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Repeating Old Oil Mistakes

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eye on the news

Repeating Old Oil Mistakes

Now as in the 1980s, punishing the industry for high prices misunderstands the nature of energy markets. March 17, 2022
Politics and law
Economy, finance, and budgets
Infrastructure and energy

Russia’s invasion of Ukraine is driving up already rising fuel prices and inflation. Prices at the pump are almost twice what they were two years ago. But the Biden administration’s response has been all over the map. First, officials denied the severity of the situation. Then, they claimed it would be transitory. Next, they argued rising prices would be solved by massive increases in government spending. And now they attribute blame not only to Vladimir Putin but also to alleged price-gouging by oil companies.

Last fall, the administration was pressuring these same oil companies to drill less because of climate change. Now it asks them to drill more, while accusing them of purposefully withholding supplies to raise prices. And this week, Senator Elizabeth Warren took the allegations of corporate greed to new heights, calling for a “windfall profits tax” on oil companies that she accuses of controlling the price of gasoline.

The idea has a long history. In 1980, after President Jimmy Carter lifted price controls for domestic crude, Congress passed the Crude Oil Windfall Profit Tax Act to address fears that oil companies would earn excessive profits—a term Congress never actually defined. Of course, if the government artificially forces the price of a product below the market rate, then removing that price control will cause the price to increase. The government had controlled domestic crude oil prices for decades, which led to supply shortages, especially after the OPEC oil embargoes of 1973–74 and 1979. When Congress passed legislation to lift controls and provide an incentive for companies to drill for oil in the U.S., increasing prices was the goal.

It worked. As price controls gradually unwound, U.S. crude oil production rose. The same thing happened when natural gas prices were decontrolled around the same time. It’s why the U.S. became a leader in gas: the opportunity for profits led to technological improvements that made drilling for shale gas deposits profitable. In the last decade, that supply bonanza led to much lower natural gas and oil prices that saved consumers hundreds of billions of dollars.

The original windfall-profits tax wasn’t even a tax on profits. It was an old-fashioned excise tax based on the difference between selling prices and a variety of pre-decontrol prices for different types of oil wells. The system was a convoluted mess that Congress repealed in 1988, by which point domestic crude oil prices were less than half what they were in 1981.

That brings us to today. The increase in crude oil and gasoline prices didn’t begin several weeks ago with Russia’s invasion of Ukraine, but when the Biden administration took steps to reduce crude oil supplies: cancelling the Keystone Pipeline and a sale of oil leases in the Gulf of Mexico and placing a moratorium on new oil and gas leases and drilling permits on federal lands. Amid claims that oil producers are withholding supplies to raise prices, the administration has rejected past efforts to boost supplies.

If you artificially restrict new supplies by making it harder for companies to drill for more oil, then prices will go up. If you increase taxes on profits that companies earn by selling oil and gas, those companies will supply less, causing prices to go even higher. Getting the story right requires a clear-eyed understanding of why oil is getting more expensive in the first place and of realistic solutions to lowering prices.

Photo by David McNew/Getty Images

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