Large-scale federal intervention into America’s energy markets began in the 1930s and continued through the 1970s. A series of major laws and executive actions sought to control energy prices, restrict competition, and limit imports.
In the late 1970s, policymakers began reversing course and largely deregulated markets for oil, natural gas, and coal. Fortunately, Congress did not reregulate energy markets when prices peaked in 2008, and markets remain mainly deregulated today.
Those high prices resulted in renewed producer investment in domestic supply. Natural gas production is now higher than it has ever been in the United States, and crude oil production has returned to its higher mid-1980s level. The increase in production led to a fall in prices, and by 2016 the prices of both oil and gas had dropped by 70 percent since their highs in 2008.
Today, U.S. oil, gas, and coal markets are generally free from price controls and trade restrictions, but Congress still manipulates the energy industry by tax preferences, spending subsidies, and environmental regulations. Those interventions produce various distortions different than the prior price and trade controls, which are the focus here.
Policymakers are often tempted to regulate energy markets. But the following sections on oil, gas, and coal discuss how past federal interventions often backfired, harming producers, consumers, and the broader economy.1
Oil Market Policies
Oil markets have long-term price cycles. The peaks and troughs of those cycles have often coincided with demands for federal intervention. In the 1920s, oil prices were peaking and many commentators believed that oil supplies were running out. Congress was confronted by requests to augment supplies, so it enacted a generous depletion allowance in the tax code for producers in 1926, which increased investment returns substantially. This change induced additional exploration activity and subsequently the discovery of large new oil reservoirs.
During the 1930s, the situation was reversed with prices low and dropping. That led to demands for more “orderly” competition and oil price supports. The Texas Railroad Commission in 1930 issued rules that mandated production reductions to increase prices. The wildcatters in East Texas exploring for new oil ignored the order, and in 1931 a federal district court ruled the order illegal. Ultimately, the Texas legislature added new powers that allowed the Texas Railroad Commission to limit supply legally.
Federal intervention increased enormously in the 1930s. The National Industrial Recovery Act of 1933 (NIRA), which passed with support from large oil companies, substituted producer agreements for normal market competition. The oil industry was the first to adopt a “fair trade” code under the Act. When the Supreme Court ruled NIRA unconstitutional in 1934, the major producers once again turned their attention to Washington. They favored federal regulation to limit supply, but when some in the Roosevelt administration argued for public-utility style regulation of major oil companies (which would involve limits on rates of return), oil company support shifted to the Connally Hot Oil Act of 1935, which gave federal sanction to state government programs that restricted output and raised prices.
After World War II, oil imports increased dramatically because of various state-level policies that limited production and increased domestic prices. Independent oil firms, such as Occidental and Amerada Hess, profited by importing lower-cost oil into the United States. To maintain prices, state production boards further restricted domestic supply. Domestic producers resented the production restrictions and lobbied for import restrictions.
After an intense lobbying effort, Congress adopted a clause in the Reciprocal Trade Act Amendments of 1955 that authorized the president to limit imports of a commodity if he thought such imports would be detrimental to national security. In 1959 President Dwight Eisenhower invoked the clause and imposed oil import quotas.
International oil companies, which were now effectively shut out of the U.S. market, sold their oil in Europe. As a result of a growing world output supplying a smaller market that did not include the United States, the world price of oil declined until the early-1970s. Oil companies responded by reducing their royalty payments to Middle East countries. Those nations responded to the unilateral reduction in their royalty payments by organizing the Organization of Petroleum Exporting Countries (OPEC).
By the early 1970s, oil-import quotas and strong economic growth had exhausted the U.S. oil surplus. State-level production restrictions ended, but domestic production reached a peak in 1970, and then declined until 2008.
In the United States, the effects of a tighter world oil market were aggravated by President Richard Nixon’s price controls. The Nixon price controls, which began in August 1971, were complex and went through a series of phases over time, and they focused exclusively on the prices charged by the largest oil companies. Historically, surplus gasoline produced by the large oil companies was the source of supply for independent retailers. As the world market tightened and crude oil prices rose, the large companies were not allowed to increase their gasoline prices to reflect the increased crude prices, so they reduced their crude imports and stopped shipping gasoline to independent gas stations. By 1973 severe shortages of gasoline developed at independent retailers. Those stations asked Congress for relief.
