COMMENT CHEVRON'S DERR: BEWARE THE CUTTING EDGE

Kenneth T. Derr
Chairman and Chief Executive Officer
Chevron Corp.
San Francisco

From an address to the American Legislative Exchange Council's annual conference, Colorado Springs, Colo.

Here is the latest message from California:

In considering the impact of business regulation upon our state's economy, beware of the cutting edge.

For many years California has exported regulatory fashions the way Italy exports shoes. Other states have been receptive customers for laws tailored for California, especially laws in the environmental arena. Everyone wants to be on the cutting edge.

Before your state buys into any more of them, take a good look at what the cutting edge has cut.

Employment has been cut. California has lost 333,000 jobs in the last year alone.

Competitiveness has been cut. Many of the businesses that employed those third of a million people have moved to other states.

Revenues have been cut, and, consequently, services are being cut drastically. California legislators have been struggling to close a $10 billion gap in the state budget.

SELF-INFLICTED PROBLEMS

Obviously, this sorry state of affairs can't all be blamed on the regulatory climate.

But it remains true, as Gov. Wilson's Council On California Competitiveness found, that "many of the state's problems are self-inflicted." The council, a blue ribbon group headed by Peter Uebberoth, concluded that California's economy is being smothered under a thick blanket of regulations on every subject you can think of: environment, taxes, workers compensation, and a host of others.

The issue of excessive regulation has surfaced in many other states and at the national level as well. President Bush underscored his concern in a very direct way when he imposed a moratorium on new regulation earlier this year.

I'm especially interested in this subject because it is so critical to the industry I know best.

A SECRET SCANDAL

What is happening in America's petroleum industry ought to be a national scandal. Instead, it seems to be a national secret.

The upstream half of the industry has been devastated. The downstream half is coming under enormous financial pressure. In both cases, the root cause is not economic factors, not technical factors, but political or regulatory factors, most of them copies of California originals.

Let me paint the picture as I see it from my desk every morning.

Chevron is in the process of cutting 2,300 jobs from our exploration and producing operations in the U.S. Further cuts lie down the road.

Chevron is not alone. The U.S. petroleum industry has lost about 440,000 jobs during the last 10 years.

Put that number in context.

Consider the tremendous hand wringing over the shrinkage of the U.S. auto industry. The auto industry has lost a little more than 10,000 jobs since 1982. Remember the sense of national shame evoked by the demise of our steel industry? Steel has lost something like 250,000 jobs in the last decade.

The U.S. petroleum industry has suffered the steepest decline of any industry in modern times. Yet no one outside of Houston seems to have even noticed.

Moreover, just as in autos and steel, petroleum jobs are not simply disappearing. Many of them are going to other nations.

At the same time we have been laying off people in the U.S., Chevron has been adding employees in our overseas operations--200 in Angola, 200 in Nigeria, 100 in Papua New Guinea. In total, we expect to add 600 Chevron employees outside the U.S. by the end of this year.

CAPITAL EXPULSION

Along with jobs, our capital dollars are also leaving the U.S.

As recently as 1985, Chevron spent 68% of its exploration and production budget in the U.S. This year, our U.S. upstream budget is projected at just 40%.

Our planned joint venture in Kazakhstan is one project that's gotten a lot of attention. Along with our partners, we plan to invest $1.5 billion during the next 3 years and perhaps $20 billion during the life of the project.

Again, we're one part of a major trend. A survey by Arthur Anderson of 30 U.S. oil companies shows that since 1987, foreign exploration and development expenditures have increased 83%, compared with an increase of just 13% in the U.S.

Some people call this "capital flight." But when you look at why this is happening, I think it would be more accurate to call it "capital expulsion."

Alan Murray, Mobil's CEO and president of the American Petroleum Institute, told last year's annual meeting of the API, "We're not leaving, we're being kicked out."

ACREAGE LOCKUPS

The reason is that a host of state and federal land use restrictions have virtually cut off industry's access to potential new oil and gas discoveries.

The most glaring example is the utter failure of Congress to include the Coastal Plain of the Arctic National Wildlife Refuge in its version of a national energy bill.

ANWR is considered the most likely prospect left in the U.S. for a really big oil discovery--a field in a class with Prudhoe Bay. One study has estimated that successful development could create as many as 750,000 jobs by 2005. Industry's record at Prudhoe Bay shows the prospect could be developed without harming the environment.

Ironically, by the end of the congressional struggle, the only contingent still fighting hard to allow exploration was the Alaska delegation. What does it tell us about "the new federalism" when the people of a state are overwhelmingly in favor of development and vet opposing outside interests prevail against them?

The reverse has been the case in the sad story of leasing on the Outer Continental Shelf. Local activists in communities on both coasts have been able to prevail against the national interest and, indeed, against the clear mandate of the OCS Lands Act amendments of 1978.

