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

| About: Exxon Mobil (XOM)

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 (NYSE: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 (NASDAQ:GOOG) earned 25.3 cents in profit. Apple Computer (NASDAQ:AAPL) earned 14.6 cents per share for every $1 in sales. Microsoft (NASDAQ: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."

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