More wisdom from one of the most economically illiterate presidential administrations in U.S. history.
President Biden spoke from the White House today and called for Congress to consider a windfall-profits tax on oil companies. The reason: “The oil industry has not met its commitment to invest in America and support the American people.”
Joe Biden has decided that gasoline prices and oil-company profits should be lower than they currently are. He doesn’t say how much lower.
To solve this problem, he is asking Congress to consider a windfall-profits tax. First, it’s going to be hard to set any tax rate based on Biden’s loose grasp of the situation. How much profit should the companies be allowed to keep? He said he supports “a fair return for hard work” and that they therefore should be allowed some profit, but Shell’s third-quarter profit of $9.5 billion was too much. Shell’s proper profit, then, according to Biden, is somewhere between $1 and $9.7 billion.
But we’ll leave that for Congress to figure out (they’re geniuses, so it should be easy). The real issue is that Biden is again promoting a pricing conspiracy theory.
Oil companies do not set the price of gasoline. Gas stations, most of which are small businesses completely independent from the oil company on the sign in the parking lot, set their own prices, and they do so in a highly competitive environment. (Ryan Mills looked at how these businesses really work over the summer; check out his piece here.) The level of coordination required to get tens of thousands of small businesses across the country to conspire to hold up their prices would be astounding.
Gas stations are, of course, affected by the price of crude oil, since that’s the top input cost for gasoline. So we could read Biden’s comments as suggesting that the oil companies are holding up the price of crude oil, which then forces the gas stations to charge more than they should.
But this too would require a mindbogglingly complex conspiracy. Crude oil is globally traded. American crudes are purchased by foreigners, and foreign crudes are purchased by Americans. If American oil companies were working alone to hold up their prices, it would fail immediately because every other country’s oil would undercut them.
To hold up prices, then, American oil companies would need oil companies from every other country in the world to work with them. OPEC is intended to do that with its member states, but even OPEC has a hard time keeping its members in line with production targets. OPEC attempts to do this through meetings and orders from within an organizational structure. There are records of their decisions. If this conspiracy is as Biden alleges, he should show us the evidence that American oil companies are working together to keep prices high. There would have to be communications of some kind to let everyone know what to set their prices at.
But they wouldn’t only have to fool every oil company in the world. Traders on commodities markets, who study every movement of the price of oil and production data from around the world, would also have to be in on it. The prices of crude oils are really “set” (if you can call it that) by traders, who are always looking for opportunities to get a better deal for their clients. This aspect of competition is why banning oil exports, another idea that is sometimes discussed, would be counterproductive to any effort to lower prices. Allowing more buyers for a product, rather than fewer, increase the incentive to produce, which helps keep prices low.
The sheer number of people who would have to be involved to successfully hold up the price of oil would be, conservatively, in the hundreds of thousands. Secretary of the Treasury Janet Yellen, who is an accomplished economist, knows that the oil market doesn’t actually work this way, yet she was standing silently behind Biden with a straight face as he spewed this nonsense. She should have retired from the Fed and written a big book about central banking, as Ben Bernanke did, but instead she has decided to give her tacit support to one of the most economically illiterate presidential administrations in U.S. history.
Not that long ago, politicians in the U.S. and abroad were complaining about the extraordinary profits in ocean shipping. It’s true: Ocean carriers made lots of money due to high container rates in 2020 and 2021. But now container rates are collapsing, and the high profits are disappearing. It’s exactly what we’d expect from a competitive market.
It’s not smart to make any decision based on one quarter’s profits. Oil companies did do extraordinarily well recently. They’ll do worse in the future. Biden should leave them alone and stop pushing a pricing conspiracy theory to the American people.