Congress responded not with a repeal of the price controls on large companies that had caused the problem, but with the Emergency Petroleum Allocation Act of 1973 (EPAA), which created a two-tier price control system for all domestic oil rather than just the oil of large companies. The price of “old” domestic oil was frozen, but “new” production above 1973 levels, as well as imports, were now free of controls.
The shortages disappeared, but new problems arose. In any market in which the price of an input, in this case crude oil, varies, the market price of the output, in this case gasoline, is determined by the most expensive crude oil necessary to meet market demand for gasoline. Thus the price of all gasoline was determined by the price of the most expensive crude oil used to make any gasoline. After EPAA, the most expensive oil was imported and thus its price, and not the lower price of price controlled “old” domestic crude oil, determined the price of all gasoline. But because many refiners had access to domestic old oil that was subject to price controls, they made larger profits than refiners dependent on higher priced “new” domestic or imported oil.
The Federal Energy Administration (FEA) responded to unequal profits across refiners by creating a scheme in 1974 to redistribute money from those refineries with above average access to price controlled “old” domestic oil to those with below average access. All refineries responded by trying to be below average, a reverse of Garrison Keillor’s world of Lake Wobegon. The most straightforward way to be below average in your use of price-controlled oil was to increase your use of uncontrolled imported oil, which was the exact opposite of the goal of U.S. policy at that time. The incentive to increase imports remained until all the excess profits from access to “old” price-controlled oil were exhausted.
The price controls for old oil, ironically, made it very valuable so those who had access “hoarded” it hoping that the price difference between it and uncontrolled imports would grow. Thus the policies enacted by the government to “protect” American consumers from the world market actually increased our dependence on the world market and resulted in spot shortages as well.
The EPAA regulations were scheduled to expire after two years, and Congress replaced them with new rules under the Energy Policy and Conservation Act (EPCA) of 1975. This law placed price controls on previously uncontrolled new oil produced since EPAA had passed. So we went from a two-tier price control system to a three-tier system. The retroactive capping of domestic “new” oil prices created a new source of uncertainty for domestic oil supply investment, and increased incentives to import.
Using power granted under the 1975 law, President Jimmy Carter, in 1979, began to repeal price controls on oil through a series of administrative actions. President Ronald Reagan finished the job in 1981.
Congress allowed oil price controls to expire, but decided to place a windfall profits tax on oil companies in 1980. The tax was not really a tax on profits, but an excise tax on domestic oil production, and thus it made domestic production less attractive, while encouraging imports. One congressional study found that the tax reduced domestic oil production by 3-6 percent and increased U.S. imports by 8-16 percent.2 The windfall profits tax was repealed in 1988, and the period since 1990 has been generally free of petroleum market regulations.3
One exception has been the ban of crude oil exports from the United States, which was enacted by the EPCA. From 1985 through 2008, U.S. crude production declined and the ban was largely irrelevant. But the shale oil boom since 2008 made it relevant again until it was recently repealed. The export ban resulted in a divergence in the price for crude in the United States and the rest of the world during some periods, including an almost $30 a barrel gap in September 2011.4
The effects of the crude export ban were similar to the effects of oil regulations in the 1970s. Because there were no restrictions on petroleum product imports or exports, U.S. gasoline prices were set in the world market. But those refiners in the U.S. that used lower priced domestic crude made excess profits because of their cheap input. Thus the net effect of the export ban was to reduce domestic oil producer profits and increase some U.S. refiner profits. The end of the export ban enacted in the December 2015 omnibus budget agreement has reversed those effects.
Coal Market Policies
Like oil producers, coal producers have had various reasons to dislike open markets, and have often called for federal regulations. As in the oil industry, there have been struggles between lower- and higher-cost producers. Further, coal producers have faced competition from fuel oil, natural gas, and nuclear power.
