Why I'm Anti a 'Windfall Profit Tax' on Big Oil

I was going to speak today about our national budget and discuss discretionary versus non-discretionary spending. But I decided to put that article aside for another time and address something recently in the papers again: creating a "Windfall Profits Tax" on Big Oil. 

This is a tricky first subject to write about. Many of you may automatically think I'm taking a position that is anti-Democrat or pro-Republican. But my position has to do with neither party - it has to do with business and economics, first, and a desire not to hurt us, second. Sometimes the cure is worse than the disease, and in this case, I see it no differently.

I know the price of oil is having a terrible impact on many families. Indeed, every time I fill up my tank the absurdity of the gas prices I pay jump right out at me. Add to that the fact that the price of food has skyrocketed (I can't believe a gallon of milk costs $5 friggin bucks these days!) and many Americans are feeling a terrible squeeze.

Having grown up on welfare and food stamps I know what it's like to be poor. I know what it's like to eat macaroni and cheese dinners at night. I know what it's like to watch gas fare replace meat at the dinner table. it's shocking, it stinks and it has got to stop.

But creating a windfall tax on big oil companies is not the answer. (In fact I thought it was just politicking until Congress actually voted on the bill - I couldn't believe it!)

Let me explain why I believe this using everybody's favorite bad-guy these days, ExxonMobil (XOM). I'm going to go over a list of common reasons good friends of mine have used when debating with me recently:

Popular Reason #1: $40B Dollars is a "Windfall Profit" Which Deserves a "Windfall Tax" 

Yes, it is true that XOM earned an astounding $40 billion dollars profit in 2007. Even more astounding when I think about it is that they earned that money on over $350 BILLION in revenue. But a closer look at the numbers reveals a company whose profit of $40 billion is far from a "windfall" by any definition of the word you want to use.

For 2007, Exxon's profit margin was 11.3% of sales. That means that for every dollar in revenue the company generated, they earned 11.3 cents in profits.

How does that compare with the rest of corporate America? if you look at the numbers, it's clear that Exxon - regardless of the eye popping number of $40 Billion performed...well, quite average.

For every $1 in sales Google (GOOG) earned 25.3 cents in profit. Apple Computer (AAPL) earned 14.6 cents per share for every $1 in sales. Microsoft (MSFT) earned 30 cents in profit for every $1 in sales as did Warren Buffett's Berkshire Hathaway (BRK).

Clearly, each of the companies above earns far more in profits for every dollar in sales then Exxon does. But how does Exxon compare with the rest of corporate America? It's profit of 11.3% is actually slightly less then the average profit of all companies in the S & P 500 - 12%.

That's right - even with oil skyrocketing this year the company's profit margin is actually expected to DECLINE to the 10% range as costs increase for the business as a whole and profits decline.

From Exxon's point of view an 11.3% profit margin is great - especially when compared to the 5% profit margins it earned throughout the 1990s when oil hovered between $10 and $20 bucks a barrel for the better part of the decade.

Takeaway: For 15 of the past 20 years Exxon earned profits less then half the average company in America. If profitability is the measure of how we define "windfall profits" then there are far more companies that can be taxed at whatever rate we choose. This is a slippery slope to me that implies that can quickly turn into a corporate witch-hunt.

Popular Reason #2: A "Windfall Profits Tax" on Exxon Can Be Used to Give Relief to Drivers 

Who would decide what % of Exxon's $40 Billion in profits is fair to take? How would that decision be made? if the government decided that 25% of the total profits, or $10 Billion was to be taken as a "penalty" for "windfall profits" where would that money go? How much of an impact would that have on our lives? Would it mean that every driver in America gets 5 gallons of gas for free, one time?

Secondly, if Exxon has less profit to invest in its business that means it will have less profit to plow into finding new sources of oil or investment into alternative energies. We've already seen how incredibly expensive oil has become due to excessive demand - do we need any more pressure on companies finding additional supply?

Last but not least, does anybody know who even owns the stock in Exxon? 99% of the company is owned by large investors like pension funds and mutual funds. Most of you reading this right now probably have Exxon stock in a retirement account through your 401k and don't even know it.

In short, a "windfall profits" tax on Exxon would be like robbing your left hand to pay your right hand. It just simply doesn't make any sense to me whatsoever.

The less money Exxon has in profits the less capital it will have to be able to compete and drill for new

Popular Reason #3: Exxon Actually Got Taxpayer Breaks, So They Should Give Some Back! 

Of all the conversations I have with folks, this seems to upset them the most. And that's understandable. But there are a couple of points I must make here that are critically important:

Exxon doesn't compete with mom and pop operations any more. That world is long gone. Today, Exxon's biggest competitors are international oil companies often owned by foreign governments.

