Blame economic illiteracy for policies that target oil and gas companies but hurt everyone else.
Blame economic illiteracy for policies that target oil and gas companies but hurt everyone else.
A merican families are experiencing the worst inflation in living memory. Inflation is rising faster than at any time during the 1970s — up to 7.9 percent from just 1.2 percent in Donald Trump’s last year in office. But that’s nothing compared with what’s happening at the pump, where gasoline prices are shattering all records, and now electricity prices are soaring, too.
Democrats have responded with predictable calls for confiscatory windfall-profits taxes, with a twist. In a move vaguely reminiscent of Inspector Clouseau striking back at the suit of medieval armor he just accidentally bumped into, the Democrats have proposed a Big Oil Windfall Profits Tax that would channel the tax revenue back to consumers.
Intentionally or not, the idea is a tacit recognition that government-induced scarcity creates the equivalent of a monopolized or cartelized market.
In an idealized market of “perfect competition,” supply and demand meet where the marginal cost of producing every additional unit intersects with the demand curve. At that price equilibrium, the market achieves the highest sustainable output at the lowest sustainable price.
But as this Khan Academy video explains, in a market subject to monopoly power — or to cartels that can maintain discipline — the production decisions are skewed, because producers can make more profit per unit by reducing their output. As long as those monopoly or cartel conditions prevail, consumers lose big, because you end up with reduced output and higher prices.
In that situation, producers are making a profit above and beyond the price they would be quite happy to accept in a competitive market. Not only does this result in a hidden forced transfer of wealth from consumers to producers, but the transfer is highly inefficient, owing to the “deadweight loss” associated with such market conditions: Consumers lose significantly more than the producers reap in profits.
In a truly free market, monopolies and cartels tend to break down. But governments can shore them up, which is why the most dangerous monopolies and cartels are those created and enforced by the government.
And that is just what we are seeing here. As investment manager Paul Tice explained in a recent Wall Street Journal article:
The main risk to the industry over the next decade is not the potential for oil and gas demand to go down because of the global energy transition away from fossil fuels. It is the high likelihood of more energy supply-chain bottlenecks created by government officials. A supply-constrained scenario would be bullish for oil prices, giving producers even more incentive to keep hydrocarbon reserves in the ground now to produce them at higher realized prices down the road.
Despite President Obama’s best efforts to curtail the shale boom, the oil industry went on an investment binge during his administration, racking up huge amounts of debt to expand capacity. Those debts came due just as the pandemic hit, creating a tsunami of bankruptcies in the oil and gas industry.
As Tice explains, the industry has learned to live within its means, expanding capacity slowly from cash flow, rather than incurring debt to finance capital expenditures. As a result, the industry has been slow to expand capacity in response to the dramatic increases in prices.
But rather than encourage the industry to ramp up production, the Biden administration is embracing policies that can only make the industry even more hesitant to expand.
As a presidential candidate, Senator Kamala Harris pledged to end fracking “on Day One.” President Biden so far hasn’t endorsed that politically suicidal pledge. But he did run on an anti-fossil-fuel promise, as he said in his final debate with Trump: “No more drilling on federal lands. No more drilling, including offshore. No ability for the oil industry to continue to drill, period. Ends.” And while he hasn’t bragged about his successes on that front recently, he hasn’t abandoned the pledge either.
The Biden administration is reducing the amount of federal land available for oil and gas production, while canceling or slow-walking leases. When a federal judge blocked new guidelines that would have required cost-benefit analyses to be skewed by climate impacts, the Department of Interior retaliated by halting all new federal oil and gas leases.
The Biden administration has also blocked energy development on private land. President Biden canceled the Keystone XL Pipeline on his first day in office. In April 2021, a federal court vacated a key permit for the nearly-complete Dakota Access Pipeline, and the pipeline has been in limbo ever since, with the administration making little effort to revive it.
Adding to the industry’s worries, last summer’s proposed listing of the lesser prairie-chicken under the Endangered Species Act could halt oil and gas drilling in the most important patches of Texas, Oklahoma, and New Mexico.
