The Price of Oil

In October 2021, the price of gasoline in the United States rose to its highest level in seven years. There were many reasons for this: surging demand following a year-and-a-half of lockdown, a slower than expected recovery of oil production, and imbalances in products inventories due to energy shortages in Europe and East Asia. Experts believed prices would fall in the new year. Instead, Russia’s invasion of Ukraine in February 2022 sent them to new and historic heights, rattling markets and increasing the US price of gasoline to more than $4 a gallon.

It is easy to see that the price of oil is one of Joe Biden’s biggest problems, but harder to figure out whether Biden can do much about it. If he can’t, who can? An entire industry exists to predict future changes in the price of oil. Oil companies themselves try to imagine where the price will be, so that they can schedule capital expenditures to meet future demand, often without much success. 

Today, the volatility of oil prices is taken for granted. But this was not always the case. From the early 1930s to the 1970s, the price of oil in the United States was managed through a combination of voluntary action by private actors and regulatory oversight from state agencies. Crisis in the early 1970s motivated the federal government to institute formal controls over the price of crude oil. While these controls were inexpertly administered and pursued contradictory goals, they succeeded in absorbing the impact of the shock in global oil prices and ensuring access to energy on affordable terms to most Americans. Where the policy did not succeed, however, was in increasing domestic production and making a meaningful impact on oil imports. A second oil shock in 1979 convinced policymakers to do away with controls and helped spawn a militarized commitment to “securing” the oil of the Middle East, the blowback of which we continue to confront today. US power and a free market, many leaders argued, would produce abundant and affordable energy. 

Examining the history of oil prices reveals two persistent features. The industry has often been subject to various forms of price-setting, both by government and by firms with market power; and at the same time, the entanglement of market forces with geopolitics has meant that true control over the price of energy remains elusive, absent agreements on a planetary scale. Such coordination now appears necessary to counteract the spiraling volatility endangering access to energy and complicating the energy transition away from fossil fuels. To arrest volatility and avoid the worst effects of climate change, it’s time to get oil back under control.

Out of control

During the early days of the US petroleum industry in the late nineteenth century, growing demand for oil products drove a constant search for new deposits. Oil produced from the ground belonged to whomever obtained it first according to the so-called “rule of capture,” a concept summarized in the closing scene of Paul Thomas Anderson’s 2007 film There Will Be Blood. With production fragmented among many different companies and without a central authority imposing order, the market went through a constant boom-and-bust cycle.

To secure their investments, companies managed volatility through vertical integration and concentrating ownership. Oil magnate John D. Rockefeller sought stability of prices through monopolization. At its peak, Rockefeller’s Standard Oil controlled roughly 90 percent of the domestic industry. While Standard was broadly unpopular, oil economist George Stocking argued that “unrestricted competition” led to waste and depressed prices, necessitating a degree of concentration and cooperation to keep profits at a level that allowed for investment in new production.¹ After the US Supreme Court broke up the Standard Oil monopoly in 1911, both the large vertically integrated “majors” and smaller “independents” sought measures to limit competition and prevent overproduction. “The inescapable fact,” according to one editorial in 1928, “is that the oil industry has just so much of a market to supply… too much crude produced means oversupply of products and this results in inadequate returns.”² 

But managing competition was different from managing demand. Amidst the global economic depression of the early 1930s, prices in Texas collapsed from $1 per barrel to as little as $0.06 per barrel. To eliminate rampant price cutting, the majors lobbied state authorities to take action to rein in smaller producers, who they contended were driving the market glut by producing “hot” oil that could not find a market.³ In August 1931, the Governor of Texas ordered National Guard troops to the oil fields to shut down production. By 1934, state agencies like the Texas Railroad Commission (TRC) imposed limits on how much oil drillers could produce through centrally organized “pro-rationing” schemes—in effect placing American oil production under government control to ensure stable prices. 

While the TRC restricted American domestic production, the majors worked to control competition and prevent oversupply on the global market. Experts regarded it as “oligopolization”; critics called it a cartel. An initial private agreement made in 1928 recognized “excessive competition” led to “tremendous overproduction.” After World War II, the majors established an informal oligopoly, the infamous “Seven Sisters” that included BP, Shell, Exxon, Mobil, Chevron, Gulf, and Texaco to control the flow of oil internationally, particularly new production from the fields of the Middle East. 

