Price Controls/Windfall Taxes Are Probably Necessary

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The EU agreed this week to a cap on natural gas prices. Governments across the EU are enacting taxes on energy companies, much to the chagrin of the industry. The free pass oil and gas producers have enjoyed from government intervention on the economic front has expired, probably for good. The transformation will probably boost economic growth. Taxes will be imposed on imports of energy-intensive products from countries unwilling to suppress the use of fossil fuels. Companies and nations that are invested in the production of oil and gas — and profit from high prices — will see their sales volumes and incomes cut.

I took a position in the Ford Council of economic advisers almost 50 years ago, at the invitation of Alan Greenspan and Paul MacAvoy, to participate in an effort to remove US price controls from oil and natural gas. At the time, in 1975, price controls were hobbling the adjustment of the US economy to higher energy prices, limiting increases in production, and strangling the growth of regions like New England.

The situation was similar in Europe, Japan and much of the world. Market liberalization and the creation of liquid commodity markets was still years in the future.

Efforts by many in the administration of President Gerald Ford, as well as those in the subsequent Carter and Reagan administrations, ultimately removed most of the shackles on markets. Entrepreneurs stepped in and introduced commodity market institutions similar to those that had existed in agricultural and metals markets for decades, and some cases centuries.

Broken Markets

The removal of government shackles on energy markets worked — for a few decades. However, today it has become clear to me that the institutions that worked for corn, wheat, copper, coffee and soybeans no longer work for energy. The EU, by agreeing to cap the rise in natural gas prices has reached the same conclusion. The oil and gas industry does not today, and likely will never satisfy the conditions required for a functioning competitive market.

I regret the conclusion. Years ago I was one of the strongest proponents of markets.

Strong government interventions in oil, gas and probably electricity markets are required because the participants in the business do not and cannot meet the basic criteria required for true competition to exist.

Markets work when there are a large number of buyers and sellers, none of whom can influence prices. This principle has underlaid the successful agricultural markets for probably two centuries. No farmer is large enough to affect the price of corn by holding output from the market, and historically, no buyer had sufficient market power to depress prices by cutting purchases. The situation today has changed with the emergence of large buyers such as China. However, the large buyers cannot utilize their buying power without risking driving up prices at home, increases that would create political dissent.

Energy is different. There are fewer and fewer sellers. Further, the theoretically independent sellers face pressures from investors to limit investment, with a view to boosting prices, revenues and dividends. Output growth will remain subdued although the pressures on companies from investors may invite action from antitrust authorities in 2023, under what’s known as a “common ownership” violation of antitrust laws.

There are also very few trading companies left. The increases in prices and price volatility has forced all but the largest traders out of business. It may not be an exaggeration today to say that Vitol, Trafigura or Glencore can essentially dictate prices.

The situation has become so extreme that Qatar, fingered by Belgium police for allegedly bribing EU officials, can reasonably threaten to limit supplies of natural gas to Europe at a time when the region is in a state of war. This is not a free market.

Government Intervention

Government intervention is the correct response to the situation. Windfall taxes are one reasonable solution. Higher prices have forced governments to boost deficit spending to prevent serious recession. Researchers at Bruegel, a think tank, calculate that Germany will spend more than 7% of GDP to offset the impact of higher energy prices. German legislators will logically look closely at energy companies operating in Germany and seek to capture as many euros of profits as can be found. German citizens will shed no tears for the energy companies forced to pay up.

Price caps or price controls are also reasonable remedies for the current situation of disorderly and uncompetitive global energy markets. Here the EU price cap on natural gas prices may represent a rational response to the anticipative actions of natural gas suppliers.

While ICE, the operator of the key futures market, and almost all analysts deplore the proposed price cap, no one has been able to provide a reasonable economic justification for the dramatic increase in prices this summer. Many will say prices responded to market forces. However, Reuters reported in October that LNG tankers were waiting off the coast of Spain, delaying unloading, “as part of a trading strategy” waiting for higher prices. This is not a free market. Government intervention was necessary.

US President Joe Biden understood the threat and acted. The release of more than 100 million barrels of strategic stocks by the US and International Energy Agency countries was one way of soothing anticipative global energy markets. By my calculation, that release depressed global crude prices by $23 per barrel from Mar. 31 through the end of November. This is one way to address the lack of competition in energy.

Strategic stocks are, however, limited. The ability of governments to use regulatory and fiscal powers is unlimited. The catastrophic rise in energy prices in 2022 has begun a new cycle of taxation, price controls and other forms of intervention that could have permanent negative impacts on oil and gas. The agreement by EU nations to proceed with the carbon border adjustment mechanism may be just the first of many efforts to wean the world off oil and gas.

Philip Verleger is an economist who has written about energy markets for over 40 years. A graduate of MIT, he has served two presidents, taught at Yale and helped develop energy commodity markets since 1980. Kim Pederson is editorial director of PKVerleger LLC. The views expressed in this article are those of the author.

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