Biden officials counter that reversing these policies would increase production only years down the road, too late to help in the current crisis. That’s yet another display of economic illiteracy. Forecasts of future conditions dictate today’s decisions and can often dictate today’s prices. And energy companies are smart enough to see that, with an even more punitive regulatory regime now taking shape, they are better off playing it safe — and leaving that oil and gas in the ground for now.
Next week, the Securities and Exchange Commission is expected to propose a new rule that would require all publicly traded companies to disclose their greenhouse-gas emissions as well as their estimates of climate risk. Any banks or investment funds that invest in fossil-fuel companies will have to “report” on how they are worsening climate change, subjecting those companies to public shaming and possible regulatory penalties. This can only increase the cost of capital for energy companies seeking to expand production.
New rules will require pipeline companies, liquefied natural gas (LNG) export facilities, and other energy infrastructure projects to report and reassess greenhouse-gas emissions at every stage in the federal approval process. As James Danly, a commissioner of the Federal Energy Regulatory Commission (FERC), recently testified to the Senate, the new rules will smother natural-gas investments — and hence the nation’s electricity sector — in additional delays, costs, and uncertainty.
For example, larger facilities will automatically have to undergo a multiyear, full-blown environmental review under the National Environmental Policy Act, where they would normally have been able to complete their environmental reviews in less than a year. And on top of the added cost and delay, FERC will now make its ultimate decisions on relevant permit applications according to an almost totally arbitrary test, creating prohibitive uncertainty. As Commissioner Danly notes: “It appears as though FERC designed this process in order to make it impossible to rationally allocate capital. These policies will have a direct effect on electric rates and reliability.”
These regulatory problems are on top of already raising electricity prices, due to the lagging supply of natural gas, on which the country now depends for most of its electricity. In New York City, residents saw their electricity bills jump by 23 percent just in the month of January. Across New England, residential electricity bills could rise as much as 25 percent by June.
It could get much worse. The strategy behind Obama’s Clean Power Plan was basically to foist California’s suicidal regulation of electricity on the rest of the country. Because of renewable-energy mandates and other anti-fossil-fuel measures, Californians pay about 66 percent more for electricity than residents in the rest of the country. Depending on what the EPA does next, those increases could be coming to your neighborhood soon.
Indeed, the government’s purposeful constriction of natural-gas output will have a negative impact on gasoline as well as electricity. Oil extraction from shale formations produces prodigious amounts of natural gas. The spot price for gas at the oil wellhead is typically negative — which means producers will pay buyers to take it — but there is often no pipeline infrastructure to move it. The only option then is to flare the gas, producing carbon emissions with no offsetting benefit in terms of electricity production. As federal and state regulators seek to restrict this wasteful flaring of natural gas, oil producers see yet another reason to keep the oil in the ground.
The Biden administration’s anti-fossil-fuel policies are totally counterproductive, even to the goal of transitioning to “clean energy.” The political obstacles to the Biden administration’s clean-energy goals are daunting enough as it is. Without abundant fossil fuels, above all natural gas in the power sector, to cushion the blow of renewable-energy mandates, those mandates are not politically feasible. California’s mandates are producing the equivalent of a high-income migrant crisis as those who can move to Texas and Florida are doing so in huge numbers.
This matters because we know the administration doesn’t have the stomach for painful climate policies. In the space of just one year, as gasoline prices soared, President Biden ran from supporting a carbon tax (which would have raised the price of gasoline) to promising never to impose a tax on gasoline, to considering a suspension of the existing gas tax.
Senate majority leader Chuck Schumer recently bemoaned “the bewildering incongruity between falling oil prices and rising gas prices,” which, he said, “smacks of price gouging and is deeply damaging to working Americans.” He pledged to haul Big Oil CEOs to come testify before Congress.
The spectacle of energy-company executives patiently explaining Economics 101 while members of Congress insult and intimidate them has become a decadal ritual. Watch for Representative Maxine Waters to call for nationalizing the energy industry if she manages to put a coherent sentence together at all.
It’s only a matter of time before Democrats realize that they themselves are the principal cause of the “bewildering incongruity” in the energy market. Meanwhile, policies intended to hurt the oil and gas companies will continue hurting everyone except them.