Profit, Politics, and Petroleum: Making Sense of the Oil Industry

Good energy policy starts with a good understanding of energy issues. But both major political parties have glaring blind spots when it comes to understanding the energy sector.

Let me preface this column by noting that I am a registered Independent. I have major disagreements with both political parties, and I strive to approach issues from a completely objective viewpoint.

I think Republicans get it mostly wrong when it comes to climate change, and the importance of transitioning to alternative energy. But they seem to understand the current critical role of fossil fuels in the economy, and they mostly get it right when it comes to supporting nuclear power.

Democrats never seem to understand how the oil industry works. For example, look at the list of Democrats who signed onto the “Big Oil Windfall Profits Tax” introduced last year by Senator Sheldon Whitehouse (D-RI). In announcing the bill, Senator Whitehouse said it would “curb profiteering by oil companies and provide Americans relief at the gas pump.”

The bill was cosponsored by Senators Jeff Merkley (D-OR), Elizabeth Warren (D-MA), Bernie Sanders (I-VT), Richard Blumenthal (D-CT), Tammy Baldwin (D-WI), Sherrod Brown (D-OH), Jack Reed (D-RI), Ed Markey (D-MA), Cory Booker (D-NJ), Michael Bennet (D-CO), and Bob Casey (D-PA). Congressman Ro Khanna (D-CA-17) introduced the legislation in the U.S. House of Representatives.

In addition to claims of price gouging, this same cast of characters has sometimes blamed oil company profits for inflation. Here’s Senator Bernie Sanders doing that.

These politicians do not seem to understand that oil companies don’t control prices. Oil is the world’s most valuable commodity. Oil prices are set by buyers and sellers in global markets, based on supply and demand expectations.

Firms like ExxonMobil produce such a small share of the world’s oil they couldn’t move prices much if they wanted to. They benefit from high prices, but don’t set those prices. If they did, prices would never fall.

Saying profits cause inflation confuses cause and effect. It’s like saying hospitalizations cause car crashes. It is true that a car crash can result in hospitalization, but hospitalizations do not cause car crashes. If you believe the latter — and you try to address the problem by focusing on the hospital — you are working on the wrong problem.

Likewise, high profits in the oil industry and inflation are both caused by high oil prices. But high oil prices are caused by supply and demand factors.

Outside of rare circumstances, it’s impossible for oil companies to gouge you, because they don’t set the price. An example of true price gouging would be if a local gas station that sets its own prices doubled them when supply is ample. But Chevron earning more from high global prices set by markets is normal capitalism. That’s how the entire global commodity markets work.

I can only imagine that in the minds of some politicians, executives of Big Oil are meeting in smoke-filled boardrooms, rubbing their greedy hands together, and deciding to raise prices because Russia invaded Ukraine. But that’s not how any of this works.

If politicians want to address oil prices, they need to address the supply side and the demand side. When politicians propose windfall profits taxes on oil companies, intending to give rebates to consumers, it might sound good, but it doesn’t address the core issue.

High prices should signal consumers to use less energy, but rebates would diminish the price signal — which wouldn’t alleviate pressure on demand. On the supply side, punitive taxes on oil companies might sound appealing, but that’s less money that can be allocated to projects, which affects future supplies. Former Venezuelan president Hugo Chávez learned this lesson the hard way, and Venezuela is still paying the price.

Some have expressed outrage that oil companies are using record profits to buy back shares or pay special dividends to shareholders. But it’s common for companies, not just in the oil industry, to buy back shares or pay dividends when profits are high. It’s a part of how our capitalist system works. If companies can issue shares, they should be able to buy them back.

For consumers worried about high oil prices, there are options. You can invest in an oil company. Thus, when oil prices rise, so do your shares. Or consider switching to an electric vehicle to reduce your reliance on fossil fuels.

In conclusion, understanding energy issues is crucial for effective policymaking, yet both major political parties often exhibit significant misunderstandings of the energy sector. By understanding the complexities of the energy sector, policymakers and consumers alike can make informed decisions that contribute to a more sustainable and economically sound future.

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