As a result, most of the offshore is now effectively--if not permanently--off limits. The exception has been the Gulf of Mexico, but now we're having problems there, too.

As one example that almost defies belief, we're having real trouble getting permits to explore and develop a big natural gas discovery about 35 miles off the West Florida coast. This is 100% dry gas. It's the closest thing in nature to an environmentally clean, safe fuel.

Utilities in Florida are eager to contract for long term deliveries of this gas, partly to have a cleaner alternative to the coal many of them now burn. But the state has the project tied up in red tape.

Time and again the message to our industry is "drill someplace else." And now, regrettably, that's just what we're doing--overseas. At this point if a lease sale were held in a controversial area such as Offshore California, we would not show up. That's what it has come to.

That's the fate of oil exploration and production in the U.S.

DOWNSTREAM TARGET

The manufacturing segment of the industry appears to be the next target.

Without a doubt, the piece of legislation with the single biggest impact in this area is the federal Clean Air Act as amended in 1990. I know that last year, Jim Kinnear of Texaco gave you a thorough, thoughtful overview of this subject, so I won't go into it all again.

I'll just remind you that one of the most controversial and economically dubious provision of this law allows state governments in areas that are in attainment with the Clean Air Act, to "opt in" to a set of reformulated gasoline specifications required for nonattainment areas.

As Jim told you, the cheapest of these varieties of "government gas" is expected to add 5-7 cents/gal to the cost of gasoline.

California has since one-upped the feds again. The new fuels mandated by the state's Clean Air Act could add 20 cents/gal or more. And some states, with no problem comparable to California's, are considering opting into this more costly standard.

One consequence that Jim did not fully describe is the total cost burden the Clean Air Act will impose on industry. According to the EPA's figures, the new amendments will cost American industry something like $25 billion/year. That's beyond the estimated $32 billion/year industry has been spending to comply with the older version of the law.

Refiners will bear a disproportionate share of the load--$30-50 billion during the next 5 years.

And what that translates to is more plant closures, more lost jobs, more economic pain for American communities.

In California, in just the past year, four refineries have temporarily or permanently ceased production. At least four more are threatened.

Even the largest refiners are facing some very tough decisions. I know we are at Chevron, and we're the biggest refiner in the nation.

We've already announced a downsizing of our facility in Port Arthur, Tex., and a reduction of some 700 jobs. Environmental costs played a big role in that decision.

Now, as if the Clean Air Act weren't enough to cope with, our industry is staring at a new wave on the legislative horizon: state and federal regulation to reduce global warming.

Whatever the intended objective--whether reducing global warming or reducing local smog--the emerging regulatory agenda promises to do for manufacturing in the 1990s what land restrictions did to resource extraction in the 1980s: stop it, shrink it, and ultimately banish it from American soil.

OIL'S ROLE

I was in the Middle East recently and picked up an interesting bit of information.

Some of the large Persian Gulf oil producers are taking a long look at the U.S. fuels market. They see a growing opportunity to export not merely crude oil but refined products as well. Considering that we're already dependent on imports for half of our oil supply, this prospect is more than a little troubling.

The sad fact is that when we call attention to this phenomenon, when we point out that America is transferring petroleum related capital and jobs overseas, a certain portion of the public is going to applaud and another portion is going to shrug and say, "Who cares?"

The key question has to be, "Why should consumers care?"

The first and simplest reason consumers should care about what happens to the petroleum industry is that it costs them money.

Because of its central role in our economy, a change in the price or supply of oil affects everyone and everything. When the cost of energy goes up, the cost of production and distribution of goods goes up too.

And ultimately those costs must get passed through to the consumer.

That leads directly into the issue of competitiveness in a global economy. Again, because energy costs are so basic to our whole system of production, a nation that imposes higher costs for energy is asking its industries to carry extra weight in the global horse race.

When U.S. industries can't compete--for whatever reason--others will enter our market and supply the consumer. That's what we're seeing in the petroleum production sector and may soon see in petroleum manufacturing.

So what? The U.S. trade deficit for imported oil is now running about $55 billion/year. This fact gets little attention, compared with all the worry over our $41 billion trade deficit with Japan.

Also, 440,000 American jobs have disappeared in a decade. Even in an economy the size of ours, those numbers measure a very serious loss.

ECONOMIC CONSEQUENCES

Ironically, when we try to persuade lawmakers to look at the economic consequences of stringent regulation, we sometimes hear our own line of reasoning used against us.

People like Sens. Tim Wirth and Al Gore argue that environmental spending is good for the economy because it creates jobs and industries. But they miss a crucial distinction.

When we lay out capital to further reduce air emissions at a refinery, for example, we don't make one additional gallon of gasoline. Instead, we produce the same number of gallons but at a greater cost to consumers.

