product. It is this variance that takes place that creates much of the inefficiency that I think we are seeing here today.

I think clearly the fly-up, and I am a consumer in the Northeast and can fully appreciate having questions when my bills showed up, and I was on a balanced billing program and discovered that what I thought was more than sufficient to cover it, it was not even close. The worst part is when you get to the end of those balanced billing programs and you have a true- up month. Then you find out what you owe. So I fully appreciate what has been expressed here today.

Some of the things that as an association we would like to at least encourage and to think about, turning back to the tax law policy, are the opportunity to expense certain items such as delay rentals that we experience as part of the contracting for the right to go out and drill and the geological, geophysic, and geoseismic type of expenses that are incurred to go out and again develop prospects.

As you may know, those are allowed to be capitalized, but that tends to be extending way out into the far future. The opportunity to reflect the actual costs that are being incurred to go out and develop the prospects, as you heard mentioned earlier, section 29 tax credits, particularly in the area of tight sands, which is typical of the formations that we deal with up in this part of the country. As you may know, the actual wells that were eligible for that as far as new well spuddings ended in 1994, and then you simply had the opportunity to collect that credit on wells that were producing after that point in time, I believe, through 2002.

I think a point of question that I heard mentioned, and I believe it was by Mr. English and Mr. Houghton, and I believe you may have mentioned this as well, all three of you, Congresswoman Thurman as well, was the question about, do these tinkerings with the Tax Code help the process ultimately achieve the desired end, which is to get the product up in supply and, therefore, reduce the cost. I think predictability and reliability on a consistent policy is critically important, and the fact that tax credits may have been allowed for new drilling back in 1994 hasn't done much in this area since that time.

So, with that, I am going to conclude my initial comments. Again, I appreciate the opportunity to speak here today. We are happy to answer any questions when this panel is completed.

Chairman HOUGHTON. Thank you very much, Mr. Holbrook. Mr. Heine.

STATEMENT OF BRUCE D. HEINE, ASSISTANT VICE PRESIDENT, NATIONAL FUEL GAS DISTRIBUTION CORPORATION, BUFFALO, NEW YORK

Mr. HEINE. Good afternoon.

Again, my name is Bruce Heine. I am an Assistant Vice President with National Fuel Distribution. I am in charge of the gas purchasing area. I would like to thank Members of the Subcommittee and the chairman for the opportunity to participate in this hearing. Today I am speaking on behalf of National Fuel, a natural gas utility that serves approximately 700,000 commercial, industrial and residential customers in both western New York and the western Pennsylvania area.

An unprecedented rise in the cost of natural gas, along with colder than normal weather this past year has caused consumer bills in our area to increase significantly over the last year. Now, I am going to refer to a number of exhibits that are attached to my testimony. It might be helpful to look at those as we go.

Exhibit 1 shows the components of our average annual rates. The increasing purple line represents the gas cost element--

Chairman HOUGHTON. Let me just interrupt a minute. Are these going to be available for everyone?

Mr. HEINE. I believe there should be copies.

Chairman HOUGHTON. Because it is hard to sort of follow it.

Mr. HEINE. Okay.

Chairman HOUGHTON. These exhibits and the testimony of Mr. Heine. As with other testimony, they are going to be available afterwards. Thanks. Go ahead.

Mr. HEINE. Okay. The purple line on Exhibit 1 represents the gas cost element of a customer's bill.

Chairman HOUGHTON. We don't have colored up here.

Mr. HEINE. Oh, you don't? Okay.

Chairman HOUGHTON. Just black and white.

Mr. HEINE. All right.

Chairman HOUGHTON. Is this Exhibit Number 1?

Mr. HEINE. Exhibit Number 1.

Basically, what the exhibit is showing, the bottom line is basically the utility cost of service. You can see that the middle line, which is the gas cost, is rising significantly, while the utility charge or utility cost of service is decreasing slightly. So you can see the top line, which is the total of the two, is clearly being influenced by the cost of gas, as opposed to the utility charge.

So why are natural gas prices so much higher recently as compared to previous years? This year follows, again, a period of oversupply when drilling was down due to relatively low gas prices. Supplies have been steadily declining, and even though National Fuel's market requirements have been somewhat stable, demand has grown elsewhere in the United States, especially if natural gas is used for electric generation. Factors outside of our control and outside our geographic region affect the marketplace where we purchase the commodity.

