Wednesday, March 12, 2008

Oil Profits

Robert Murphy addressed the commercial oil industry and their profits in a column at Townhall earlier this week. The industry gets a bad rap both on exploring, producing and supplying the energy we all use but also on the effects that we the consumer produce when we use it. In addition, there is all that money the industry is making - due in large part to politicians in our country artificially constricting domestic exploration and more importantly due to the fact demand is skyrocketing from developing nations. The actual supply of oil being produced is actually increasing, to almost 85 million barrels per day. Another small factoid is that speculation in the commodities market, along with political factors in the Middle East also raise prices.

"When it comes to public hatred of big business, there’s no better target than oil companies. This hatred has been all the more intense since Exxon Mobil announced last year’s net income at $40.6 billion, the largest-ever profit for a publicly-traded company. With the threat of recession looming, many policymakers have been tempted to pay for relief measures by raising taxes on “Big Oil”—including the House’s recent bill rolling back tax deductions on integrated oil companies (though leaving them in place for other companies). Understandable as this impulse may be, it is a bad idea for average Americans. If the government tries to “do something” about record oil profits, it won’t provide meaningful relief revenue, but will certainly raise the price at the pump."

The major reason for the profits of these companies is their sheer scale. In order to compete with national oil companies like SaudiAramco and Petromex, the private energy industry has consolidated and merged to a large degree as once major players like Texaco and Phillips have combined operations with other firms. This has led to huge revenue streams that lead in turn to the imposing profit numbers. But if you look at the industy in terms of margins, you see that several other industries are more profitable. The oil industry makes around nine cents profit for each dollar of revenue. Industries such as banking and software can make several times that figure, and the average of the S&P 500 companies is 13 cents per revenue dollar.

Many politicians decrying these profits are threatening to impose additional taxes on the industry, which would of course be passed on to all of us consumers. The fact of the matter is that the firms paid almost $81 billion in taxes in 2006, and almost certainly more last year. Taxing something is an almost sure way to reduce the supply. As Murphy notes in closing:

"If politicians are concerned about gas prices, they shouldn’t erect extra hurdles for those companies in the business of finding new supplies of oil. If the government really wants to do something, it can roll back restrictions on offshore and Alaskan drilling. Beyond that, it should just let market prices and the profit motive do their jobs."

I have faint hope politicians will keep their noses out, but I have been surprised on occaission. While drilling in Alaska seems to be off the table for now, there are some developments in the Gulf of Mexico that could wind up being sizable domestic contributions to supply.

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