Trump wants oil companies to slash prices after the Hormuz disruption. But suppressing market signals during a supply shock risks shortages, underinvestment, and weaker US economic performance. 

President Donald Trump criticized fossil energy producers for “making too much money” as a result of the large supply disruption in the global market for crude oil attendant upon the closure of the Strait of Hormuz. Trump continued: [“The oil companies] ought to give some of that back to the public. And they better cut the retail price, the consumer price.” 

Narrowly, we must ask whether those comments reflect sound economic thinking. More broadly: What effects can we expect when policymakers seek to limit market price and profit responses to a major supply chain disruption?

Until Iran began to threaten and attack oil shipments transiting through the Strait of Hormuz, about 25 percent of the world’s maritime trade in crude oil and petroleum products, and roughly 19 percent of liquefied natural gas (LNG), transited through the Strait of Hormuz. Accordingly, the hostilities with Iran and its threats to shipping have created a supply disruption either the largest or among the largest in the modern history of the international crude oil market. 

It can surprise no one, therefore, that crude oil prices this year have increased sharply, and with them the prices of refined petroleum products, transportation fuels in particular. Higher prices have the obvious effect of increasing the quarterly or annual earnings by fossil energy producers: Oilprice.com reports that over the last year, earnings by the energy sector have increased by 128.2 percent, compared with 37.9 percent for the S&P 500.

But that is only the beginning of the story. Prices rise, and prices fall, and with them the economic returns to investment earned by fossil energy producers. During 1999-2025, those annual economic returns ranged from -38.97 percent to 64.17 percent, with an annual average of 10.8 percent. For the same period, economic returns to the S&P 500 ranged from -36.55 percent to 32.15 percent, with an annual average of 9.99 percent. Notice, however, that returns to the energy investments are 11 percent more volatile—that is, riskier—than returns to the S&P 500.

Why Price Controls on Gasoline Would Backfire

Consider now some implications of the proposal that the oil producers “give some of that back to the public.” What that means fundamentally is that upside potential would be limited, while downside risk would not. After all, no politician ever will advocate that the public make contributions to oil producers as compensation for a bad year. (Nor should they.) This asymmetry means that over time oil producers would not be able to earn a competitive rate of return; the obvious result would be underinvestment in and underproduction of the national wealth embodied in fossil energy resources. The outcome would also be inconsistent with the administration’s stated “energy dominance” agenda, dependent upon an efficient level of investment in domestic energy production.

Trump suggested that the oil companies aim for retail gasoline prices around $2.50 per gallon. (Prices as of August 27 are about $4.10.) One problem would be different prices for virtually identical products: Profits would vary across producers with different cost conditions and other central parameters, and so they would “give back” different price reductions. More broadly, retail gasoline prices reflect competitive market conditions rather than some arbitrary target. If demand and supply conditions have resulted in a market equilibrium price—the price balancing demand and supply—around $4, an artificial price of $2.50 would yield gasoline lines at retail stations, as consumers compete for “cheap” gasoline by waiting in line. The shortages, queues, and massive geographic distortions observed during the 1970s offer a useful lesson on the effects that ensue when prices are held below market-clearing levels. 

There is the further matter that the cost of crude oil is only 57 percent of the retail price of gasoline. Refining costs are 21 percent, distribution and marketing—transporting gasoline to retail stations and operating the stations themselves—are 8 percent, and federal and state taxes are 14 percent. Moreover, federal policy among several distortions includes the renewable fuel standard—the ethanol mandate—which drives up refining costs and gasoline prices. The administration has supported the program, which is little more than a massive subsidy for midwestern agricultural interests.

The market clearly recognizes that the threats to energy transport in Hormuz, the Bab al-Mandab Strait, and perhaps other bottlenecks have increased markedly as a long-term proposition, regardless of the outcome of the current hostilities in the Persian 
Gulf and the negotiations between the United States and Iran. The planned and ongoing increases in pipeline capacity and the like might help, but such alternatives clearly are higher cost than threat-free transit by the waterways; that is why such expansions have not been utilized heretofore. 

This long-term shift in the threat environment means prices permanently higher than otherwise would have been the case, and over time an investment increase in US energy infrastructure and production. That obviously would be an efficient market response to a major shift in international conditions, yielding, again, an increase in US national wealth. Policies that constrain the returns generated by such higher prices weaken that investment response. The central issue is not whether high gasoline prices are desirable—clearly, they impose real costs on consumers—but whether suppressing the market signals created by a major supply disruption ultimately would reduce supply, investment, and the productive efficiency of the economy. The clear answer is “yes.”

About the Author: Benjamin Zycher

Dr. Benjamin Zycher is a senior fellow at the American Enterprise Institute, where he works on energy and environmental policy. He is a former senior economist at the RAND Corporation, a former adjunct professor of economics at the University of California, Los Angeles (UCLA) and at the California State University Channel Islands, and is a former senior economist at the Jet Propulsion Laboratory, California Institute of Technology.  He served as a senior staff economist for the President’s Council of Economic Advisers, with responsibility for energy and environmental policy issues. Dr. Zycher has a doctorate in economics from UCLA, a Master in Public Policy from the University of California, Berkeley, and a Bachelor of Arts in political science from UCLA.

The post Trump Wants Oil Companies to Cut Prices. Here’s Why That Would Hurt the US Economy appeared first on The National Interest.