The companies linked their commercial priorities to the emerging Cold War, delivering oil to Western Europe through the Marshall Plan and using their market power to establish a price using a “delivered price” based on freight rates from the Gulf of Mexico. This new “posted price” was stable, though high compared to the cost of production: Middle East oil at the wellhead cost as little as $0.10 per barrel while the majors sold it for $1.20. The stability of the system was maintained by the market power of the oligopoly, which managed more than 80 percent of the global oil trade through their own vertically integrated corporate structures. For much of the 1950s, the price for oil shipped from the Middle East was fixed between $1.75 and $2.20 per barrel, depending on its point of departure.⁴ Acting collectively, the majors restrained production in the Middle East, while the TRC did the same in the United States. In each area, the problem was not preventing scarcity, but managing abundance—there was always more supply than demand, necessitating cooperative and restrictive measures.

While the majors controlled the global market through an oligopoly that restricted competition, restrained production, and kept prices high, smaller independents leveraged political power within the United States to push through protectionist policies, including quotas on the majors’ imports.⁵ For smaller refinery customers, the Kennedy administration introduced a system of “import tickets” to ration imported crude to the highest bidder. Oil industry advocates argued that the quotas were justified on national security grounds, claiming a strong domestic industry would be needed in the event of war with the Soviet Union.⁶ In practical terms, however, the quotas raised prices from $2.50 per barrel to $3.50 per barrel between 1959 and 1969 and transferred $6 billion from consumers to oil companies every year.⁷ Protectionism in the name of the Cold War kept the price of oil high, benefitting independents and forcing consumers to subsidize domestic oil production.

Despite subsidies like the import quotas, generous tax breaks, and support from allies in Congress, the domestic American oil industry entered a slow decline in the late 1960s. While domestic production continued to increase, costs rose among older wells and squeezed profits, resulting in a decline in drilling activity and refinery construction after 1964. The majors chose to invest in their fields in the Middle East, where oil could be produced much more cheaply. Oil consumption throughout the Western world grew at a rapid rate, rising to 34 million barrels per day in 1970, and most of this demand was met with Middle East oil as output from the United States stagnated. 

The choice to control

Transformations in the global oil market during the 1960s opened the way for a series of debates on the future of domestic oil production. Though the US Department of the Interior confidently predicted continued abundance up until 1980, geologist M. King Hubbert foresaw an inevitable decline in domestic production—rising costs and the slowing rate of reserve replacement were expected to generate a peak around 1970 and a decline thereafter. 

Among economists, maintaining oil abundance depended on questions of price. Keynesian theorists who had been influential during wartime advocated controlling inflation through price controls, which alleviated inflationary pressure on prices and wages while managing aggregate demand. During WWII, the Roosevelt administration initiated price and wage controls to limit the cost of the war and to aid in keeping the wartime economy from spiraling out of control. Private industry, including oil companies, supported the controls both as measures necessary to win the war and as effective means of maximizing production.⁸ As inflation began to tick upward in the late 1960s, progressive Democrats and some economists again advocated for wage and price controls to offset the “cost-push” nexus driving up wages and prices. 

On the other end of the spectrum were economists like Morris A. Adelman, who, drawing on the work of Harold Hotelling and Erich W. Zimmerman, contended that the price mechanism, once suitably unshackled, would guarantee adequate supplies. Milton Friedman chastised the major oil companies for relying “so heavily on special governmental favors,” and argued that a deregulated industry would cause prices to decline, as greater competition and less protection led to investment and increased production. Opposition to price controls depended on a “quantity theory” of monetary policy, which held that changes in the money supply were the main cause of inflation. “Direct control of prices,” argued Friedman, doyen of the new monetarist school, “does not eliminate inflationary pressures. It simply shifts the pressure elsewhere.”⁹ According to the Adelman school, oil was theoretically limitless so long as the price was permitted to rise during times of shortage, encouraging investment in new and more expensive fields and methods. Abandoning efforts to stabilize the market would unlock oil companies’ potential to satisfy the nation’s energy needs and ultimately serve consumers in the long-term.