Higher-cost producers have used federal regulation of worker wages, health and safety, and the environment to disadvantage lower-cost competitors. From the 1930s to the present, coal disputes have been struggles between traditional Appalachian underground mines, which are unionized, and cheaper market substitutes such as non-union and surface-mined coal, and since 2008, cheap natural gas. More expensive coal has attempted to reduce competition from cheaper substitutes through regulation.
As with oil markets, major federal intervention began in the 1930s. Most coal companies were in favor of the Roosevelt administration’s National Industrial Recovery Act, which substituted a producer cartel structure for market competition. After the Supreme Court ruled NIRA unconstitutional, industry leaders and politicians from coal states looked for a substitute.
The substitute was the Guffey Coal Act of 1935, which imposed price controls and various labor regulations on the industry. The effect was to limit competition and to favor high-cost Appalachian coal at the expense of lower-cost coal sources. The Supreme Court struck down the Act in 1936, but a second Guffey Act that included price controls was passed in 1937.
The law was renewed in 1941, but allowed to expire during World War II. After the war, Congress considered a variety of policies to stem the industry’s decline. The depletion allowance was raised modestly, but legislative efforts to boost demand for coal and restrict competition were not successful.
Instead, higher-cost union mines pushed for indirect methods of equalizing coal industry costs at higher levels, such as by having Congress mandate higher mine safety standards. The Department of the Interior imposed new mine safety standards in 1946 and those were codified in a 1952 law. At first, federal rules exempted small low-cost operators, but over the next decade, more comprehensive safety laws were passed that eliminated many smaller competitors. The 1969 Coal Mine Health and Safety Act caused the exodus of small mines, and thus reduced competition for the underground unionized mines.
Another competitive threat to the large high-cost mines in Appalachia was western surface mines. Surface mining began to grow rapidly in the mid-1960s. The struggle to enact federal regulation of surface mines began with the introduction of a bill by President Lyndon Johnson in 1968, and ended with the passage of the Surface Mining Control and Reclamation Act of 1977. In between, President Gerald Ford vetoed bills in 1974 and 1975. The Appalachian mine operators and unions favored federal restrictions, while surface mine owners resisted them. By 1977, however, the unions had organized numerous surface operations, and resistance to surface mining regulation crumbled. The passage of the 1977 Act and the new source performance standards in the Clean Air Act Amendments of 1977 decreased both the productivity and pollution advantages held by western coal.
Federal policies moved in coal’s favor during the 1970s. Expensive and uncertain Middle East oil induced policymakers to adopt policies to shift the nation toward greater coal consumption from domestic sources. The Energy Supply and Environmental Coordination Act of 1974 directed the Federal Energy Administration to prohibit the use of oil or natural gas by electric utilities that could use coal, and it authorized the FEA to require that new electric power plants be able to use coal. The Energy Policy and Conservation Act of 1975 extended those powers for two years and authorized $750 million in loan guarantees for new underground low-sulfur mines. Further pro-coal mandates were passed in the late-1970s.
Coal’s policy history has reflected a series of struggles between high-cost producers and lower-cost substitutes. From the 1930s until 1970, the coal industry was plagued with chronic excess capacity, but disinvestment was slow because of the reluctance of marginal workers and operators to migrate from Appalachia. The struggle over safety legislation was partly a manifestation of the battle between segments of the industry over excess capacity.
Since 1985, coal, like oil, has not been subject to explicit economic regulation. Instead coal regulatory efforts have been environmental in nature regarding the pollution from its use rather than the economics of its production. There has been a continuing struggle over the use of so-called mountain-top removal techniques in Appalachia that blast away the tops of hills and expose the coal, which is then surface mined.5 And in response to the 2007 Supreme Court decision that held that the Clean Air Act did apply to greenhouse gas emissions, the Obama administration issued emission standards that effectively banned new and regulated the CO2 emissions of existing coal-fired power plants.
