When I talk to people about the current oil market and oil prices, I often come across three misconceptions. The first is that the high price of oil today will cause a replay of the tremendous losses and dislocations of the1970s after OPEC raised the price of oil. The second is that because the United States had become a net exporter of oil and petroleum products before the recent price increase, we American consumers should be able to buy oil at the old lower price. The third is that countries that rely more on imports will be at risk of not getting the oil they want.
On the first, there are three big differences between the 1970s: (1) the latest price increase of oil since President Trump attacked Iran is substantially smaller, percentagewise, than the increase engineered by OPEC in 1973; (2) the United States is now a net exporter, not a net importer, of petroleum and petroleum products; and (3) so far, we have avoided price controls on oil and gasoline.
The second misconception—that our status as exporter should insulate us from higher oil prices—betrays a misunderstanding of the how the oil market works and, indeed, and how markets work in general. The third misconception—that import-dependent countries will be more at risk than oil-rich countries—is closely related to the second misconception.
I’ll deal with each in turn.
The 1970s versus today
Over a few months in the fall of 1973, the Organization of the Petroleum Exporting Countries, OPEC, got its cartel act together and almost quadrupled the price of oil. The world price rose from about $3 per barrel to almost $12 per barrel. In 1973, the United States consumed 17.3 million barrels of oil per day (mbd), which amounted to about 6.3 billion barrels for the year. The price increase, along with a recession, caused the amount of crude oil consumed in 1974 to fall to 16.6 mbd, a total of 6.1 billion barrels for the year.
In 1974, the first full year after the OPEC-engineered price increase, the United States imported 6.1 mbd, which amounts to 2.2 billion barrels for 1974. So, the loss to the US economy due to the price increase was $19.8 billion. US gross national product in 1974 (we measured GNP then, not gross domestic product, which is approximately the same) was $1.434 trillion. The loss to the economy, therefore, was 1.4 percent of GNP.
Why not measure the loss to consumers on domestically produced petroleum? Because their loss on the domestic petroleum and petroleum products they bought was offset by a gain to petroleum companies, which were largely owned by Americans. So, for the US economy as whole, that loss was a wash.
Unfortunately, price controls made the loss to the economy larger than this 1.4 percent of GNP.
We had price controls beginning with President Nixon’s price freeze of August 15, 1971, and lasting until January 28, 1981, when, after only eight days in office, President Reagan ended them.
After Nixon’s price freeze ended in mid-November 1971, Nixon began various phases of price controls that allowed small percentage increases. The effect on the oil and gasoline markets was minimal. But in October 1973, when the OPEC price increase began, Nixon’s price controls did not allow domestic oil to be sold at anywhere close to the new world price. In fact, the price allowed on so-called “old oil” was only $4.25 per barrel. So that price, not $12, was the price that was allowed to be passed on to refiners and, ultimately, consumers. You might think that was a bargain for consumers, and it was. But because the price of gasoline was not allowed to reach free-market levels, we had shortages. The millions still alive who were driving in 1973 and 1974 probably remember the headache of lining up for as much as half an hour to get gasoline and sometimes finding that the amount they were allowed to buy would not fill their tanks. The loss in people’s valuable time and in their sense of well-being was large.
That was the visible damage done by the price controls. But there was also what nineteenth-century French economist Frédéric Bastiat called the “unseen” damage. With not enough refined petroleum products, including gasoline, to satisfy demand, the government stepped in with the Federal Energy Office and allocated those products around the country. There was a lot of arbitrariness and favoritism. What there wasn’t a lot of was allocation to the highest-valued uses. Central planners in the US government were no better than central planners elsewhere. Refined products, including gasoline, were misallocated around the country.
Here’s how economists Rajeev Dhawan of Georgia State University and Karsten Jeske of the Federal Reserve Bank of Atlanta, in a 2006 article titled “How Resilient Is the Modern Economy to Energy Price Shocks?” explained it:
One can see how price controls have negative effects on productivity. In a market without price controls and any other frictions, the price of a good like oil or a service like labor provides an efficient way of rationing scarce resources because the market allocates them to the most productive use. Specifically, only those firms with the highest productivity are willing to hire workers and purchase energy at a given market price. If, by contrast, the price is not allowed to work as an allocation mechanism, inputs may be used by inefficient firms. For example, if there are lines at gas pumps, those agents who are the most patient or just plain lucky get the gasoline, while the most productive agents may either get no gasoline or waste precious time and resources while waiting in line. This situation affects businesses directly if they purchase gasoline but also indirectly if it creates uncertainty about whether employees arrive at work on time. If the rules of supply and demand are suspended, then idled resources and misallocation of energy lead to less productive use of energy, which shows up as lower productivity or TFP [total factor productivity].