Advocates of “decontrolling” the price of oil found a home in the Nixon administration, which came to power in 1969 determined to shake up American energy policy and combat rising inflation. Budding neoliberal policymakers like William E. Simon, Nixon’s advisor on energy, favored deregulating the price of natural gas and ending the import quotas, allowing both to be governed by market forces, which Simon (in line with the Adelman school) believed would ensure long-term supply.

Despite the presence of Friedman acolytes like Simon and George P. Shultz in his administration, Nixon chose price controls out of concerns that managing inflation through fiscal-monetary policy alone would sap economic vitality and endanger his chances of reelection. Price controls, which polled at over 60 percent in early 1971, were linked to his simultaneous decision to end the dollar’s convertibility into gold and embrace an expansionary fiscal-monetary policy that would stimulate economic activity.¹⁰ In August 1971 Nixon ordered a general wage and price freeze, including on the price of domestic crude oil, leaning on advice from Treasury Secretary John Connally.¹¹ For Nixon, embracing controls was a domestic political decision. Yet domestic prices would soon be influenced by events and forces that lay outside the President’s power, as the oligopoly’s system for managing global prices and the TRC’s sway over domestic production began to fall apart.

Adjusting to crisis

Price controls, while politically popular, produced complications for normal industry operations. Refiners, for example, had relied on seasonal price changes to adjust their throughputs from gasoline to home heating and residual fuel oil. Price controls were imposed in August 1971 and price levels adjusted monthly. Without clear indications from price changes, refiners’ output lagged behind demand, producing shortages of petroleum products in the winter of 1971–1972 and again more markedly in 1972–1973.¹² Between 1969 and 1972, the supply glut which had persisted since the 1950s vanished as world consumption boomed under the military stimulus of the Vietnam War and the internal, political imperatives for full employment among the NATO powers and France. Years of falling investment within the United States produced a decline in production, and in 1970 production peaked, just as M. King Hubbert had predicted. By 1972, the TRC allowed producers to pump as much as they could to meet demand at federally controlled prices, ending nearly forty years of prorationing.¹³

With Middle East oil supplying a large and growing portion of the market—especially in Western Europe and Japan, which had become entirely dependent on imported oil—producer states secured considerable leverage over the majors by the late 1960s, utilizing threats to nationalize their industry or shut off production if their demands were not met. Apart from bringing their oil industries under state control, the OPEC states wanted to raise the price of oil, which the majors had kept stable since the late 1950s. OPEC protested the unequal terms of trade that limited the value of capital goods—vital for economic growth—that member states like Iran, Venezuela, and Algeria could import with their oil export revenues. A stable price eroded oil’s purchasing power. By raising the dollar price of oil, OPEC hoped to gain advantage against American corporations while keeping pace with rising inflation in the West.¹⁴ 

In 1971 the OPEC states secured major price increases from the companies. As energy historian Richard Vietor noted, Nixon’s decision to control the price of oil “coincided with the collapse of the ten-year-old system for petroleum-market stabilization.”¹⁵

The shift in the balance of power between OPEC and the majors complicated the efficacy of Nixon’s controls regime. As the price of imported oil rose past that of domestic crude, smaller refiners in the United States selling at controlled prices were unable to purchase imports as they had done in the past. Refiners had trouble obtaining crude for the 1973 summer driving season, resulting in gasoline shortages and lines at pumping stations—months before the embargo of October, it should be noted—as gasoline retailers did what they could to meet public need by self-rationing limited supplies.¹⁶

In October 1973, OPEC pressed the majors to accept a doubling in their rate of taxation. This, in effect, doubled the price of oil outside the United States, from $2.50 per barrel to $5.10 per barrel. OPEC doubled the price again in January 1974 to $11.65. At the same time, Arab oil producing states declared an embargo on oil shipments to the United States in response to the US resupply of Israel during the October War against Egypt and Syria, while reducing their total production by 25 percent. The result was the first “oil shock”—a simultaneous price increase and supply shortage. 