So yes, on the surface it seems absurd that the US government would give tax breaks to this company when their making all this money. But consider this: Exxon competes again Russia's Gazprom, Saudi Arabia's Aarmco, China's Cnooc and many other very large and very well funded competitors.

And unlike Exxon, which gets relatively small tax breaks from our government, their competitors are actually divisions of their own government! So Exxon isn't competing directly against corporations in a fair way - it's now competing with government sponsored oil companies from Russia, Suadi Arabia and China and each government is pouring all of the resources at its disposal to make sure these companies have a competitive advantage over Exxon.

The tax breaks our government gives Exxon is paltry compared to what countries like Russia are doing to fund and support oil giant Gazprom. (For an example of just how much backing Gazprom gets from Russia check out the stories this week about how the government is trying to help them take British Petroleum's $60 Billion properties away from the company and hand them to Gazprom).

In short, the international battlefield for natural resources is going to be incredibly tough for a very long time to come. Anything we do to cripple Exxon - which is, in a way, our national oil company - would put them at a serious disadvantage against these well funded giant competitors.

And if you believe that oil and national security are closely aligned we simply cannot allow that to happen.

Popular Reason #4: Big Oil Companies Like Exxon Love It When Oil Prices Are So High 

Sure, oil companies like it when oil prices rise. But they certainly don't like it when they rise as much as they have so fast!

You see, oil companies and oil producing states have this formula clocked to a science. If you can imagine a supply/demand curve you can visualize a point on the chart where the optimal price meets optimal demand. In other words, its the price where you can sell the most amount of oil and gas to the most amount of people for the longest period of time.

I know this is a hard one but stick with me folks: oil companies know that for an average consumer oil should not exceed a certain percentage of their total expenses. Let's say for example that oil companies know that once oil and gas prices exceed 5% of a families budget, demand will drop off as the family changes its habits, cars, etc.

Whenever oil becomes too expensive for consumers a couple of things happen that oil companies hate: (1) demand drops off (as witnessed by the 40% drop in SUV sales last month and; (2) competing forms of energy become economically feasible.

Put yourself in the shoes of the oil company (as hard as that sounds) for a second: would you rather get paid big money for only 5 - 10 years (if you consider 11.3% profit margins big money in a corporate sense of the word) OR would you rather make 8% profit margins for the next 25 years?

It's kind of like the drug industry. The never invent the cure they only look to treat these illnesses. The same goes with oil firms: the higher the price of oil stays the more likely we'll find a "cure" in the form of alternative energy. And that's something that they simply do not want.

Popular Reason #5: High Oil Prices Are All About the Economic Growth Coming From China and India

Well that's true - for the most part. As you all remember from Econ 101 - increases in demand tend to put upward pressure on prices.

Indeed, when America boomed economically after World War II the old Europeans saw the price of commodities like steel soar through the roof. And there was nothing they could do about it - it was just a new fact of life: America was a new economic powerhouse and the demand it created was going to send prices higher until the market could adjust to meet the new demand.

But there's something else that's been nagging me recently every time I go fill up my gas tank. It's the fact that I, like many Americans, drive a gas guzzling SUV.

So these days, as I've driven past empty Hummer and SUV car showrooms I've started to wonder what part my desire to drive an SUV played in this whole affair.

15 years ago America was still shaking off the oil shock of the 1970s and most of our cars were still small. But since then, it seems that not only have we added many new cars to the road, but the cars we did add we super-sized.

Double the cars at double the size. Regardless of the impact of India and China I have to believe that I and many of my friends who bought large trucks must have played some part in the increase of demand.

Nope, my feelings on this one is that whole oil is overvalued in the short-run (remember, it's priced in dollars and dollars are declining and demand is finally starting to seriously dry up); in the long-term, we're going to have to seek more permanent solutions to our dependence on oil.

And no, I do not own stock in Exxon nor have I been paid to say what I just said. I just don't see making big oil pay a "windfall tax" as a serious solution to a very serious problem.

And if there's one thing I'm sick of at this point of my life, it's being looked in the face by politicians and being told that there are actual solutions to our problems that don't require any pain.

If we keep believing stories like that, we'll never be able to say we were able to carry the baton handed to us by the "Greatest Generation."

Comments

[buyitcheap:]

You're absolutely right. It's not the right answer. If that were the case, we'd have had a windfall profits tax whenever any company has a good year, like financials did in 2007 just before they screwed us all. What about a Batman box office tax? Nobody expected the movie to do that well, so isn't that a windfall? My concern is, the more this argument flows into the lexicon of our discussions, and becomes accepted, we creep closer and closer to a socialistic/nationaliz... economy. Keep up the good work!

2008 Aug 06 07:23 AM

[Michael Fit...:]

Windfall profits tax didn't work before, and they won't work now. They will lead to less domestic production. If Congress wants to get serious about the US's oil problems, they will focus on adopting a long-term comprehensive strategic energy policy, not on domestic oil producers!

thefitzman.blogspot.co...