The problem of high prices is not just a New York and Pennsylvania issue. It is a problem that is being felt nationwide. Exhibits 2 and 3 illustrate these factors.

Exhibit 2 shows the decline of natural gas deliverability over the past 5 years. In 1996, the total deliverability from the U.S. Was about 53 billion cubic feet a day. Today, it is around 51.5 billion cubic feet a day. This represents a 3 percent decline.

Meanwhile, Exhibit 3 shows how natural gas demand nationwide has been on the increase. The economy and deregulation has fueled the demand for natural gas. Most forecasts now predict the demand for natural gas to reach 25 BCF per day.

Now that prices have risen in response to the supply and demand shift, drilling activity has picked up again. Both large producers and small independent drillers now have the incentive to get the gas production back to the level where it can meet the growing demand. Most experts believe the market price for natural gas will level off as additional supplies come to market.

How is National Fuel affected by the rising cost of natural gas? It is important to realize that National Fuel does not benefit from higher natural gas costs. The price we pay is passed along to the customer dollar for dollar without markup. National Fuel has taken steps to manage gas costs while ensuring reliability of supply. We balanced our purchasing portfolio between storage gas, fixed price gas and gas purchased under market priced mechanisms. Hedging strategies such as this do not necessarily reduce prices but do soften the effect of price volatility.

Exhibit 4 illustrates our winter commodity supply mix and how it is balanced between storage withdrawals, fixed price and market price gas.

Where does National Fuel's gas supply come from? We purchase gas supplies from the southwestern United States and Canada. Storage gas also makes up approximately one-third of our supply during the winter months. The majority of gas supplies for sale to customers of National Fuel are brought to National Fuel by seven major upstream interstate pipelines that traverse our market area.

In addition, local production or locally produced gas accounts for around 30 percent of the total volume of gas moved through our system. Although it is closer, local produced gas is not necessarily cheaper than other sources of supply. Local gas is sold at market prices and is usually purchased directly by local industry.

How does National Fuel keep our natural gas purchase prices as low as possible? We consistently evaluate different sources of supplies, pipelines and storage contracts to make sure we are using the very least cost reliable options. We work to make sure that our pipeline supplier rates and services are prudently priced and in our customers' best interest. State regulatory commissions review all of our contracts and purchases related to gas purchasing.

However, with gas prices rising, it is more difficult to keep gas supplies at the low-cost level we have experienced in the past. Market price of gas is out of our control. It is really driven by supply and demand, and it is very difficult to influence that.

What will the future bring? Our customers need to know that supplies of natural gas are adequate. Rising prices, while they hurt in the short run, have encouraged greater exploration and production for new gas supplies. There are more rigs drilling for natural gas than ever before. Many experts believe these new supplies will help moderate prices later in the year.

Exhibit 6 shows the number of drilling rigs active in the U.S. And Canada. As you can see, it has gone from 800 rigs last January to approximately 1,150 currently nationwide. This is encouraging. Also on Exhibit 6 is the latest price forecast from the Petroleum Industry Research Association, or PIRA. This is somewhat encouraging, since it shows prices leveling off around $4 to $4.50, which is a considerable break from the $10 we saw in January.

National Fuel has been serving northwestern Pennsylvania and western New York for over 100 years. As an active part of the community, and as gas customers ourselves, we are working to keep costs down by strategically acquiring and managing our natural gas supplies.

I would like to thank you for this opportunity to present this information to the Committee.

[The prepared statement of Mr. Heine follows:]

Chairman HOUGHTON. Thank you very much, Mr. Heine. Mr. Nalbone.

STATEMENT OF JOHN J. NALBONE, JR., PRESIDENT, UNIVERSAL RESOURCES HOLDINGS, INC., DUNKIRK, NEW YORK

Mr. NALBONE. Thank you, Mr. Chairman.

I am the president of a local production firm, Universal Resources Holdings. We operate in western Pennsylvania and western and central New York. We were formed in the mid-1970s. Our firm has drilled in that period of time about 660 wells, and most of them were all funded by organized limited partnerships.