The Nixon administration responded to the crisis of October 1973 by expanding the controls program, producing the most ambitious energy management system in American history. The Emergency Petroleum Allocation Act (EPAA) passed in November allocated available crude supplies to refiners all over the country. Imbalances between refiners obtaining old oil versus those with access to new oil were corrected through “entitlements,” introduced in late 1974, which equalized the costs to refiners based on their access to the cheapest crude.¹⁷ While “old” oil produced from wells that were active in 1972 (roughly 60 percent of domestic production) was priced at $5.25 per barrel, “new” oil was set at the price of imported oil, roughly $12 per barrel.¹⁸ The tiered approach was designed to encourage investment in new production under controlled prices, alleviating dependence on imports and offsetting the risk of another embargo. By the time House minority leader Gerald Ford assumed the helm of the disgraced Nixon White House in August 1974, the US market in crude oil had become thoroughly regulated by priority-allocation rationing, a tiered system of government-fixed sales prices, and refinery subsidies to offset the resulting cost differences.

Measuring success

The allocation system enforced by the EPAA and its successor, the Energy Policy and Conservation Act (EPCA) passed in 1976, was incredibly complex. It had goals—reducing imports, propping up small producers, and encouraging domestic production, all while protecting consumers from sudden price spikes—that were in some instances contradictory.¹⁹ The controls tried to increase production while weaning Americans off imported oil, which policymakers regarded in the post-embargo context as a threat to national security.

Given the different goals as well as the changing nature of the controls program from 1971 to the period after the price shock of 1973–1974, judging the relative success of the controls’ program was difficult. While crude oil products were used for many different applications, for planners the chief product to worry over was gasoline. One study found that controls lowered refiners’ costs and encouraged them to increase throughput, which increased stocks of gasoline and likely contributed to lower prices at the pump (while the price of crude was controlled, the price of products like gasoline derived from crude prices and was managed less rigidly by the EPAA/EPCA).²⁰ Keeping pre-1973 output at the “old” level of $5.25 meant the average domestic price of crude oil hovered between $6.80 and $7.80 from 1974 until January 1976, when new regulations on imported oil raised the price to over $8.00 per barrel.²¹ That was significantly lower than $12.50–$13.00, the price that persisted on global markets, though the price did slowly rise as “new” oil and imports displaced “old” oil priced at the lower level. 

A study by C.E. Phelps and R.T. Smith for the Rand Corporation argued that controls had little impact on the price of gasoline or fuel oil. Crediting Morris Adelman as a key influence, the authors contended that imported petroleum products, and thus trade policy affected by global trends, were the chief influences over the price of gasoline—not the domestic planning program. “Market forces,” argued the Rand economists, “impose a greater discipline on refined products prices than do the FEA controls.”²² Others disputed Phelps and Smith’s findings, citing the relatively small amount of products imports (around 1 percent of total products’ consumption).²³ Finding refinery margins to vary markedly from market to market, Robert T. Deacon concluded that controls on crude actually lowered gasoline prices by as much as $0.03 per gallon compared to international prices, proof that controls were effective and disproving the Phelps and Smith thesis.²⁴ 

Admittedly, given the profit-seeking ownership of the industry, there was no way for federal policy to increase domestic production while maintaining lower prices. While there were proposals for a “public option,” the US government did not nationalize the oil industry or pursue public oil production, preferring instead to leave the job of investing in new production with the companies. Any “new” oil that came online was sold at the higher-tier price. This produced upward pressure on domestic prices, as refiners were allowed to pass on the cost increases in higher gasoline prices.

