TABLE II-15.—PROJECTED U.S. REFINERY CAPACITY THROUGH 1975 AND REQUIRED CRUDE RUNS VERUS PRODUCT

IMPORTS

A-Maximum runs feasible with projected capacity (92 percent).

B-Crude runs required to hold product imports at constant percentage of total demand-14.48 percent (based on 1971). C-Crude runs required to hold product imports at same absolute level as 1971 (2,196,000 bbls/day).

ATTACHMENT III

STATEMENT OF DUKE R. LIGON, BEFORE THE HOUSE AGRICULTURE COMMITTEE, MAY 17, 1973

Mr. Chairman, I appreciate the opportunity to appear before you today to discuss the allocation program and relate its impact upon the agricultural sector of the economy.

EXPLANATION OF THE ALLOCATION SYSTEM AND ITS ADMINISTRATION

On May 10,1973, the Chairman of the Oil Policy Committee announced an allocation program. The program is to be administered by the Office of Oil and Gas in the Department of the Interior. A set of guidelines are being drafted and will probably be published by the end of the week. The basic components of the allocation program are as follows:

1. Suppliers of crude oil, natural gas liquids and petroleum products are to make available in each State to each of their customers, including the purchasers in the spot market, the same percentage of their total supply of crude oil and products that they provided during the corresponding quarter of the base period. The base period is defined as the fourth quarter of 1971 and the first three quarters of 1972.

2. Suppliers may be asked to set aside 2 percent which may be increased to as much as 10 percent of their total supply to meet priority needs assigned by the Office of Oil and Gas. The basic purpose of an assignment must be to assure adequate supplies of crude oil and products to priority users who are not well served by a proportional allocation from their traditional supplier.

3. Priority will be given by the Office of Oil and Gas to supplying the following activities or to independent marketers, jobbers and refiners who supply the following activities:

(a) Farming, dairy and fishing activities and services directly related to the cultivation, production and preservation of food.

(b) Food processing and distribution services.

(c) Health, medical dental, nursing and supporting services except commercial health and recreational activities.

(d) Police, fire fighting and emergency aid services.

(e) Public passenger transportation, including buses, rail, intercity and mass transit systems, but excluding tour and excursion services.

(f) Rail, highway, sea and air freight transportation services, and transportation and warehousing services not elsewhere specified. (g) Other State and local government activities.

(h) The fuel needs of residents in States or parts of States not well served by major oil companies and unable to obtain sufficient crude oil or products.

(i) Difficulties caused by natural disasters.

Wholesale and retail marketers of gasoline shall not be deemed priority customers unless they supply a substantial proportion of their product to these priority users.

4. Non-priority customers who do not have a supplier with a supply obligation may apply to the Office of Oil and Gas for assistance on the basis that they are not otherwise covered by the program. The Office of Oil and Gas will assign a supplier for those not otherwise covered by the program.

5. The Office of Oil and Gas will receive complaints from anyone who feels he is not receiving a proper allocation of supply. If it is deemed necessary, the Office of Oil and Gas may require a public hearing and submission of data by suppliers on their 1971 and 1972 exchanges and/or sales of crude oil, unfinished oil in products, and whatever other information the Office of Oil and Gas believes necessary to conduct the hearing. The Office of Oil and Gas will then verify the accuracy of complaints against the supplier and if justified, impose mandatory allocation on the supplier.

6. The price at which crude oil, natural gas liquids, and petroleum products shall be sold in compliance with this program shall be at the seller's prevailing rates in that area to the class of customer involved. No price controls are added by this program, but the Cost of Living Council's rules remain in effect.

The net result of the allocation program as it concerns the agricultural community is that suppliers of oil products should now have access to the quantity of petroleum products that they had for the previous year. In addition, if a farmer or the supplier of a farmer finds that this basic allocation is inadequate, he can, because he is a priority user, request the Office of Oil and Gas to allocate some of the set-aside oil supplies to meet his needs. The Office of Oil and Gas will consider the merits and circumstances of the situation and respond accordingly.

The program has been made flexible so that suppliers can respond to obvious priority needs pointed out by government officials and those that they recognize themselves. When verified by the Office of Oil and Gas, these responses will be credited as supplied from the set-aside volumes. There is no necessity for suppliers who are above of priority needs to wait until bureaucratic reviews are made before providing the needed supplies. This can be done immediately and the paper work can be handled later.