Our peak operational year was 1981 when we had drilled 141 wells. Prior to the Tax Reform Act of 1986 and the oil price crash of that year, we had drilled about 620 of those wells, but in the 15 years since, we have not even drilled 40 wells, and no wells since 1992 when the window of time expired for drilling the section 29 tight gas sand wells.

Chairman HOUGHTON. You might explain what section 29 is for everybody out here.

Mr. NALBONE. That is the unconventional fuel production tax credits which were given for the natural gas and coal industry for hard-to-produce oil and gas, for what you call low-margin or low-yield reservoirs. This particular region, western Pennsylvania and western New York, is that type of region that falls under that jurisdiction.

Chairman HOUGHTON. Thank you.

Mr. NALBONE. So since 1986 the national oil and gas industry has been devastated, with most of their experienced skilled tradesmen leaving for other industries, due to massive layoffs and inactivity.

The government impact on drilling/production since the Tax Reform Act of 1986. During this time, our national production has declined from about 9 million barrels a day to less than 6 million barrels a day. In 1981, the industry had over 4,100 rigs running; today, it is barely over 1,100.

The effect of the tax rate reduction from the top 70 percent bracket to the current 39 percent bracket, which might be, hopefully, reduced to around 33 percent, coupled with the elimination of several types of tax credits that were there before the Tax Reform Act, plus the change in the passive loss rules requiring passive losses to be offset only by passive income, and the implementation of the alternative income tax devastated the usual capital sources for most of the smaller independents like us, who combined had accounted for over 50 percent of the national natural gas production in the early to mid-1980s.

During this period when supplies were made plentiful, the consumer prices were reasonable and the perception of a "gas bubble" left little incentive for the lawmakers at that time to develop long-term tax policies that would ensure the continuation of ample supply.

How independent producers sell gas now.

Since 1986, and with the gas deregulation, we have seen the coming of a much more complex and volatile pricing market with the presence of numerous large gas marketing firms dominating this market as middlemen and futures market speculators causing the wild price swings on the spot market. To counteract the loss of profit caused by deregulation, the local area distribution companies have successfully prevailed upon their respective State public service commissions to allow the charging of what are excessive tariffs to transport gas across their wholly depreciated pipeline distribution systems. Thus, the consumer is bearing the brunt in the end of having to pay these higher prices for excessive middlemen and gas transportation markups and the supply shortages.

My suggestions for improving the supply and lowering prices. I think we need better tax incentives for encouraging the undertaking of risk for substantially more drilling today. These necessary incentives should be significantly easier for lawmakers to justify than the billions of dollars given to the farm industry.

The recommendations, which I believe would turn the supply problems around and result in lower consumer prices, are: Restoration of several of the key tax provisions that stimulated the drilling boom of the early 1980s that were taken away from the industry with the Tax Reform Act of 1986. Namely, return to us at least this the following: the 10 percent investment tax credit on recoverable tangible equipment. The return to the passive loss rules that existed prior to 1986 so that our traditional investors would have the incentives to return to us within the limited partnership formats that existed in the past.

Extend for us, for at least 10 more years, the section 29 program for the tight gas sands production, which is set to expire at the end of the year 2002, for the existing wells that are drilled and properly registered with FERC. Allow the extension of those fields for new offset wells under the program. A great part of the remaining national undeveloped reserves are in tight gas sands reservoirs. This would have great benefit for the drilling play in the Western New York and Western Pennsylvania areas.

Lastly, allow the elimination of the alternative minimum tax for new oil and gas drilling investments, as the implementation of this tax over the past 15 years was as much a detriment to the investor incentives as the passive loss rules.

Thank you for allowing me to make the address here.

[The prepared statement of Mr. Nalbone follows:]

Chairman HOUGHTON. Thank you very much.

What I am going to do is turn to Ms. Thurman and ask her to ask questions and then Mr. English. If there is any time left, I will proceed. As I look out the window, we had better be careful that we are not all stranded here overnight.

So, let us get on with this. If we are a little truncated in our questions, it is not that we are not interested, but we can follow up in other ways.

Go ahead, Ms. Thurman, please.

