Therapists advise against making major decisions when you’re highly emotional. Democrats should heed that advice and stop proposing rash ways to lower gasoline prices.
With pump prices now averaging $4.33 per gallon, President Biden and his fellow Democrats in Congress clearly worry that motorist pain could doom them in the November midterm elections. Biden’s Energy Secretary, Jennifer Granholm, practically begged U.S. energy firms to produce more oil at an industry conference on March 9. Biden officials are pleading with Middle East drillers and even pariah nation Venezuela to boost supply. Some Democrats in Congress want to impose a new “windfall tax” on oil companies that could finance taxpayer rebates meant to compensate for costly fill-ups. And there seems to be some chance Congress could suspend the 18.4-cent-per-gallon gasoline tax.
The common failure of all these ideas is a misunderstanding of the dynamics in the oil and gas industry, which in the United States is dominated by private-sector firms answerable to shareholders and investors—not to government ministers. “The left thinks oil companies set oil prices,” says Dan Dicker, founder of The Energy Word and author of “Turning Oil Green.” “That’s just false. Oil companies don’t set prices. If they did, they wouldn’t have let oil prices go negative in 2020.”
Democrats proposing the Big Oil windfall tax, including Sen. Sheldon Whitehouse of Rhode Island and Rep. Ro Khanna of California, cite Exxon Mobil’s profits to make their case. In 2021, they point out, Exxon’s profit jumped 60% over pre-pandemic levels. Gas prices during that time rose from $2.69 to $3.41. That means, by extension, that Exxon profits when oil and gas prices rise.
Even greedy oil companies lose money sometimes
That’s generally true. What Whitehouse, Khanna et. al. don’t mention is that Exxon and other energy firms also suffer when oil and gas prices go down. In 2020, for instance, the sudden COVID pandemic caused such an oversupply of oil that the price briefly turned negative, meaning producers couldn’t sell their product and had to pay for storage. That didn’t last long, but low prices for most of 2020 wrought havoc in the industry, forcing cutbacks that persist to this day.
That oil oversupply was great for motorists. Gas prices fell to a low of $1.87 in 2020. But Exxon posted a gargantuan $22.4 billion loss, the largest in its history. That’s why Whitehouse and Khanna compare 2021 profits to pre-pandemic levels of 2019, two years earlier: using the normal year-over-year comparison would force them to acknowledge even greedy oil companies lose money when the market turns against them.
If Exxon represents the whole U.S. fossil fuel industry, then its revenue and profit during the last two decades help illustrate how we got to $4.33 gasoline in 2022. In 2008, U.S. oil prices hit $145 per barrel and gas prices peaked at $4.17. Exxon was the world’s most valuable company, with revenue of $425 billion and a record profit of $45.2 billion. The 2008 recession dented profits, but Exxon came roaring back, with record revenue of $433 billion in 2011 and a $41 billion profit.
Then oil and gas from the U.S. fracking revolution began to flood the market, pushing oil prices—and Exxon’s numbers—down. By 2019, the last year before the COVID pandemic, Exxon’s revenue was 40% below the 2011 peak, and profit was 65% lower. Exxon’s stock became a dog, dropping 6% from 2011 through 2019. During the same time, the S&P 500 soared by 97%.
Big oil? Not so much
It wasn’t just Exxon. Beginning in 2015, many oil and gas firms suffered from unprofitable investments, as new supply slashed prices. In 2014, the average price of U.S. crude was $93 a barrel. That fell to $49 in 2015, with prices staying in that range until 2020, when they fell to $39. Giant firms like Exxon survived and recalibrated, but many others disappeared. In its “oil patch bankruptcy monitor report,” Texas law firm Haynes Boone documented more than 600 industry bankruptcies from 2015 through 2021, involving $321 in debt those companies defaulted on.
Investors fled. “A lot of investors became disenchanted with the oil and gas industry in terms of return on investment,” says Buddy Clark, co-chair of the energy practice at Haynes Boone. “There’s been a lack of reinvestment over the last six years. Producers and investors are not enthralled with throwing money away.” As a portion of the equities represented in the S&P 500 stock index, energy firms fell from 13.3% in 2008 to just 2.7% at the end of 2021 — the third lowest representation out of 11 sectors. Big Oil became a misnomer.
Those are the factors constraining domestic oil production today. High prices are luring some producers back. Research firm Baker Hughes counts 663 oil and gas rigs in operation as of March 11 — 261 more than the same point last year. But that’s still far below the recent peak of 2,031 rigs in 2008. Even with prices near $100 per barrel, many firms are reluctant to drill because more supply could bring prices crashing down again.
“If somebody would guarantee that prices would stay high for a long time, everybody would run out and do it,” says Clark. “But the public equity markets are screaming at producers to not outspend their cash flow, and return money to shareholders through dividends.”
Biden administration officials can’t guarantee investment returns on new oil drilling. In fact, the very thing Biden wants—lower prices—is a disincentive to invest in new wells. The oil and gas industry complains about hostile rhetoric from Biden and many other Democrats who want to move the economy off fossil fuels. But even loving rhetoric from Biden wouldn’t change the profitability equation.
A windfall tax on large energy producers would just raise their costs, which they’d try to pass on through the supply chain, all the way to consumers. If the purpose is to lower energy costs and stimulate production, that would be counterproductive.
The government could probably speed up the permitting process for things like pipelines and wells on federal land, but that would only marginally improve the cost-benefit equation that determines whether producers drill more. Besides, three-fourths of U.S. oil production takes place on private land where federal permits aren't an issue. Biden may actually be doing everything likely to make a difference by releasing oil from the strategic reserve and jawboning OPEC members with the most spare capacity to produce more.
There’s one thing no politician is willing to say: Higher gas prices may be the market’s way of saying American drivers have had it too good for too long. “It’s time this country grew up,” says Dan Dicker. “This country is not entitled to $2 gasoline in unlimited supply.” Maybe after the midterms.
Rick Newman is the author of four books, including "Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman. You can also send confidential tips.