That's not to say the extra cost has no benefit. It should help the environment. And as long as the benefits to the environment are greater than the increased costs of products, we can accept these new regulations.

But we still have to recognize that such expenditures are more in the nature of a tax than an investment. Ultimately, they subtract from our total competitiveness, particularly if manufacturers in other countries aren't held to the same high standards. That holds true even when such expenditures produce a tangible result--like clean air--that can be said to improve our quality of life, if not our standard of living.

But increasingly, we're spending vast sums for negligible--or in some cases negative--environmental gains. In such cases, the economic benefits of the pollution control business are extremely dubious.

CALIFORNIA SCENE

A case in point is the issue of clean air legislation in California.

Remember the objective of clean air laws is to reduce emissions that contribute to smog.

The new federal formula for reformulated gasoline is expected to remove 59 tons/day of pollutants at a cost of $56,000/ton.

You think that's bad?

It's a bargain compared with California's self-imposed standards for the future. California's Phase II gasoline standards will reduce emissions an extra 39 tons/day at a cost of $130,000/ton.

An industry trade group came up with a formula that would have produced 80% of the benefit for only 50% of the cost. The California Air Resources Board turned it down.

Unfortunately, in this whole debate, more effective, less costly approaches have received little or no consideration.

Studies project that a high tech automobile inspection and maintenance program could remove 240 tons/day of pollutants at a cost of only $7,000/ton. And a statewide effort to scrap older high polluting vehicles could remove 170 tons/day for only $3,500/ton.

In other words, compared with the most stringent mandates for reformulated gasoline, a scrap program could remove four times the pollutants for less than 3% of the cost.

But so far as I know, there is no public plan to pursue a scrap program. And it took recent EPA action to force the issue of enhanced inspection and maintenance.

MORE MESSAGES

Let me share a few more messages from California.

We've seen a recent opinion survey of California voters that tells us:

A large majority believes the state's business climate is deteriorating. Two thirds agree the state's regulatory climate puts California businesses at a competitive disadvantage.
However, an equally large number disagree that the burden of environmental regulation on business should be reduced.
A majority believes the state is not making adequate progress in improving the environment, and a near-majority believes environmental quality will get worse.
This view persists despite solid evidence that California has made tremendous environmental progress. The South Coast Air Board recently confirmed that smog in southern California had been reduced 50% during the last decade. But the good news somehow isn't reaching the public.
And here's the finding that may go to the heart of the matter: 73% believe lawmakers carefully consider potential economic impact when environmental regulations are adopted.

I wish I could believe it. But my experience says, despite good intentions, cost/benefit figures don't ultimately play a big role in the process.

Clearly, the public is laboring with misinformation or no information at all. In a democracy, that's the road to ruin.

INFORMATION PROGRAMS

Some more concerted effort is urgently needed to place the facts before the people. Industry has been trying, but the survey results indicate we aren't succeeding.

We're going to need help.

Our elected officials enjoy "the bully pulpit" as Teddy Roosevelt called it. You've got to use the public forum as the stage to bring forth the facts.

We in industry must play the role of responsible informant. We have to be more responsive to the public appetite for information. We have to be forth-coming with our expertise.

I can only assure you that industry is anxious to play that role--and much more. We recognize the need for enlightened environmental action and, through our trade groups, we're designing and implementing broad-based programs to ensure that our good intentions are carried out in the most effective manner.

The Chemical Manufacturers Association has launched an ambitious program called Responsible Care to spell out for all member companies and for the public steps that will be taken to protect the environment and ensure human health and safety.

The American Petroleum Institute is developing a program to improve environmental performance in the petroleum industry. Its called STEP, for "Strategies for Today's Environmental Partnership."

Senior managers throughout industry are involved in these efforts. In the last few years I've spent considerable time on the Business Council on Sustainable Development, an international group formed to bring the perspective of industry to the recent Earth Summit in Rio. I've also served on the President's Commission on Environmental Quality. From these experiences, I can tell you that business is eager to play a lead role.

The media too has a crucial role. We can't have any sort of public dialogue without their help. I know there are still editors of conscience, dedicated people who take seriously the title of "the fourth estate." Somewhere, along with the daily diet of scandals and horrors, they have to be able to find a place for the decisions that will define "the American way of life" in the next century.

ECONOMY, ENVIRONMENT

For far too many years, public policy in America has been wrenched this way and that by a belief on all sides that economic growth is incompatible with environmental protection.

Increasingly, the evidence from many nations around the world shows us the belief is false, that a society must be economically healthy to be ecologically healthy.

We're learning that energy, environment, and economic development are three basic human needs. Our policy should aim not for a tradeoff among them but for a synthesis among them. If our society could achieve that, this great nation would find itself once again on the cutting edge, and once again we could say to our competitors, "beware!"