2008 Aug 06 07:59 AM

[OTL:]

You covered all the important points for this topic very well. Good job.

For the past decade or more I have wished that 1) All politicians be required to take an IQ test 2) All politicians be forced out of office after 1 term. They are directly responsible for the decisions that have been made to bring us to where we are today.
RP
optionstradinglessons....

2008 Aug 06 08:19 AM

[Pipeweld:]

Dylan, Thanks for some coomon sense!

2008 Aug 06 08:30 AM

[john s. gordon:]

try not to beat up on the poor politicians - they only do what their corporate campaign contributors tell them to do (it's payback time charlie).
> jack

2008 Aug 06 08:33 AM

[mcadoo3312:]

Very well done.

2008 Aug 06 10:09 AM

[Bo20990:]

I came across something interesting to me. The following came from the Congressional Budget Office. Was prepared on May 18, 2007.... Everything you hear, the Members of the majority party are condemning the Bush Tax Cuts and constantly talk about doing away with the tax cuts and taxing the wealthy... They never tell you that small business owners who create the most jobs, with the way the tax code is structured, fall into the wealthy class. This makes it plain to see that we have a spending problem, not a taxing problem... No reason for entrepreneurs to invest and take a chance when the government is going to take away large portions of possible profits. Might as well buy the governments bonds and take what they'll give you...

Growth in Federal Tax Revenues From 2003 to 2006

Total federal revenues grew by about $625 billion, or 35 percent, between fiscal year 2003 and fiscal year 2006. CBO’s analysis of that increase in revenues since 2003 is necessarily preliminary because relevant data are not yet fully available. CBO examined the available data using the commonly employed method of analyzing the sources of revenue growth as a percentage of GDP. Had revenues grown at the same rate as the overall economy between 2003 and 2006, federal receipts would have increased by only $373 billion. The other $252 billion of the actual increase in revenues represents growth in excess of GDP growth. As a result, receipts as a share of GDP rose from 16.5 percent in 2003 to 18.4 percent in 2006, an increase of 1.9 percentage points.

Sources of Growth in Tax Revenues

That increase of 1.9 percentage point of GDP can be traced to changes in different types of revenues (see Table 2). The bulk of the revenue increase was associated with corporate income taxes: Revenues from corporate income taxes rose from 1.2 percent of GDP in 2003 (their lowest level since 1983) to 2.7 percent in 2006 (their highest level since 1978). That increase of 1.5 percentage points of GDP in corporate income tax revenues accounts for the bulk of the overall 1.9 percentage point rise in revenues. Revenues from individual income taxes increased 0.6 percentage points, from 7.3 percent of GDP in 2003 to 8.0 percent in 2006. And revenues from taxes other than corporate and individual income taxes were relatively stable over the period from 2003 to 2006, slipping 0.2 percentage points, from 7.9 percent to 7.7 percent of GDP.

2008 Aug 06 12:16 PM

[Dr. Fred:]

The first step is to have an EDUCATED Congress that WANTS to be serious. Most only seem concerned about the political "game" (followers that point their finger at everyone else) than take responsibility or be leaders we elected to represent us! We should "flush" them and the news media... can we start over again please???

2008 Aug 06 12:44 PM

[kurt walter:]

Will Obama become America's first Marxist president?

2008 Aug 06 01:55 PM

[dtblount:]

OTL, I'd like to add a 3rd rule to your list: CONGRESS MUST HAVE MORE NON-LAWYERS.

There is no reason a bunch of lawyers should be deciding US policy on energy, banking, healthcare, economics, etc, etc...

As for windfall profits, the only success they would attain is to make the US less of an attractive place to base operations. The most important aspect of Capitalism is allowing for the environment that rewards success. Levying taxes on companies with record profits is simply anti-Capitalistic.

Populist economic policies simply do not work...


Cheers

2008 Aug 06 02:40 PM

[henarl:]

Excellent !! It should be mandatory reading for every member of Congress (at least all of the literate ones).

2008 Aug 06 03:03 PM

[Ron Abate:]

Excellent article. Considering the long period of time between the time when expenditures are made to acquire and develop a field and the revenues from that field, even though the price crude has increased dramatically the discounted rate of return basis of those profits are quite modest. Fields last for 30 years. For example, a $125 price today versus a $3 price in 1973 works out to an 11% annual rate of increase, not really spectacular. If you then adjust the $3 per for inflation over the period, even assuming modest inflation of 3% per annum, the inflation adjusted increase would be a modest return of 8%. The real windfall profits are made by politicians who purchase remote land and then earmark funds for a road to that land. In a matter of a few years or even months, that politician can double or triple their money with very little risk. Those are windfall profits but you will never hear about them. Throw the bums out but I am afraid that we would only vote for new bums because in a democracy our elected representative are a reflection of us.