These contradictory impulses to satisfy both the public demand for affordable fuel and the industry owners’ condition for greater investment undermined the government’s stabilization apparatus. Despite tariffs on imported oil, domestic production could not compete with imports, which remained cheaper to produce and more abundant, and supplied a growing share of the US market. Though the US government hoped to reduce imports both for balance-of-payments reasons and to limit US exposure to another embargo, there simply was not enough domestic oil to meet demand. By 1978, the average price of oil within the United States had risen to equal the price on the global market, marking the effective end of the controls regime. Imports accounted for a quarter of total consumption.²⁵ 

While the controls remained politically popular, critics argued they were unworkable and unfairly targeted producing companies. Policymakers had drawn advice from geologists and oil executives early in the crisis, but by the late 1970s economists had emerged as a vocal and powerful group influencing policy, with decontrol and neoliberal voices the loudest and best organized. An efficient market, they argued, obviated the need for controls or import quotas, which inevitably produced inefficiencies and sowed the seeds of future shortages.²⁶ The government could best manage energy policy by getting out of the way. By the time President Jimmy Carter confronted his own inflationary spiral, such price theory arguments were a major rhetorical device to use against returning to a more state-directed system of energy planning, particularly when a new geopolitical shock undid what was left of the decade’s energy order.

Domestic deregulation and global militarization 

In 1979, the price of oil worldwide tripled. The cause was not coordinated action by OPEC, but a revolution in Iran that shut down that country’s oil production, removing 4.8 million bpd or 7 percent of total supply from the global market. Responding to an anticipated shortage, OPEC producers raised their prices from $13 per barrel to more than $30 per barrel. 

Rather than satisfy consumer demands for lower prices, President Jimmy Carter advocated for cutting consumption. As American consumers adapted to new world volatility, Carter focused on the national security concerns linked to imported oil. It was under Carter, a candidate favored by environmentalist and progressive Democrats, where a commitment to deregulating energy at home and militarizing US efforts to secure oil abroad became ingrained within US policy. On June 1, 1979 Carter committed to ending price controls through phased price increases, to conclude in 1981.²⁷ Following the seizure of the US embassy in Tehran in November 1979 and the Soviet invasion of Afghanistan in December, Carter codified the US commitment to station military forces astride the world’s oil fields permanently: “An attempt by any outside force to gain control of the Persian Gulf region will be regarded as an assault on the vital interests of the United States.” 

Government planning failed for a variety of reasons, not least geopolitical uncertainties. The upheaval of the Iranian Revolution punctuated an ideological shift away from planning in the United States. This shift was felt across the world. As historians Rudiger Graf and Giuliano Garavini have argued, politicians in Western Europe during the 1980s moved toward using market solutions to energy problems after decades of experimenting with state intervention. President Ronald Reagan signed an executive order formally ending price controls on January 28, 1981 after only a week in office, despite continued opposition from Congress.²⁸ In 1982, Reagan vetoed a bill that would give Congress stand-by authority to institute price controls in the event of a major disruption in imports. OPEC had raised prices and the Arab states had embargoed the United States, but they had not caused gas lines and shortages: “It took government to do that,” Reagan argued.²⁹

Reagan’s surrender to market forces did not resolve the energy crisis. Rather than a change in government energy policy, it was the aggressive deflationary policies pursued by the Federal Reserve under Chairman Paul Volcker between 1979 and 1981 that resolved the imbalance between supply and demand which had persisted throughout the previous decade. As Volcker’s policies raised interest rates to cut inflation, the United States fell into a deep depression and consumption fell from 18.5 million barrels per day to 15.2 million barrels per day between 1978 and 1982. Reagan boasted in 1983 that decontrol had caused gas prices to drop, when in reality it was the slowing economy and an increasing global over-supply that caused prices to dip. 

In 1985, prices collapsed further and the American oil industry suffered one of the worst downturns in its history. The Carter Doctrine, meanwhile, was demonstrated by the US efforts to protect tankers traveling through the Persian Gulf during the Iran-Iraq War, as well as the enormous demonstration of US military power against Iraq in 1990–1991. The militarized commitment to “securing” Middle East oil remains a feature of US foreign policy, even as its justification grows more nebulous in light of rising non-Middle East oil production.

The failure of decontrol

In the 1980s, the US replaced a public-private framework of price controls with a new framework that combined deregulation and muscular foreign policy in the world’s major oil-producing region. The post-oil shock instability has become the norm, rather than the exception, as prices now oscillate and the industry proceeds through a boom-and-bust cycle. Oil-producing states attempt to move markets, but the effects of their measures are imprecise and often limited. Commodities traders, not state bureaucrats, wield more power over the prices of key goods like oil, which now float on an ever-changing market, beyond the scope of Western politicians, oil executives, or OPEC’s oil ministers. But this power is not the power to control, as procyclical trades exacerbate scarcity pricing or short-sell glutted markets. 