Within two weeks following the initiation of the allocation program, the Oil Policy Committee shall begin hearings to determine any changes that may be required to make the program equitable to all classes of suppliers and purchasers, and whether the program should be made mandatory. The Chairman of the Oil Policy Committee will designate an ad hoc board to conduct such hearings and report its findings to the Oil Policy Committee. The board shall be composed of representatives of the Interior, Treasury, and Commerce Departments, GSA/OEP, and any other representatives as the Chairman of the Oil Policy Committee may feel appropriate. The Chairman of the Oil Policy Committee shall designate the Chairman of the Board.

The program described herein will apply to all segments of the industry. The oil companies' adherence to these guidelines will be monitored and, if voluntary compliance fails, mandatory measures will be taken by the Administration. We hope and expect, however, that this will be unnecessary. Our preliminary soundings suggest that the companies are aware of the problems created by curtailments and are willing to continue to provide a fair share of the petroleum products to their established customers.

STATEMENT OF DUKE R. LIGON

Mr. Chairman, I appreciate the opportunity to appear before you today to discuss some of the various aspects of oil production, refining, and distribution. The major subject matter is indeed complex, but I have confined my discussion to various items that we have information on and appear to be applicable to your needs.

In Attachment II there is a general discussion of petroleum utilization in the U.S. today. I call it to your attention as containing a broad overview. My verbal comments will concentrate on more specific concepts.

The functions of the petroleum industry may be conveniently divided into five parts: (1) exploration and drilling, (2) production, (3) transportation, (4) refining and (5) marketing. The significance of these functions will vary between companies, but all of these functions are carried out by fully integrated oil companies.

The industry may be considered to fall into two rather broad classifications, “majors” and “independents." A major company, for the purpose of this analysis, is one which engages actively in most phases of the industry and does so on a large scale at a near-national level. Many major companies operate internationally.

Table 1, in Attachment 1, shows the volume of production by the 73 top producing companies in the U.S. An independent company, on the other hand, typically participates actively in one or more, but not all, phases of the industry, and usually operates on a regional basis. No absolute line may be drawn between the majors and independents, however, as there are many medium-size companies that are integrated to some degree. An independent refiner, for example, may market some of his refinery output through his own stations in a several-state area. He may have some production but it would be incidental to his refining operations, and he would have to buy most of his crude oil. An independent producer usually sells the oil which he produces at the lease. The five parts of the petroleum industry described above extend from the gleam in the geologists' eye to the housewife stopping at the service station for a "dollar's worth of regular."

CRUDE OIL PRODUCTION

Before any well can be drilled, the oil company must obtain the mineral rights on the land where it proposes to drill. Normally, these rights are obtained by leasing from the owner who frequently own both the surface and the minerals below. A mineral lease may be obtained from a private party, a state or municipality or the Federal Government, as is the case on public and acquired lands and the other continental shelf.

An oil lease is not a lease in the general sense of the term; it is rather the delegation from the mineral owner (lessor) to the lessee of exclusive rights to "capture" such minerals. In return the lessee gets to keep and sell the greater part of these minerals as compensation for his efforts. In the case of oil and gas, the amount is usually 7/8 of the total from private lands and ranges down to 5/6 or less on some Federal lands. The part not retained by the producer goes to the lessor or land owner as their royalty share. The royalty interest is normally free of all costs of capture except for special treating costs that might be specified in the lease. The royalty may be paid in cash or in "kind." Most lessors prefer to take their royalty in cash based on the selling price of the oil sold from the lease. In some cases the royalty may be paid in kind. This is the case now of most oil production from Federal leases.

We would note parenthetically that production of royalty oil on Federal leases, both onshore and offshore amounted to about 225,000 barrels per day (Bpd) in February 1973. Of this total, about 65,000 Bpd is being taken by the government in kind for sale to small refiners whose prior source of crude has been curtailed. Before February 1973, royalties from the Gulf of Mexico production had been paid in cash to the Government. However, the present shortage of domestic oil to small midwestern refiners has prompted the Government to elect taking its royalty oil in kind and to allocate it on a systematic basis to these distressed refiners. Of the 100,000 Bpd available from the Gulf OCS, about 30,000 Bpd has been granted to 7 applicants with additional applications on hand for 142,000 Bpd. Problem is, however, there are only about 70,000 Bpd left to allocate.