The bottom line is that the loss to the US economy was the direct 1.4 percent of GNP estimated above plus the loss from the distortions due to price controls. A reasonable estimate that includes that loss would put the total loss to the US economy at over 2 percent of GNP.
There’s a further loss from the price controls. When US refiners who had to buy oil at the world price complained that some of their competitors were locked into contracts that provided them oil at $4.25 per barrel, the government could have seen the folly of its ways and ended the price controls. But no. As Austrian economist Ludwig von Mises explained about a century ago, when governments see their regulations causing havoc, they often step in with further regulations that also cause havoc. In this case, President Ford introduced the entitlement program that gave refiners that bought foreign oil an entitlement to buy domestic oil at the regulated price. The price of gasoline at the pump, therefore, was based on a blended price of foreign and domestic oil. For much of the rest of the decade, that program led to enough gasoline being sold to satisfy demand. But it also gave an artificial incentive to buy foreign oil and that strengthened the hand of the OPEC cartel, thus making the world price higher than otherwise. That made the loss even higher than the 2 percent of GNP estimated above.
Now compare the “hit” to the US economy today to the hit in 1974. In 2025, the United States is a net exporter of petroleum and petroleum products. This means that the loss to consumers from the current price increase is more than offset by the gain to domestic producers, which are largely owned by Americans. Therefore, there is a small overall gain to the US economy. That fact might be small comfort to US consumers. But the comfort they feel should be bigger. Don't forget that tens of millions of us Americans own stock in US oil companies either directly or through our defined contribution pension plans.
Moreover, while the loss to consumers qua oil consumers from the price increase is substantial, the price increase on oil creates one offsetting gain to consumers. The increased demand for our oil causes the value of the dollar to be slightly higher than otherwise. With a higher-valued dollar, we US consumers pay slightly less for imports. I thank energy economist Ben Zycher of the American Enterprise Institute for pointing this out.
The net result is that the price increase, unlike in the early 1970s, is a gain to the US economy.
Should our status as a net exporter insulate us?
Why do we American consumers pay the same high price for oil that the rest of the world’s consumers pay? The short answer is that oil is sold in a world market. If we tried to pay less for oil than someone in another country was willing to pay, the seller would sell to that person. As consumers, we all compete.
I was the senior economist for energy with President Reagan’s Council of Economic Advisers from August 1983 to July 1984. While in that job, I discovered an interesting case. In the late 1970s, Turkey’s government had announced that it would no longer allow people in Turkey to pay the high world price for oil. What happened next? Imports of oil into Turkey immediately ceased. I don’t have my memo on the issue handy, but if I recall correctly, the Turkish government relaxed the policy within about a week.
Of course, Turkey at the time was a net importer of oil, so the case isn’t completely comparable to ours. But it’s comparable enough. In a free market, goods and services are sold to those willing to pay the market price, whether they buy from foreigners or from domestic suppliers.
Should our domestic oil producers be allowed to sell to those who want their oil most? Is that fair? Consider this. Many of my neighbors in coastal California have houses that they bought a few decades ago for a price that, adjusted for inflation, was well under half of what their houses are worth now. I don’t know one of them who, when he goes to sell, charges only what he bought it for. Is it fair that these homeowners charge the market price when they go to sell? I think so. And I infer from their behavior that they do too. Why should oil companies be prevented from exercising the same right that homeowners rely on?
Will net importers get no oil?
Now to the third misconception: that being an importer—especially being an importer of oil from the Persian Gulf—puts you at a greater risk of not getting oil than if you were not an importer or were not importing from the Persian Gulf.
The reason it’s a misconception goes back to the workings of a world market. Take a country that has very little domestic production and imports almost all its oil from the Persian Gulf. The closing of the Strait of Hormuz has raised the price of oil and people in that country will be worse off. But they can get oil. It will just be from some other country, and they will have to be willing to pay the world price. It’s true that transport costs will be somewhat higher but that’s a small effect.
I started training myself as an energy economist in 1973 and 1974, when I witnessed the destruction that Presidents Nixon and Ford had inflicted on Americans with their price controls and other controls such as 55-mph speed limits (Nixon) and requirements for fuel economy for vehicles (Ford). In 1977, when President Carter proposed restrictions on air conditioning and usage of recreational boats, I was motivated to continue learning about, and speaking out against, federal energy policy. During that whole time, the United States was a net importer of petroleum.
But during that time, I never worried about where our oil came from. I realized that it didn’t matter. Even in the extreme case where we bought no oil from a particular country, a reduction in that country’s oil supply would have affected us. The way to tell was to see what its effect was on world supply. If world supply fell, we would pay more whether or not we imported from that country.
The world oil market is like a game of musical chairs, except that the number of chairs equals the number of players. It makes for a boring game, but when it comes to international trade, boring is good.
Conclusion
I question the wisdom of attacking Iran and motivating that government to reduce the supply of oil. But even if the higher price persists, we are not replaying the 1970s.