Mrs. THURMAN. First, let me thank you for giving us ideas of what you believe could help and comments on some acts that actually exacerbated the problem earlier on.

Do you remember how much total those dollars were when they were cut out of the budget?

Mr. NALBONE. No, I don't, ma'am.

Mrs. THURMAN. Okay, because all of that would have to be, from our perspective, scored for revenue costs and looked at. I would just caution you not to play one industry off of another. Some of us believe in our farmers and think food is a very important issue, as well as our fuel costs.

Mr. NALBONE. Well, that subsidy is due to oversupply, and this is different.

Mrs. THURMAN. In some cases, but, nonetheless, we won't argue that. I caution you not to do that, because remember that the chairman of the Finance Committee on the Senate side is Mr. Grassley, and he has interest in some of these other areas, as well as alternative fuels. Just kind of a sidebar there. But we would like you to be successful, because certainly we are here to help the consumer.

But let me ask you this question: In one of your charts, let me see if I can get this right, you mentioned the residential rates have gone up about 30 percent. Your costs have gone from 90 cents to $1.20. But, what we are hearing here today from the consumer is much more dramatic than this. We have heard from a consumer who thought that she was going to have an increase, all of a sudden, from $150 to $600 per month. I agree with what Mr. Holbrooke said about how we had a more severe winter and there are some reasons for the increases. But that certainly doesn't give us reasons for the total increases people are facing.

So I am a little concerned about why this has happened. With suggestions for drilling incentives, what are the incentives to help people like them, other than just subsidies from the Federal Government?

Help me here. Whoever wants to answer that question, or who would like to respond to me later with the answer to that question, please do.

Mr. HEINE. Well, I guess I can respond on what some of the things we are looking at at National Fuel to try and reduce gas costs even though we really don't have much influence on the commodity. It is supply and demand that is causing that rise. But one of the things we can do is look at other alternatives of gas supply.

I mentioned, that the majority of our gas comes up through the interstate pipelines. What we have done over the last year, and we are continuing to look at, is storage alternatives where you don't have to pay the pipeline supplier's year-round demand charge just to have the gas delivered in the winter, because our customers in western New York and Pennsylvania are heat-sensitive customers.

What storage allows us to do is purchase gas more cheaply in the summer and have it there in the winter without paying the same high demand charges all year. You still may have the problem of higher commodity cost even in the summer, but it is one of the alternatives that we are looking at.

Mrs. THURMAN. Sir, based on the tax cuts we are trying to look at here, what incentives can we give you then to store it at an earlier time? Is there anything that could be helpful? I am sure that someone is going to require some kind of additional storage tanks or whatever. Is there something either already in the Tax Code or something that you have looked at that would be to your benefit as a new tax incentive?

Mr. HEINE. Well, the storage contracts that I am referring to are usually regulated by the FERC. They are like interstate pipelines. So, I am not sure. At least I can't think of anything right now from a tax cost incentive that would influence those, but I haven't really thought about it either.

Mrs. THURMAN. Anybody else?

Mr. HOLBROOK. Yes. Just picking up on Mr. Heine's observation of using less southwest deliverability, basically what he is saying is using less of the long line pipeline capacity that you are paying for, in some cases, 1,500 miles of transportation pipeline. I believe I alluded earlier in my presentation to the fact that we calculate that to work out to be about $1.50 per every 1,000 cubic feet that are utilized by the utility in this part of the world.

I believe our observation also was that even if the producer here got a small fraction of that as an incentive to go out and do more development, that could leave somewhere in the nature of $1 per 1,000 cubic feet that could be available as discount, as a reduction in the cost to consumers in this region by spending a few more dollars here but a lot less dollars in other parts of the country. So I think that is something, at least from our perspective. It may not be a tax issue, but it clearly is something, we think; and we would like to see it encouraged in whatever manner you can encourage that activity.

Mrs. THURMAN. Ms. Lindsley and Ms. Sosinski, and other, we really want you to know that we thank you for being here. I can't even imagine what some have faced. I just lost my mother, and I had her living with me in Washington. She had surgery and had to be fed through a tube. Heating was very important because she was cold and she was uncomfortable. I can really say to both of you, you have my sympathy. Hopefully, with Amo, we can help with your situations. I agree with you that one of the issues of particular importance is the flexibility of the programs that are available.