For the most part of the past century, the United States has been capable of producing oil in excess of our market requirements. It was not until the late 1960's that this country required more oil than it could produce. When supply was in excess, a different set of problems arose that affected the well being of the oil and gas producing industry. Much has been said and written about these conditions and some of the factors that were related to production had to do with equitable producing rates that would bring stability to the industry and at the same time provide a fair and equitable distribution of the available supply. We are talking about the proration system of producing oil to meet the market

demand. Rather than to take the time here to relate historical facts, we are attaching a reproduction of a chapter from the Interstate Oil Compact Commission publication entitled "Oil for Today and for Tomorrow." We believe it to be a fair and factual discussion of conservation practices and laws as they evolved to meet the needs of the times. What the article describes is now of only historical interest as most U.S. oil fields are now being produced at their maximum efficient rate (MER). Important exceptions to MER production currently remain only in the Elk Hills Naval Petroleum Reserves (which is not subject to state market-demand prorationing but has been recently reported as being able to produce about 160,000 Bpd in about 30 to 60 days) and a small number of fields in Texas. Only three major Texas fields, East Texas, KellySnyder and Tom O'Connor, are restricted below 100 percent of their respective market-demand factors. Conservation problems encountered at higher operating rates have compelled reduced production in these fields while unresolved issues of correlative rights to the crude oil also preclude higher production from East Texas. A very few fields have MER's in excess of 100 percent of their market demand factors and these have unresolved problems of correlative rights.

Table 1, in Attachment 1, shows 1970 and 1971 crude oil producing rates for 73 of the Nation's largest producers. These companies in total produced 7.5 million barrels of crude oil daily. The remaining 1.5 million barrels a day were produced by small independents. We would like now to focus on the "smaller independent operator" and his role in the industry. His financial status is usually a sound indication of the condition of the industry. This is understandable, since he drills and operates a large number of wells and leases. By virtue of his size, flexibility and financial status, he may handle many functions that are unprofitable to the major producer.

Independent operators are primarily drilling contractors, although most of them own at least some oil production. Major companies do not now maintain company drilling crews, preferring instead to contract out their drilling requirements. Independents with drilling crews, having lower overhead, can generally drill wells at lower cost. Another advantage is that one independent may drill wells in the same area for other operators, which reduces tearing-down, moving and rigging-up costs, a significant part of drilling costs.

Most contractors try to obtain some production for themselves because this tends to stabilize their financial status and serves as collateral for expansion. The independents do very little extensive pre-drilling exploration work, preferring to obtain lease interests from brokers, drilling deals and farmouts from major companies.

Contrary to the majors (though they too are becoming more dependent on borrowed capital) independents rely mainly on borrowed capital which requires that money invested must begin to pay dividends almost immediately. Much of the capital obtained for independent's drilling is classified as "non-oil money" as it is obtained from people who are not primarily engaged in the oil business. The independents, therefore, serve as an avenue for large quantities of capital that would not be otherwise available. In the past several years, drilling costs have risen to a point where drilling contracts at prevailing rates have yielded returns on investment so low that the drilling activity has declined rapidly. In other words, there has been insufficient exploration and development of our oil and gas resources. The gas well drilling trend, however, did turn upward in 1972 increasing 28.7 percent over 1971, probably in anticipation of higher prices for new natural gas. Oil well drilling on the other hand dropped 4.7 percent in 1972 versus 1971.

In the United States crude oil prices are commonly "posted" by buyers of crude oil. Posted prices serve as offering prices to the seller and as the basis for financial settlements of producing interests and for royalty oil taken in kind. Price differentials are applied to the varying gravities of oil; the lighter the oil, the higher the price. Platt's Pricegram reports these crude oil price changes on a regular basis. A sample copy of a page from their most recent crude price supplement can be found in Attachment I. In general, the price is the same for a given quality of crude in a single area though on occasion buyers may differ in their postings. Price differences by areas primarily reflect nearness to market and differences in crude oil qualities.

The price of crude at the wellhead has been relatively stable since the late 1950's. The price rise in April of this year is the first one since November of 1970. U.S. average wellhead prices in current and constant dollar values is as follows:

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