Why a Windfall Profit Tax Is Needed for Oil Companies

by: Bill James

As oil prices rise, oil companies should be assessed a windfall profit tax to prevent profiting from deceiving their customers. Oil companies' failure to notify customers of Peak Oil is the same as cigarette companies deceiving their customers about cancer.

The following graph illustrates the basic nature of oil field geology. Oil companies understand oil field geology and have publicly denied it to the peril of their customers.

[Click to enlarge]
Peak OilClick to enlarge
Trust is essential to free market capitalism. Profits drive action. Each of us specializes in order to profit from our primary talents. We pay a profit to vendors that specialize in filling other needs to be reliable suppliers. Society benefits as each of us specializes in tasks where we can compete most profitably, adding the greatest value at the least cost. Benefits of specialization and collaboration collapse as trust diminishes.

In his book The Wisdom of Crowds, James Surowiecki notes:

Modern capitalism made the idea of trusting people with whom you had "no prior personal ties" seem reasonable, if only by demonstrating that strangers would not, as a matter of course, betray you. This helped trust become woven into the basic fabric of everyday business. Buying and selling no longer required a personal connection. It could be driven instead by the benefits of mutual exchange.

Through social experiments, Surowiecki illustrates how free markets build trust through reciprocity, rewarding fair dealing with profits and punishing breaches of trust. Capitalism requires profits and punishment of vendors who violate their customers’ trust by incompetence, deceit or failing to inform them of critical information relative to the vendor’s specialty:

  • Cigarette companies misled their customers about links between cigarettes and cancer for decades. Eventually they were held accountable. Now that cigarette companies are more honest about cancer, lawsuits are fewer and less punishing.
  • Oil companies are dishonestly profiting from rising oil prices because they have failed to warn their customers about Peak Oil, misleading customers by reassuring them that there is plenty of oil (which there is) without informing them that:
    • The conventional crude oil on which we build our infrastructure and economy has peaked and is in permanent decline, as noted by IEA’s 2010 World Energy Outlook and the U.S. military’s Joint Forces Command’s Joint Operating Environment 2010.
    • Six or more years are required to develop an oil resource. Customers are being led to believe they can currently rely on oil that will not be available for a decade.
    • Capital to develop these oil resources has not been allocated and may never be.
    • Previous attempts to develop some of these oil sources failed after billions of dollars were invested -- so there is no certainty that technical skills exist, within plausible financial limitations, to develop the oil fields.
    • Net Energy from these resources may be less than 5:1. Oil as the lifeblood of the U.S. economy is based on Net Energy of greater than 10:1. At 5:1, it will take twice as much oil, at far greater costs, to obtain the oil we use to accomplish the economic work that is required to sustain the current economy.
    • The price of gasoline from such sources may far exceed $5 a gallon.

Windfall Profit Tax on Oil Companies
Life requires energy. Less affordable energy, less life. Because energy is critical to life, and energy infrastructure takes decades to replace, energy vendors have a responsibility to inform their customers of energy risks far enough in advance of those risks for customers to adapt. Customers’ lives, livelihoods and families are at stake. Instead of warning their customers, oil companies encouraged and lobbied governments to subsidize the creation of oil’s Potato Famine potential: A monolithic dependence on a single source of energy 65% beyond the nation’s ability to control.

Peak Oil (the limits of oil field geology) was proven in 1970 when U.S. domestic oil production peaked as predicted in 1956 by Dr. Hubbert. World Crude Oil Production effectively peaked in 2005 at 74 million barrels per day (mb/d). Oil companies such as Exxon (NYSE:XOM), Chevron (NYSE:CVX), Arco, Shell (NYSE:RDS.A), BP, etc., do not deserve to profit from deceiving, misleading and failing to inform their customers of these global conditions. Federal government officials also failed to warn citizens, and they are culpable for the consequences.

Awareness and Action
If you are surprised by rising gasoline prices, then hold the vendors accountable. By about 2030, there will be 95% less Net Energy from oil. If this surprises you, then your vendors have not informed you of risks in a meaningful way.

The United States of America existed in 1900 with little use of oil. Today we know far more about materials, technology, manufacturing and science than in 1900. We have applied these insights to the communications infrastructure since 1984, creating millions of jobs, vast innovation and re-tooling of a fundamental infrastructure. Power and transport infrastructure networks remain frozen in the government’s central planning that mobilized World War I (see below). We have the gas mileage of the Model T. The highway and oil are monolithic government solutions.

In a free market, the lifeblood of our economy will change from oil to ingenuity.

Investment Guide
Consequences of Peak Oil are so huge that picking single companies or even market segments is as difficult as forecasting Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG) and Facebook in 1984.

But this general principle will hold true. Life requires energy. Less affordable energy, less life. More efficiency, more life.

Long-term energy investments focused on Net Energy solutions of 20:1 or better will likely do very well; wind and solar both fit this category. Investments in efficiency products will do well. Investments in depleting resources will likely do poorly.

Investing in companies that deceive their customers is very risky. Protecting capitalism requires vendors be trusworthy or be prevented from profiting by deceipt or incompetence. My best guess is oil products will be rationed sooner than later, likely when gasoline hits $5 a gallon.

Network investments seem likely to be big winners. The government subsidies to oil and central planning of highways limit efficiency to 32 passenger-miles per gallon. Free market networks, such as railroads, are 97 times more efficient, averaging 436 ton-miles per gallon. When governments end central planning, innovations applied to communication networks will be applied to power and transport networks. Investing in this shift seems attractive.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.