With high costs, particularly in situations like this, we ought to have some ability to work with people that are having problems, and not reject folks if they are a penny over the income cap. There ought to be some sliding scale for costs and income to really take into account, your good suggestion. We appreciate your being so kind to give us these stories that we can take back to our colleagues. Thank you very much.

Chairman HOUGHTON. Thank you, Karen. Phil.

Mr. ENGLISH. Just very briefly, Mr. Chairman. I would like to thank all of the panelists for making a very substantial contribution to our discussions and giving us concrete things that we can take back to Washington.

Mr. Nalbone, I particularly appreciated your tax suggestions. All of them make eminent sense to me.

The investment tax credit I think is something we ought to revisit. Its elimination created a hole in our Tax Code that has not been filled; and, obviously, this would benefit a far broader range of industries than simply yours.

The passive loss rule and section 29 credit I do think ought to be revisited as part of an energy bill.

Finally, you have hit on something that particularly rubs my rhubarb, and that is the corporate AMT. The first bill I introduced when I came to Congress was to repeal the corporate AMT. I have reintroduced it every year. I do not feel it has any justification in tax policy, and it clearly is a drag on the economy.

You have given me a fresh example of an area of the economy which has been severely impacted by the corporate AMT, which is a well-intentioned but nonsensical approach. I am particularly grateful for your suggestion on how we could create an exception to the corporate AMT, because, short of full repeal, I am also committed to going in and knocking holes in the provision.

So I thank you, and I thank all of you for taking the time to testify.

Mr. Chairman, I yield back the balance of my time.

Chairman HOUGHTON. Thanks, Phil. I won't take very much more of your time, but I want to ask a question.

Here you have the people who are responsible for the sourcing, and here you have the consumers. We are not going to be able as a panel, as Members of the Ways and Means Committee, to rejigger the whole energy policy of this country. We can't do that; and, even if we could, some of the critical issues would be longer term things.

I think the thing that I am most interested in, and I hope you join with me, is that we don't come back here next year at this time and have the same situation. I hope we can soldier through this winter.

But what specifically can we do now to be able to minimize the impact of these different economic forces at work so that you don't have the same situation with Ms. Sosinski; and, Jeff, you were talking about the same thing. What do we do?

So I am going to ask all of you just to give us one thought: What would you think that we as a group could do now to be able to -- not solve everything, but to do something which would be able to help your cause and also everybody here?

Go ahead.

Ms. LINDSLEY. I feel what you have done today, listening to the consumer and hearing our needs and becoming aware of what we need rather than the industry. The consumer, we are the ones that pay their bills, and I think what you are doing right now is what will help us in the long run, that you are hearing us, that you are paying attention to what we are saying.

Chairman HOUGHTON. All right, thank you very much. I hope we do.

Ms. SOSINSKI. I realize that the government has guidelines when they have their HEAP program, that there has to be a cutoff, but I also feel that when you have these people that have such high doctor bills, medical bills and prescription bills, that somehow a certain percentage could be taken off their income to help them be eligible for the HEAP program.

Chairman HOUGHTON. All right. Yes, Jeff?

Mr. AIKEN. From what I have seen, anytime there is an industry that has been deregulated, I think the consumer ends up picking up the great brunt of the burdens that are left, and I think that maybe some regulations there to get away from this vast deregulation thing that the governments have headed to for so long -- like I said, we have taken it pretty big time since deregulations have started.

Chairman HOUGHTON. Mr. Holbrooke?

Mr. HOLBROOK. I think Mr. Aiken's observation is an understandable one. I think if the market doesn't get an opportunity to receive the proper signals, then I think it is understandable to advocate the alternative, which is to have government regulation. I mean, I think that is an understandable observation.

I would submit to you, this industry is capable of operating in an efficient manner. It needs consistent signals in terms of where it is valued. It needs a consistent energy policy from the Federal Government in terms of where it wants this energy industry to go.

As I said earlier, I think it is important that the tax laws, your specific area of focus, show your interest in encouraging increased drilling activity, increased supply, because that increased supply won't bring the price down.

