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The Honolulu Advertiser
Posted on: Sunday, November 30, 2003

Taking on the oil oligopoly

By Ben Cayetano

For decades now, Hawai'i's drivers have paid the nation's highest gasoline prices, at times paying as much as 60 cents per gallon more than the average Mainland price. The negative impact of these high prices on the cost of goods and services in Hawai'i cannot be overstated.

Hawai'i's oil companies have regularly stonewalled the state government's inquiries into the high cost of gasoline. It's part of the price of living in paradise, they argued. The reality, of course, is that Hawai'i's gasoline market is an oligopoly — a market where a few players control price and do pretty much what they please.

Past attempts by the state government to investigate gasoline prices followed a pattern: An investigation would be called, testimony given and little would be done. The biggest obstacle was the high cost of taking legal action. Paying for lawyers and other experts was just too costly.

The first break came in 1995 when the Legislature authorized the governor to hire private lawyers on a contingent fee basis. This made it possible for the state to hire the nation's best law firms at minimal costs.

In 1998, the state sued Hawai'i's five oil companies for antitrust violations. It was a first. Led by Chevron, lawyers for the oil companies put up a ferocious defense, contesting the state's attempts to look into their books with a blizzard of legal motions and paperwork.

Subsequently, court-appointed mediators met with the state's lawyers and suggested that unless the state had direct evidence of an actual meeting of conspirators, the judge would not let the case go to the jury regardless how strong the state's circumstantial proof. As governor, I had to make a decision: proceed and if the judge ruled against the state, appeal the ruling or settle. An appeal could take years. My administration had only a couple of years left. I decided to settle. The settlement cost the oil companies $35 million, small change for them, a big disappointment for the state.

Suing the oil companies and winning is tough. They have tremendous resources and employ top-notch lawyers. Their tremendous economic power discourages witnesses from coming forward to testify against them. Basically, the law allows them to do as they please as long as they don't conspire to set prices. Oil company executives don't meet like the Mob did in Appalachia. They usually operate in an oligopoly — a market where a few big players like ChevronTexaco exert great influence on prices. They behave like elephants; the bull sets the lead and the others follow.

Chevron Hawaii's oil refinery at Campbell Industrial Park: Although Hawai'i made up only 3 percent of Chevron's national market, a 1998 lawsuit found, it accounted for 23 percent of its profits.

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The 1998 lawsuit, however, produced a wealth of new information which justified a case for state regulation of gas prices. For example:

• Contrary to what the oil companies had been saying over the years, transportation costs were a small part of the gasoline price structure, no more than 3 to 5 cents a gallon.

• Gasoline (made from Indonesian crude oil) is one of the few products that can be made in Hawai'i cheaper or at the same costs as gasoline on the Mainland.

• Chevron regularly sold gasoline to military exchanges and national rental car companies at prices equal to or less than California.

• Although Hawai'i made up only 3 percent of ChevronTexaco's national market, it accounted for nearly 23 percent of the company's annual national profits.

• Competition among oil companies in Hawai'i was virtually non-existent.

Given this information, the 2002 state Legislature responded by approving the Gas Cap Law, the first of its kind in the nation. The new law is scheduled to go into effect in 2004. Gov. Linda Lingle opposes it and has vowed to try to repeal it.

In September 2002, two university professors, Jeff Gramlich and Jim Wheeler, presented the state with a bombshell: Their research paper concluded that Chevron and Texaco created a tax scheme that defrauded the federal government and some states of billions and hundreds of millions of tax dollars, respectively. The research paper first appeared in a Sept. 13, 2002, New York Times article and later in national tax and accounting journals.

Gramlich and Wheeler became interested in Chevron and Texaco when they learned of a 1998 case in which the IRS sued Chevron for refusing to disclose 648 documents related to a foreign tax credit issue. To block the IRS, Chevron's lawyers argued that the documents were protected by the "attorney-client privilege." In ordering Chevron to disclose 129 of the 648 documents, U.S. District Court Judge Steele Langford made this startling statement:

"The court concludes that ... the documents themselves, adequately support a finding of probable cause to believe that one or more crimes or frauds have been committed or attempted and that the attorney-client privilege communications at issue were created in furtherance of those crimes or frauds, including a showing of the client's (Chevron's) intent ..."

Chevron appealed Judge Langford's ruling only to have a second federal judge, Saundra J. Armstrong, go a step further and order that Chevron disclose all 648 documents to the IRS.

According to Gramlich and Wheeler, here is how the fraudulent tax scheme worked:

Before they merged in 2001, Chevron and Texaco set up a 50-50 joint venture named Caltex in Indonesia. The two oil giants bought crude oil from Caltex at excessive prices, estimated at $4.50 per barrel over market, leading to excessive dividend income and cost of sales deductions on their U.S. income tax returns. When either Chevron or Texaco bought more overpriced oil than the other, Caltex paid monthly "Special Dividends" that could be construed as cost rebates, not dividends. To compensate Caltex for the added Indonesian income tax it paid because of the inflated prices, the government of Indonesia provided Caltex with free oil, which it called the Western Hemisphere Allowance (WHA). Gramlich and Wheeler believed this scheme dated from 1964 to 2002 and estimated Chevron and Texaco had defrauded the federal government and the states of approximately $8.6 billion and $433 million, respectively, before assessment of any penalty or interest.

