Blame Congress for High Oil Prices

Gasoline prices are through the roof and Americans are angry. Someone must be to blame and the obvious villain is “Big Oil” with its alleged ability to gouge consumers and achieve unconscionable, “windfall” profits. Congress is in a vile mood, and has dragged oil industry executives before its committees for show trials, issuing predictable threats of punishment, e.g. a “windfall profits tax.”

But if there is a villain in all of this, it is Congress itself. That venerable body has made it impossible for U.S. producers of crude oil to tap significant domestic reserves of oil and gas, and it has foreclosed economically viable alternative sources of energy in favor of unfeasible alternatives such as wind and solar. In addition, Congress has slapped substantial taxes on gasoline. Indeed, as oil industry executives reiterated in their appearance before the Senate Judiciary Committee on May 21, 15% of the cost of gasoline at the pump goes for taxes, while only 4% represents oil company profits.

To understand the depth of congressional complicity in the high price of gasoline, one must understand that crude oil prices explain 97% of the variation in the pretax price of gasoline. That price, which has risen to record levels, is set by the intersection of supply and demand. On the one hand, world-wide demand has accelerated mainly due to the rapid growth of China and India.

On the other hand, supply has been curtailed by the cartel-like behavior of foreign national oil companies, which control nearly 80% of world petroleum reserves. Faced with little competition in the production of crude oil, the members of this cartel benefit from keeping the commodity in the ground, confident that increasing demand will make it more valuable in the future. Despite its pious denunciations of the behavior of U.S. investor-owned oil companies (IOCs), Congress by its actions over the years has ensured the economic viability of the national oil company cartel.

It has done so by preventing the exploitation by IOCs of reserves available in nonpark federal lands in the West, Alaska and under the waters off our coasts. These areas hold an estimated 635 trillion cubic feet of recoverable natural gas – enough to meet the needs of the 60 million American homes fueled by natural gas for over a century. They also hold an estimated 112 billion barrels of recoverable oil – enough to produce gasoline for 60 million cars and fuel oil for 25 million homes for 60 years.

This doesn’t even include substantial oil shale resources economically recoverable at oil prices substantially lower than those prevailing today. In an exchange between Sen. Orin Hatch (R., Utah) and John Hofmeister, president of Shell Oil Company during the May 21 Senate Judiciary Committee hearing, the point was made that anywhere from 800 million to two trillion barrels of oil are available from oil shale in Colorado, Utah and Wyoming.

If Congress really cared about the economic well-being of American citizens, it would stop fulminating against IOCs and reverse current policies that discourage, indeed prohibit, the production of domestic oil and natural gas. Even the announcement that Congress was opening the way for domestic production would lead to downward pressure on oil prices.

There is an historical precedent for such a step: Ronald Reagan’s deregulation of domestic crude oil prices at the beginning of his first term. At the time, thanks to the decision by the Organization of Petroleum Exporting Countries (OPEC) to curtail output, the price of oil was at a level that in real terms is only now being matched. Domestic price controls ensured that the OPEC cartel would face little or no competition in the production of oil.

Price controls were exacerbated by other wrongheaded policies stimulated by the two “energy crises” of the 1970s. One of the most egregious was the infamous “windfall profits” tax, designed to punish oil companies for alleged profiteering. But since it applied to even newly discovered oil, its main impact was to discourage the exploration and drilling that would have increased oil supplies.

Although the energy problems of the 1970s were traceable to government policies, Reagan’s decision to deregulate oil prices was ridiculed by policy makers, especially those who had served in the previous administration. For instance, Frank Zarb, who had been Jimmy Carter’s “energy czar,” predicted that decontrolling the price of crude oil would lead to gasoline prices of $10 a gallon. Instead, the world price of oil plummeted, helping to fuel the extraordinary economic growth of the 1980s.

Reagan’s deregulation of crude oil prices created incentives for domestic producers to invest in exploration and to increase production. The threat of increased output by non-OPEC producers destroyed the discipline among OPEC members necessary to restrict production to maintain high prices. Facing the likelihood that an increase in supply would lead to lower future prices, OPEC producers increased output in the hopes of maximizing profits before prices fell. The cascading effect caused oil prices to tumble.

As in the 1970s, U.S. energy policies have essentially restricted the exploitation of domestic sources of energy. Curtailed supplies have combined with rapid, world-wide energy demand to increase the price of oil and other sources of energy. This provides leverage to foreign producers and threatens U.S. energy security. Freeing up domestic energy resources will do today what President Reagan’s decision to deregulate oil prices in 1981 did then: cause oil prices to fall, thereby enhancing U.S. energy security.

Mr. Owens is a professor at the Naval War College in Newport, R.I., and editor of Orbis, the journal of the Foreign Policy Research Institute in Philadelphia.

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