Chairman HOUGHTON. Well, let me just follow up on this a minute. You thought the consistency was more important than almost anything else. Therefore, you said you used the $10 figure per 1,000 cubic feet versus $3. So you are suggesting that the government, as it does in certain areas like the dairy industry, put a floor?

Mr. HOLBROOK. I know that probably would be a reasonable assumption, based upon my observation. I am fearful of the government stepping in and trying to guesstimate where the price should be. I think what we are suggesting is, for the most part, that there be sort of consistent expectations of where the prices have been.

If you look beyond this past year, they have been relatively flat. I think it has been observed by a number of parties and looked at by different studies as relatively flat for a number of years.

What I am suggesting is just a few tinkerings where we are talking here in terms of section 29 tax credits and allowing just some of the expenses, some of the ongoing expense associated with going out and exploring. I think just that would be sufficient to send the signal that this government is behind the industry.

I don't think there is a need to step in and establish even a floor. I would be fearful of that, just as I would be fearful of setting a ceiling. I think for the most part market sources should work efficiently here, as I indicated earlier. I think right now they just favor consistent management through tax policy by reestablishing what you basically took out of favor after 1992.

Chairman HOUGHTON. Okay. Mr. Heine.

Mr. HEINE. I think the focus of the New York State Public Service Commission over the last 2 years has been deregulating the merchant function in getting utilities out of merchant function so that there is a free market. I think after this winter the New York State Commission has sort of stepped back and is taking another look. We don't have the same pressure to get out merchant function.

The point I am making is that the drive that the New York Commission had to get utilities out of merchant function I think has been delayed by high costs. They don't seem to be pushing as hard. The problem with us being caught in the middle of knowing whether we are in the business or out of the business, it was difficult to sign up for longer-term gas supply deals.

For this next coming winter, we have received some indications that it is okay to do longer-term pipeline deals and gas supply deals. So, hopefully, with that change, we can look at better alternatives next winter, like I mentioned before, some storage contracts that are longer than a year-to-year type deal. Hopefully, we can negotiate some good contracts.

Chairman HOUGHTON. Rather than putting your hand in the marketers, is what you are saying?

Mr. HEINE. That is correct.

Chairman HOUGHTON. Mr. Nalbone?

Mr. NALBONE. As I said, I would like to see the extension of section 29; not only for the ongoing production but for new drilling and offset wells and enact the laws that I suggested as big changes. And try to establish them for the long term, so we have a stable, long-range environment.

We have people that are not going into this field any more. They would rather go into computer science, because they just don't feel the industry will support their work, and with so many layoffs.

So we need long-term changes and whatever you can enact, that we can rely on it for a long period of time.

Thank you.

Chairman HOUGHTON. All right. Well, thank you very much. We are all done.

[A member of the audience spoke out.]

Chairman HOUGHTON. No comments. Please, sit down. Please sit down. Officer, will you have this man sit down, please. This is not the whole point of this.

I appreciate very much you doing this. We hope to get the testimony out. If there is no further business, the meeting is adjourned.

[Whereupon, at 2:20 p.m., the hearing was adjourned.]
[Submissions for the record follow:]

Accurate Prices Program, and Redefining Progress, Oakland, CA, Mark Glickman, and Kim Rodgers, joint statement

American Petroleum Institute, statement

Anchor Glass Container, Elmira, NY, Michael Sopp, statement and attachments

Brown, Helen D., Bath, NY, letter and attachment

California Independent Petroleum Association, Sacramento, CA, David S. Hall, letter and attachments

Coyne, Hon. William J., a Representative in Congress from the State of Pennsylvania

Dominion, Jane Lew, WV, Ben Hardesty, statement

Eaton, Patricia, Bath, NY, letter and attachment

Edison Electric Institute, statement

Hall, Mildred C., Bath, NY, letter

Independent Petroleum Association of America, and National Stripper Well Association, John Swords, joint statement and attachments

Lubrizol Corporation, Wickliffe, OH, statement

National Energy Marketers Association, Craig G. Goodman, statement

New York State Assembly, Hon. Catharine M. Young, Assemblywoman, statement

Slaughter, Hon. Louise M., a Representative in Congress from the State of New York, statement