The case had all the signs of an illegal kick-back tax dodge. A serious inquiry was clearly justified. I asked the attorney general to hire a law firm to investigate and, if appropriate, sue Chevron (now ChevronTexaco) for fraud. A notice was sent out to the legal community. Fourteen of the nation's top law firms applied. The level of enthusiasm was very high. Each law firm was willing to take the case on a contingent fee basis and pay all costs. This was an extraordinary fee arrangement for the state. Win or lose, the case would cost Hawai'i taxpayers nothing. Attorney General Earl Anzai selected Winston and Strawn, a Chicago-based law firm known for its tax expertise, to represent the state.

Lingle and the Republicans were never enthused about the state's 1998 lawsuit against the oil companies. This attitude carried over to the Gas Cap Law that the oil companies strongly opposed and which Lingle vowed to repeal if she won the 2002 gubernatorial election. When it came to taking on Chevron and the oil companies, Lingle was willing to do little — except make statements about encouraging competition and recommend that gasoline prices be monitored.

Therefore, after the Legislature issued a joint resolution urging Lingle to press forward with the state's lawsuit against ChevronTexaco — the governor's public assurance that her administration would take an objective look and sue if appropriate — was welcomed by many.

Unfortunately, Lingle's public statements did not square with how her administration actually handled the case.

Lingle assigned Randy Roth, her chief of staff, to take the lead. Roth, who described the case as having "nuisance" value, ordered the state lawyers to put the case on hold until he could review it. This was reasonable enough. But the actions of Roth and the state's attorneys (the state attorney general's office and Winston Strawn) which followed revealed that the administration's position was not going to change.

The case against ChevronTexaco is highly complex. Professors Gramlich and Wheeler estimated they reviewed more than 2,000 pages of documents in researching the case. Yet, Roth and Tax Director Kurt Kawafuchi spent a mere half-hour discussing it with professor Jim Wheeler. Gramlich was never contacted.

Wheeler described his one-time meeting with Roth and Kawafuchi as one in which Roth would not let him "finish a sentence." Lingle's new first deputy Attorney General Richard Bissen — substituting for Attorney General Mark Bennett, who had properly recused himself because he had defended Chevron in the state's 1998 lawsuit — never met or contacted Wheeler. In fact, no one from the attorney general's office met with the two professors after Lingle took office.

On July 20, Bissen and Winston and Strawn issued a final report. Not surprisingly, the report concluded that the state had no case against ChevronTexaco. There would be no lawsuit.

The quality and accuracy of the report is disappointing — hardly befitting the high level of legal scholarship expected from a top law firm like Winston Strawn. The report contains numerous errors: It compares wholesale and retail prices and attributes payment of the WHA to Chevron when in fact it was paid by the Indonesian government to Caltex. The report omits entirely any discussion of the "special dividends" that are an integral part of the alleged fraudulent overall tax scheme. It offers numerous conclusions but provides little reference to supporting information.

Even more troubling is how the state's attorneys proved so accommodating to ChevronTexaco. The meetings between the state's attorneys and ChevronTexaco were voluntary. ChevronTexaco executives were not under oath. ChevronTexaco was not under subpoena or court order to produce documents. In other words, ChevronTexaco decided what documents and what kind of information it would disclose to the state. The attorney general's report states that ChevronTexaco provided "full access to previously confidential internal company documents ... "

How did the state's attorneys know they were given full access? Did they just take ChevronTexaco's word for it? And when professors Gramlich and Wheeler offered to sit in on the meetings, Winston Strawn, which had offered to hire the two professors as expert witnesses in December 2002, declined because ChevronTexaco refused to meet if they were present. Another accommodation.

Why were state attorneys so accommodating? Certainly, there were good reasons not to be. After all, in the 1998 IRS case, a federal judge gave his opinion about the credibility of Chevron and its lawyers when he ruled there was "probable cause" to believe Chevron had committed one or more "crimes or frauds" — and that Chevron's lawyers were using the attorney-client privilege "in furtherance of those crime or frauds ... "

Was it realistic to believe that the Chevron executives and lawyers would disclose incriminating documents to the state's lawyers? Would the tobacco companies, which ended up paying victims of smoking billions of dollars in damages, have voluntarily disclosed the confidential but incriminating documents that proved they knew smoking tobacco was dangerous to people's health? Would Ford have voluntarily disclosed internal documents that proved Ford executives knew that its Pinto automobile was a potential flaming death trap before sending it to market?

A month ago, an Alabama jury awarded the state of Alabama a $11.9 billion verdict against Exxon. Only $63.6 million of the total award was for compensatory damages; the other $11 billion was for punitive damages. Punitive damages are awarded to punish a defendant for civil or criminal wrongdoing. Does anyone think Exxon executives voluntarily produced the incriminating documents and testimony that angered that jury?

There were good reasons for suing ChevronTexaco, and the state's attorneys were negligent in not doing it. Filing a lawsuit was the only way to compel ChevronTexaco to produce all relevant documents and elicit truthful testimony from witnesses under oath. Tax returns, for example, are confidential bylaw until they become the subject of a lawsuit. Leaving it to ChevronTexaco to decide what documents and witnesses it would make available to the state's attorneys was foolish. Resolving disputes with global giants like Chevron are not Boy Scout meetings.

Had a lawsuit been filed, it may have been that the additional evidence discovered would have shown the state of Hawai'i's case against ChevronTexaco was without merit. Unfortunately, it is highly unlikely the public will ever get to know the truth. The state's attorneys virtually assured this by entering unnecessary confidentiality agreements with Chevron which, barring some future court order, will keep the truth of this case a secret forever. A final accommodation to ChevronTexaco.

Ben Cayetano was governor of Hawai‘i from 1994 to 2002.

Correction: Chevron and Texaco bought crude oil from Caltex at an estimated at $4.50 per barrel over market, the author says. A previous version of this story misstated the price.