Economic amnesia

March 13, 2006
Last year was one of the most volatile business environments for the oil and gas industry.

Last year was one of the most volatile business environments for the oil and gas industry. A number of events especially influenced the business of refining, most notably the shut-in of a large amount of US capacity due to Hurricanes Rita and Katrina and the subsequent spike in gasoline prices.

Many oil companies reported record profits in subsequent months, and, whether accurately or not, many consumers believe that the high gasoline prices and possible price gouging were a direct cause. US lawmakers also got into the act by holding hearings that claimed oil companies were making windfall profits.

A recent study by analysts at the Cato Institute debunks these claims and argues against oil price controls and windfall profit taxes.

The study

The Cato study, “Economic Amnesia: The Case against Oil Price Controls and Windfall Profit Taxes,” by Jerry Taylor and Peter Van Doren, examined experiences with price controls (1971-80) and the Crude Oil Windfall Profit Tax (1980-88).

The authors say policies that restrain prices result in less supply and conservation. Additional taxes reduce oil companies’ incentives to invest in new supply. And because any new price controls and taxes would only apply to US companies, they would “increase the economic attractiveness of foreign relative to domestic oil.”

The study also says there is no evidence to suggest that oil company profits are particularly large when compared with profit margins of all public companies. “Restricting profit opportunities now would amount to a form of one-way capitalism in which meager profits are allowed but more robust profits are punished,” the authors state. “Intervention under those conditions would certainly reduce the incentive to invest in the oil business.”

Much of the public supported gasoline price controls in the wake of price spikes due to the hurricanes. A September 2005 poll conducted by the Pew Research Center for the People and the Press found that 69% of US consumers supported gasoline price controls.

The Cato study asserts, however, that “both economic theory and past experience suggest that aggressive price controls...will harm consumers by creating fuel shortages.”

Gasoline retailing is one of the most competitive markets in the US. Prices can, and sometimes do, change on a daily basis, swayed by the forces of supply and demand.

“Government intervention might improve overall economic efficiency if the market in question is not competitive,” the study states. But it observes that “retail gasoline markets are quite competitive.”

Historical perspective

The US attempted to control oil prices in the 1970s. The study analyzed what ended up being extremely complicated and convoluted regulations adopted under the Economic Stabilization Act of 1970, the Emergency Petroleum Allocation Act of 1973, and the Energy Policy and Conservation Act of 1975.

According to the Cato analysts, one study of the price control regulations estimated that the wealth losses of crude producers exceeded the gains by refiners and crude consumers by $1-6 billion/year in 1975-80. Another analysis calculated that the price controls actually increased world crude prices by more than 13%.

The Cato study draws three conclusions about price controls from a historical perspective. First, price controls are simple in theory but extremely complicated in practice. Second, political pressures inevitably arise to benefit favored producers at the expense of less-favored producers, which distorts markets even further. Third, price controls often exacerbate the problems they are designed to address.

The Crude Oil Windfall Profit Tax of 1980 was enacted to replace the oil price controls. The tax was repealed in 1988 due to high costs and because it generated no revenues after the oil price collapse in 1986.

“People often support price controls and windfall profit taxes because they don’t believe that oil producers have a moral right to higher-than-normal earnings,” the study says. “There is a widespread sentiment that it is somehow wrong for owners to profit when exogenous events greatly inflate the value of the commodities they own.

“Regardless of the moral issues involved, federal efforts to take excess profits from oil companies are bad public policies. They fail to achieve their proximate aim, which is to reduce prices paid by retail consumers, but do manage to reduce supply, increase imports, and impose steep costs on the economy.”

Indeed, if price controls and additional taxes didn’t work in the past, there is no reason to believe that they will ever work in the future.