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An old mistake: why are they trying to punish the oil companies?
National Review, Dec 5, 2005 by Jerry Taylor, Peter Van Doren
THE post-Katrina gasoline-price increase seems to have unleashed madness in some GOP quarters. In a remarkable press conference in late October, House Energy Committee chairman Joe Barton and Speaker Dennis Hastert demanded that the oil industry use its 2005 profits to build new refineries and pipelines--and they threatened the imposition of a windfall-profit tax if the oil industry refused. In the Senate, majority leader Bill Frist launched a public inquisition of the oil sector and is actively encouraging discussions on a windfall-profit tax; he is also recommending a new federal law against gasoline price gouging, and asking the industry to give "voluntary" assistance to the poor. And according to the American Petroleum Industry, the Bush administration is quietly testing the waters on a similar windfall-profit tax, whose profits would be used to expand federal energy assistance to low-income households.
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Gasoline prices have dropped more than 75 cents per gallon since their post-Katrina peak, but on the heels of the oil industry's multi-billion-dollar quarterly profit reports it's not surprising that many politicians have suddenly resorted to histrionics. What is surprising, however, is the number of conservatives who have happily cast their lot with the anti-oil contingent.
Are Republicans' memories so short that they fail to remember the last time heavy-handed policies were enacted, or are Republicans simply trying to pin the blame on someone--anyone--for the sky-high gasoline prices? Either way, the GOP is playing a dangerous political and economic game. If the public is encouraged to think of "Big Oil" as a public enemy, it's unlikely that voters will hire Republicans to play sheriff. But more important, the policies Republicans are flirting with threaten to do serious, permanent damage to the oil industry.
It's instructive to dwell on what happened the last time Congress tried to protect consumers from "Big Oil." The third phase of President Nixon's price-control regime, instituted in 1973, prevented large oil companies from passing on to consumers the rising cost of crude imports. So oil companies reduced imports, and cut gasoline sales to independent gas stations in order to keep their own branded outlets supplied. The lines and shortages that form our collective memory of the oil crisis were the result of the Nixon price controls--not the largely symbolic Arab oil embargo.
During the following years, Congress instituted a number of measures to remedy the situation, but they all had one thing in common: They distorted the market and created perverse incentives for oil companies, incentives that made America more reliant on foreign imports and increased the global price of crude. All of the economic postmortems undertaken of the 1970s price-control regimes paint the same ugly picture. Economist Joe Kalt calculates that domestic oil production was between 0.3 and 1.4 million barrels per day lower than it would have been without price controls. R. T. Smith, another economist, says that the lost production and higher demand that resulted from the price controls increased world crude-oil prices by 13.5 percent, which of course resulted in higher oil prices for American consumers.
As part of a political compromise that allowed the price controls to expire, Congress passed the Crude Oil Windfall Profit Tax Act of 1980. The title, however, was a misnomer: The law did not tax oil profits, but instead taxed each barrel of oil when the price per barrel went above a set government level. Like the price controls before it, the law discouraged the development of new supplies by increasing costs for oil companies. According to analysts at the Congressional Research Service, this tax reduced domestic oil production by 3-6 percent and increased imports by 8-16 percent before it was repealed in 1988. Now, as then, a windfall-profit tax would not actually tax profits; it would merely increase oil taxes, which would inevitably harm consumers.
Are oil profits so offensive that we must go down this road again? One might think so given the recent uproar, but oil profits are not all that remarkable. According to data collected by Goldman Sachs, the median return on invested capital in the oil and natural-gas sector from 1970 to 2003 was less than the median return on capital invested in the stock market over the same period. In the second quarter of this year, net profits were 9 percent of sales for oil and gas companies in the S&P 500 and 8 percent for the S&P 500 as a whole. Profits, then, would have to be very fat for a very long time before the industry could claim to have returned even average profit margins from 1970 to the present.
Calls for the industry to voluntarily reduce prices are also based on a false understanding of the market. "Big Oil" does not dictate fuel prices. Contracts between oil companies and refineries--and between refineries and retail outlets--typically tie the purchase price to local oil commodities markets. Hence, fuel prices are established by thousands of market actors buying and selling oil on numerous, decentralized markets; prices aren't set by corporate CEOs in smoke-filled boardrooms.