By some measures, decontrol seemed to meet the promises its advocates had made in the 1970s. Between 1985 and 2019 global oil production increased from 60 million barrels per day to 100 million barrels per day, driven by an explosion in demand in the developing world, particularly East Asia. Despite fears of scarcity resurfacing in the early 2000s, high prices and new technology spurred investment in American fossil fuels. Between 2010 and 2019, US oil production doubled from 5 million to more than 12 million barrels per day.

But despite this new abundance, oil today exists in a nearly constant state of volatility. Surging US production, driven in large part by aggressive investment from Wall Street, glutted the market and caused the collapse in prices in 2014–2016. As OPEC attempted to right markets with coordinated production cuts, capital expenditure dried up as and companies tightened their belts, unsure of whether future demand justified increased spending. In March 2020, the price of West Texas crude dropped to -$30 per barrel, as the market glutted in the face of a demand shock stemming from the COVID pandemic. A year later, as economies reopened, past investment decisions caught up with suppliers as investors doubted whether further spending was justified by uncertainty over future prices. In late 2021 the market tightened, in part due to past investment shortfalls, changing weather conditions, and the demand shock of post-COVID recovery. Geopolitical volatility returned with tremendous force in February 2022, when Russia’s invasion of Ukraine sent prices over $100 for the first time since 2014. Throughout this instability, the geopolitical imperative of control over supply has fueled an expensive, destructive, and ultimately futile US mission in the Middle East.

New management

A decade ago, even as concern about climate change gained force, there was little audience for debate about the limits of markets. Today, there is increasing recognition that the necessity of the transition away from fossil fuels may require “abandoning the fetish of the price mechanism in order to plan.” An examination of the history of oil price controls reveals a diverse mix of potential solutions to the current market-driven and geopolitically influenced volatility, a “chaos” and “bedlam” in need of mitigation to a smooth the transition away from fossil fuels.

From the 1930s to the 1970s, private companies and state regulatory agencies managed the price of oil. The result was an artificially inflated price which nevertheless allowed for a rise in consumption and matched supply with demand. The controls program of the 1970s, though criticized for its inefficiencies, succeeded in allocating energy at a time of profound crisis. It is doubtful that the United States could have avoided dramatic dislocations in 1973–1974 without government intervention in the oil market. 

The current crisis is of a different variety than the last: rather than allocate limited supply, controls would ensure steady access to abundant supplies while reducing demand as consumers transition, a necessary component in reaching decarbonization targets. It is not altogether clear whether the price mechanism offers the most efficient means toward accomplishing a smooth energy transition away from fossil fuels. Under current geopolitical conditions, prices are volatile and volatility leads to a bunching of capital investments and the persistence of a speculative fossil fuel industry.

As they did during the two World Wars, controls would offer producers assured profits, removing the uncertainty that comes from the boom-and-bust cycle with which the oil industry has struggled since the 1980s. A system of controls would also be tied to incentives and tax breaks, some of which lie within the scope of President Biden’s proposed (though, it would appear, defunct) Build Back Better plan. More limited means exist within existing policy instruments, including the Strategic Petroleum Reserve, which allows the United States to influence the supply-demand balance both in the short term by adding supply and in the medium to long term through purchases to refill the reserve.

Though they are certain to resist such regulations, energy companies have already outwardly admitted the need to decarbonize. Assurances that oil prices will remain stable could be tied to policies designed to compel these companies to pursue these goals more aggressively. This transition is already taking place, but should be accelerated in order to avoid an increase in 3 degrees Celsius, as outlined in the 2021 report of the Intergovernmental Panel on Climate Change.

While the Biden administration is committed to an energy transition, the United States believes the private sector will manage it without state intervention. This is a self-limiting and dangerous presumption. The volatility of the global oil market presents an obstacle to a smooth and rapid energy transition. Policymakers should consider deploying price controls for oil and oil products, in a manner that would aid the energy transition while protecting consumers and facilitating continued economic growth.