But the largest problem for coal presently is not environmental regulation but cheap and abundant natural gas. The production of natural gas through hydraulic fracturing techniques has increased production by 29 percent and decreased prices by 70 percent since 2008.6
Natural Gas Market Policies
Natural gas markets possess characteristics that are similar to petroleum markets, but with two important exceptions. First, because the transportation of natural gas across the oceans was historically impossible and now possible but expensive, natural gas producers have been more immune to import competition. Second, the retail segment of the industry has been a regulated monopoly since its inception. Thus political struggles in natural gas markets have been producer-versus-consumer battles, rather than battles between low- and high-cost producers.
The development of interstate pipelines in the 1930s forced Congress to ask whether the production and/or transportation of natural gas are characterized by market failures that warrant public action. Congress decided that interstate pipeline transportation was a natural monopoly that should be subject to public-utility regulation, under which profits and prices are limited.
In 1938 Congress passed the Natural Gas Act, which empowered the Federal Power Commission (FPC) to regulate the rates for interstate natural gas sales and to restrict interstate pipeline construction. To build an interstate pipeline, a company now needed approval from the FPC.
Congress decided in the 1938 Act that natural gas production was not characterized by market failure and should not be regulated. Congress exempted “production and gathering” from federal controls. However, the Supreme Court ruled in 1947 that this congressional exemption only applied to regulation of the physical processes of production. The exemption did not apply to regulation of the sale prices of the product.
In response, Congress enacted legislation to exempt explicitly natural gas producer prices from regulation. But President Truman vetoed the bill in 1950.
In 1954 the Supreme Court ruled in Phillips Petroleum v. Wisconsin that the FPC must regulate natural gas prices at the wellhead. This action had profound effects on the industry, and it generated a huge growth in bureaucracy at the FPC to administer a complex array of new price controls.7 The government would have to decide what the costs of production and “fair” profit levels were for the many natural gas producers across the country. The task was so complicated that the FPC essentially froze prices at 1959 levels until 1974.
Federal price controls applied only to natural gas sold in interstate commerce. Intrastate gas was exempt. As the gap between the low controlled interstate and market intrastate prices grew, producers sold their product within states and withheld supplies from interstate pipelines.
The result was that consumers in states that did not produce natural gas experienced severe shortages during the 1970s. In 1976 and 1977, many factories and institutions such as schools were forced to close occasionally from lack of natural gas.
To economists, the obvious reform was to decontrol interstate prices, but northeastern Democrats in consuming states favored continued controls because they feared constituent reaction to price increases.
In 1978 Congress passed the Natural Gas Policy Act, which replaced the FPC with the Federal Energy Regulatory Commission (FERC) and phased out control of wellhead natural gas prices by 1985 in a complex compromise of temporary price regulations. The compromise kept price controls on old gas but freed up new gas, which created numerous market distortions during the 1980s. Additional legislation was needed in 1989 to finally complete the job of full deregulation of wellhead prices.
Natural gas pipeline rates continue to be regulated as “common carriers,” meaning that the pipelines transport gas owned by others often under long term contracts. An active secondary market exists so that those with long term transportation rights can sell them to others. While distortions from this rate regulation probably exist, they are not consequential enough to have generated much academic or interest group criticism.
The 20th century experience of economic regulation of oil, gas, and coal markets illustrates how federal attempts to control imports, exports, and prices produce perverse and often damaging results. Fortunately, U.S. oil, gas, and coal markets are generally free from price controls, trade restrictions, and direct economic regulation today.
Peter Van Doren is editor of Regulation magazine and a senior fellow of the Cato Institute.
1 A more detailed history can be found in Peter M. Van Doren, Politics, Markets, and Congressional Policy Choices (Ann Arbor: University of Michigan Press, 1991).
2 Salvatore Lazzari, “The Windfall Profit Tax on Crude Oil: Overview of the Issues,” Report 90-442E, Congressional Research Service, September 12, 1990, p. 7.
3 Petroleum markets have been affected by federal policies, but mainly by environmental mandates rather than direct economic regulations.
4 Dan Brusstar and Bluford Putnam, “U.S. Oil Exports Could Narrow WTI-Brent Spread,” CME Group, December 21, 2015.
5 See Jeff Goodell, “How Coal Got its Glow Back,” New York Times Magazine, July 22, 2001.