2008 Aug 06 03:42 PM

[Oil Man 99:]

There are 355,537 oil wells in production as of 2006.

There are 4.5 million royalty owners receiving about 14% of the 5million barrels daily produced from these 355,000 wells.

Do the math and the average royalty owner gets a small check each month.

Obama likes to pontificate that he will impose a Windfall Profits Tax upon “BIG OIL COMPANIES”. However, for those of us who worked in the oil industry during the Carter years know first hand the royalty owners also had their royalty checks dramatically reduced by WPT.

It seems to me the message needs to get out that it is not only the oil companies whose profit will be confiscated under an Obama WPT scheme, but also the profits going to millions of royalty owners.

Furthermore, as we know the Oil Producing States collect production, severance, and extraction taxes on the gross value of the oil produced. Under WPT the Oil Producing State’s oil taxes will be reduced.

2008 Aug 06 09:10 PM

[Timothy Stolz:]

Excellent article! From the comments posted, it is evident that it was read by people who support your views on the windfall profit tax. Now, what is to be done about those whose minds you could change if they simply would read the article?
I plan to make a few copies and take them to work tomorrow and hand them out. What about the rest of you?
That is how change begins; one mind at a time.

2008 Aug 06 10:12 PM

[rapswork:]

i think you should look into this issue more thoroughly. you would find the u.s. oil companies are not such benign players in the cost of oil. some of it is spelled out at straightrecord.com/ene... and com/lease. u.s. oil companies have their fingers deep in foreign oil production and the oil-drilling policies of opec and member countries. most of the oil sold by u.s. oil companies is foreign oil and they pass along the same markup (generally 100 percent these days) of manufacturer to wholesale as they do on domestic oil. and a good investigation of big oil's involvement in the huge price rise probably would uncover manipulation of the stock market speculation. where do you think enron learned its tricks?

2008 Aug 06 11:14 PM

[AlexS:]

Good article. More information here than in an entire month's worth of Time, Newsweek, U.S. News, New York Times, and Al Franken. Sorry you won't be hired as a journalist. They only hire people who scream "hate Bush, hate Bush."

2008 Aug 07 12:22 AM

[moore:]

How could anyone see this any differently. Thanks for a great article. The reason we get nuts in Washington is that only the rich can run for office and they have no idea what really working your butt off is about. How do they think that taxing the workers harder to give to the non workers is going to improve anything. This is only common sense.

2008 Aug 07 10:50 AM

[AlexS:]

We should do like the Chinese back during the Cultural Revolution. Send 20 Senators to go to work picking vegetables, send 20 Senators to work on drilling rigs, send 20 Senators on that show about catching Alaska king crab, send 20 Senators to start their own business and within a year make them profitable or they lose their seat, send 20 Senators to work in a chicken processing plant. Six years of that and they can re-run for their old seats.

2008 Aug 08 01:01 AM

[rud-yard:]

A SUPER EXCELLENT ARTICLE, BY AN INTELLIGENT WRITER, WHO HAS LOGICALLY POINTED OUT THE PITFALLS OF THE WINDFALL PROFITS TAX. UNFORTUNATELY THE MASSES OF IDIOTS WE HAVE IN THIS COUNTRY BELIEVE EVERYTHING THE PHONY LYING AND ARROGANT POLITICIANS TELL THEM. THEY DON'T HAVE A CLUE
ABOUT ECONOMICS AND RUNNING A BUSINESS. JUST PROMISE THEM
"HOPE" AND "CHANGE" AND THE SHEEP WILL FOLLOW. IF THIS
PASSES YOU WILL SEE THINGS TURN FOR THE WORSE AND THE
ONE WORLD SOCIALLISTS WILL RUN OUR GREAT COUNTRY.

2008 Aug 09 01:04 AM

[Big Dog:]

Fantastic article. The oil companies and OPEC do not want us using less oil, they want us using more!!! But, if oil stays this high, they (oil companies and OPEC) know we will start seeking alternatives to oil. We do need to seek better and other ways of producing energy. Solar, wind, nuclear, ethanol, etc. Work on them all!!!
Think about this, our government does not want us using less oil. They do not want us seeking alternatives. Why you ask???? One word, TAXES !!!! They tax our use of petroleum based energy. The more we use, the more they can waste. If we start using less petroleum, and start using more alternatives, they will lose tax money. Because alternatives will be given a tax break. It is not Big Oil or OPEC that is against us, it is our own government. They will pander us to death about wanting to seek alternatives to oil. If they were so concerned about it, why after 30 years since the last oil crisis, are we still so dependent on oil? Like everything else, follow the money, and you see who is behind this.

2008 Aug 11 09:29 AM

[User 202650:]

This is a good reason to vote for Mc,Obama could lose over this tax .

2008 Aug 20 10:21 AM