The primary conclusions from the study are:

1. California refining capacity has not been able to keep up with demand growth. As a consequence, the State has become a significant net importer for all its petroleum products.

2. Permit restrictions hamper capacity additions, and massive investments made by the refining industry over the past decade have been directed at compliance with regulatory programs resulting in capacity reductions rather than increases.

3. Imports of gasoline and gasoline blending components currently account for approximately 15% of the State's demand, two-thirds of which is Methyl Tertiary Butyl Ether (MTBE). Most of the future growth in demand will have to be met by foreign imports.

4. The geographical insularity of California's gasoline market has been aggravated by the uniqueness of its fuels specifications, and domestic or foreign sources of alternative supplies are scarce.

5. Inadequate logistics and commercial factors such as lack of liquidity in forward markets and restrictions imposed by the Unocal patents constitute significant barriers for imports. The gasoline supply system is currently constrained with demand exceeding the existing infrastructure capacity.

6. The combination of restricted refining capacity, inadequate logistics infrastructure, and commercial barriers has made the California gasoline market increasingly unstable, with even small supply disruptions causing major price swings.

7. Phase out of MTBE by year-end 2002 will result in a supply shortfall in the range of 55 to100 TBD (thousand barrels per day). Given the current instability of the California gasoline market and the inadequate logistic infrastructure, this is likely to lead to prolonged shortages similar to those observed - but only over short periods - in 1999 when prices doubled and a waiver for supply of non-conforming gasoline was granted.

8. Over 80% of the net shortfall caused by the phase out of MTBE will fall to Southern California, and to the Arizona and Nevada markets supplied from the Los Angeles (LA) Basin. Unfortunately, the LA Basin is also where most of the infrastructure problems occur.

9. Based on generally accepted price elasticity estimates and recent California market experience, retail gasoline prices will have to double before demand will find a new equilibrium at a level that matches the reduced supply, causing significant damage to the State's economy. The consequences will have the greatest impact in the independent market sector, supplying institutional buyers such as government agencies, and will disproportionately impact lower income groups.

10. Permitting restraints and unavailability of emission credits make timely additions of refining capacity within the California system unlikely. These same factors are also expected to make it difficult for refiners to maintain the rate of ongoing small increases in refining capacity, which in recent years averaged around 1% per year.

11. A waiver from the federal requirement for oxygenates will improve the flexibility for refiners to source blending components and base blendstocks after MTBE is phased out. The waiver will make the supply system less vulnerable to potential ethanol logistic problems, but will not significantly alter the overall supply shortfall.

12. The shortfall cannot be met from refineries on the US Gulf Coast, which are currently running at capacity, are unable to produce Phase III California Reformulated Gasoline Base Oxygenated Blendstock (CARBOB), and may be curtailed in their ability to produce alkylates for export by anticipated developments in other US gasoline markets and worldwide petrochemical demand.

13. Even if product could be made available on the US Gulf Coast, American flag shipping will not be available in sufficient numbers, while the impact of phasing out single-hull tankers as required by the Oil spill Prevention Act of 1990 (OPA 90) is going to reduce the availability of US flagged product tankers even further in years to come.

14. Imports of blending components from worldwide sources will be attracted to California when prices are elevated to unprecedented levels above world markets over prolonged periods. However, while MTBE is a single, readily fungible component, the replacements are likely to be a wide variety of blendstocks such as ethanol, alkylates, isomerate, isooctane, and near-conforming gasoline stocks, each requiring separate storage and - in the case of ethanol - handling facilities. The combined infrastructure demands of the replacements are far more complex than the current MTBE facilities.

15. Several physical and commercial barriers that currently already limit the State's capability to import these blendstocks will increasingly become a supply obstacle:

    • Tankage for clean products, which is currently already severely constrained in the Los Angeles Basin, will be reduced by 10 to 15% over the next 7 years by the need to comply with a new regulation from the SCAQMD (Rule 1178) requiring tank modifications to obtain further emission reductions.

    • Permitting, port policies and pressure from special interest groups make it unlikely that additional terminal capacity can be constructed within the timeframe necessary to mitigate the economic impact. In fact, port policies may well lead to further terminal closures in the near future.

    • Concerns about violating the Unocal patents currently prevent traders, foreign suppliers or California's remaining independent marketers from attempting to import components and blend finished gasoline. After the introduction of CARB Phase III and the elimination of MTBE as primary blending component, these difficulties will significantly increase.

    • The California refiners control, either through outright ownership or long-term leases, virtually all of the available terminal capacity in the State. The refiners are also the only ones capable of blending around the Unocal patents. The primary responsibility of the refiners in times of product shortage is to keep their branded retailers supplied. This means that the shortfall will primarily affect the independents, who in the current tight storage market have no access to tankage or supplies from traders.

    • California gasoline markets lack liquidity in forward markets and does not offer mechanisms to hedge forward risk, leaving importers exposed to price uncertainty. On average, California gasoline prices are substantially higher than the world markets, but the price volatility is such that an importer would be exposed to the risk that a downswing will occur during the 6 to 8 weeks it takes to source and ship a cargo. In a highly volatile market, many importers will not conduct a trade that has a significant unsecured price risk over periods that long.

To avoid shortfalls and subsequent price excursions, the following actions are recommended:

1. The MTBE phase out should be deferred for a sufficient period of time to allow actions to be taken that will result in significant additional supplies becoming available to augment the California gasoline pool. Events that are anticipated to do this are:

• In Northern California: the restart of idled capacity, which could provide an additional 22 TBD of conforming gasolines.

• In Southern California: the completion of the Longhorn pipeline to El Paso, TX, followed by an expansion of the pipeline capacity to Phoenix, AZ, will enable additional supplies of gasoline to be transported from the East, thus allowing 70 to 90 TBD to remain in the California market that is currently exported to Phoenix from Southern California refineries.

• Additions of terminal and tank capacity in the Bay Area and the LA Basin, which will enable access to the California market by traders and foreign producers.

• Resolution of the Unocal patent(s) currently under review by the Patent Office, and/or settlement of suits brought by several majors so that refiners can again blend in components currently diverted from the gasoline pool to avoid patent infringement.

• A deferral of the MTBE phase out until November of 2005 should be sufficient to complete the necessary steps to ensure that a transition to ethanol can be accomplished with minimal disruption to gasoline supplies, with least cost to California consumers.

2. The intervening period of three years must be used to:

• Identify ways to allow refiners to expand capacity in cost effective ways, with permitting procedures revised to enable one-stop, fast track processing, similar to that introduced to resolve the electricity crisis.

• Implement the recommendations of the California Energy Commission's Strategic Fuels Reserve Study, which are being developed in parallel to this MTBE study. The preliminary recommendations of the SFR study are to create additional storage, as well as means to promote forward liquidity.