Today’s surge in oil company profits amid the Iran-driven energy shock has understandably generated accusations of profiteering and price gouging. I spent the first half of my career in the oil industry, so I recognize my own industry sympathies. I am also a committed free-market capitalist. But I have a gut-level discomfort with the juxtaposition of record corporate profits with American consumers struggling to pay at the pump for reasons entirely beyond their control.
Still, there is an important distinction between “windfall profits” and “price gouging” — and understanding it starts with recognizing that today’s problem is increasingly one of refining capacity and product availability rather than simply a shortage of crude oil.
Global refinery runs have fallen sharply, driven by war-related disruptions in Russia and the Middle East, and, earlier this year, China curtailing refinery operations and fuel exports to protect its domestic market from high oil prices. Goehring & Rozencwajg Associates estimates that refinery runs fell by roughly 5 million barrels per day earlier this year, accounting for much of the apparent decline in global oil demand.
If demand for gasoline, diesel, jet fuel, and other refined products holds up while refinery throughput falls, inventories tighten and refining margins soar. That is exactly what has happened. The Gulf Coast 3-2-1 crack spread — the margin implied by turning crude oil into gasoline and diesel — has recently traded far above its historical norm, while the U.S. diesel crack spread surpassed $100/barrel for the first time ever, recently reaching $108. Fuel-oil inventories at major global trading hubs are roughly 30% below seasonal norms.
Meanwhile, U.S. refiners are hardly sitting idle to exploit the shortage. Refinery utilization recently reached 98%, the highest since 2018. There simply isn’t much unused domestic capacity available to quickly fill the global shortfall.
This matters when assessing accusations of price gouging. Oil and refined products trade in competitive global markets. When geopolitical disruptions remove supply, prices rise — even though the cost of extracting an existing barrel of oil may change very little. Refiners likewise benefit when disruptions elsewhere make gasoline and diesel scarce. That produces enormous profits for companies fortunate enough to have uninterrupted production and refining capacity, but extraordinary profits are not themselves evidence of market manipulation.
Gasoline prices largely follow a market-based formula: crude oil cost plus refining margin, transportation and distribution costs, taxes, and retail margin. Those components can soar when supply is constrained, but they also move in the opposite direction. During periods of oversupply or weak demand, crude prices and refining margins can collapse, producing thin profits or outright losses. That two-way risk is fundamental to a market economy.
So, today’s record profitability is better described as a geopolitical windfall than systematic consumer exploitation. But acknowledging that distinction and adhering to free market principles does not mean policymakers must ignore the burden on consumers.
Price controls would be particularly counterproductive because they suppress the very price signals that encourage additional supply and conservation. A broad windfall-profits tax could similarly discourage investment precisely when America needs more production, refining, pipelines, storage, and other energy infrastructure. And it’s unreasonable to expect competitive companies to convene on their own to collectively cap profits in the spirit of altruism.
So, a better compromise might be a modest, temporary levy applying only to profits exceeding an exceptionally high historical profitability threshold, coupled with the ability to offset that levy through incremental domestic energy investment. Companies could reduce or eliminate the levy entirely by reinvesting extraordinary profits in new production, refinery upgrades, pipelines, storage, or other infrastructure, and importantly. Those choosing instead to distribute the extraordinary profits to shareholders would pay the temporary levy.
Any proceeds should be returned directly to American households through a temporary energy dividend or tax credit rather than disappearing into the bloated federal budget.
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The objective should not be to decide how much profit an oil company “deserves.” Nor should we punish an industry merely because global market forces temporarily moved dramatically in its favor. Instead, the goal should be to preserve market pricing and profit incentives while recognizing the extraordinary circumstances of a geopolitical supply shock.
That is the distinction policymakers should keep in mind: windfall profits produced by scarcity are not the same thing as price gouging. But neither does a commitment to free markets require pretending that extraordinary circumstances never justify a narrowly tailored response.
Scott Martindale is CEO of Sabrient Systems LLC, an independent equity research firm and RIA.