About Those Big Bad Oil Companies . . .

by Marlo Lewis on May 26, 2011

in Blog, Features

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On May 17, the Senate voted 52-48 for S. 940, the Close Big Oil Tax Loopholes Act, sponsored by Sen. Robert Menendez (D-N.J.). The bill would selectively hike taxes on the nation’s five largest oil companies (Chevron, Shell, BP America, Conoco Phillips, and ExxonMobil).

The bill failed of passage, falling eight votes short of the 60 required to overcome a filibuster.

But that was just one skirmish in the protracted political war against U.S. energy production. A majority of Senators voted for the bill and gasoline prices could hit new highs in the summer driving season. So expect more anti-oil demagoguery from the World’s Greatest Deliberative Body in the very near future.

Demagogues feed and exploit public ignorance and frustration. Nobody likes paying $4.00 a gallon for gas, and self-styled progressive politicians, pundits, and activists claim Big Oil is “price gouging,” reaping “windfall profits,” and not paying their “fair share” of taxes. They claim we’d all feel less pain at the pump if Big Oil felt more pain on April 15. This popular narrative has no basis in fact or economic logic.

On May 12, the Senate Finance Committee held a hearing on S. 940 at which all five Big Oil execs testified. The testimonies clearly explain why three “big-oil tax loopholes,” as Chairman Max Baucus (D-Mont.) called them, are nothing of the kind.

The foreign tax credit, available to all U.S. multinationals who pay taxes abroad, simply prevents U.S. firms from being taxed twice. Other nations have similar policies to prevent double taxation of their firms. Contrary to Baucus, the foreign tax credit is not a “tax break,” much less a Big Oil tax break.

The manufacturing tax credit too is available to all domestic industrial producers, not just Big Oil. The credit encourages U.S. firms to produce (and create jobs) within the USA rather than overseas. Maybe that’s a bad idea from the standpoint of global economic efficiency. Nonetheless, most Members of Congress and their constituents think it’s better to create jobs in the USA than in China. If Baucus and Menendez think differently, they should say so.

The tax deduction for intangible drilling and development costs simply allows oil companies to write off expenses that are as genuine as other firms’ R&D costs. Nothing amiss here.

The testimonies do not address the tax deduction for exhaustion of oil and gas wells, which S. 940 and Team Obama also want to repeal. Suffice it to say that producers of other depletable resources — hard rock minerals, geothermal energy, timber — also claim depletion allowance deductions. So again, what Baucus and Obama want to selectively repeal is not a “big oil tax loophole” but a deduction for which many types of business are eligible.

Now let’s look at some basic information on oil industry profits, tax payments, and gasoline prices.

We often hear that oil industry profits are high because oil companies gouge us at the pump. Supposedly, they use their “market power” to manipulate prices. But about 85% of the price of gasoline is explained by the cost of crude oil, a globally traded commodity with prices set in international markets, according to the Federal Trade Commission. And U.S. oil companies are not big enough to manipulate the price of crude even if they wanted to.

Notes ExxonMobil’s Ken Cohen:

ExxonMobil owns less than 1 percent of the world’s oil reserves, and it produces less than 3 percent of the world’s daily oil supply, so it’s really not credible to suggest that we are responsible for world oil prices. ExxonMobil actually buys more crude oil than we produce.

In the global crude marketplace, U.S. oil companies are price takers, not price setters.

Nor is there much room for market “manipulation” at the refining stage of Big Oil’s operations. Cohen explains:

The part of the business that refines and sells gasoline and diesel in the United States represents less than 3 percent – or 3 cents on the dollar – of our total earnings. For every gallon of gasoline, diesel or finished products we manufactured and sold in the United States in the last three months of 2010, we earned a little more than 2 cents per gallon. That’s not a typo. Two cents.

In contrast, Cohen points out, a “major component of the price of gas is state and federal taxes, which range from a high of 66 cents per gallon in California to a low of 26 cents per gallon in Alaska, according to January 2011 data.” You got that? ExxonMobil’s markup on each gallon of finished product is 2 cents. Federal and state bureaucrats get a much bigger markup. Bureaucrats don’t risk a dime of their own money to produce petroleum, refine it, or bring the finished products to market. Yet they collect 26-66 cents on every gallon of gasoline sold. Where’s the windfall profits tax when you really need it!

Another common falsehood, propagated endlessly by oil bashers, is that U.S. oil companies aren’t paying their fair share of taxes. Conoco Phillips CEO James Mulva dispelled this myth at the May 12 hearing.

Of the top 20 Fortune 500 non-financial companies (ranked by market capitalization), the three U.S.-based oil and gas companies represented here today are the top taxpayers on the list. In fact, ConocoPhillips tops the entire list, with a 46 percent effective tax rate. By comparison, the top 20 companies together pay an average effective rate of 27 percent. While there have been some media reports on our industry’s actual tax burden, this fact seems to be consistently and unfortunately overlooked in the debate inside the Beltway.

Politically-correct GE, the corporate darling of the Obama administration, has an effective tax rate of only 9%. You don’t hear Baucus or Menendez complain about that.

Mulva also points out how crazy it would be from an energy security and balance of trade standpoint to exclude the U.S. oil majors from eligibility for the foreign tax credit. In 1970, international oil companies (like the U.S. majors) could bid on leases in 85% of the world’s proved reserves. In those days, only 1% of proved reserves was under exclusive control of “national” (state-owned) oil companies. Today, 74% of proved reserves is under exclusive control of national oil companies and international oil companies can bid on leases in only 7% of proved reserves. Subjecting U.S. firms to double taxation would squeeze them out of the small fraction of world oil deposits to which they still have access. The Menendez plan would make America more dependent on foreign energy producers. Brilliant!

Let’s look at other charts in Mulva’s testimony.

Demagoguery is all about manipulating the optics of issues. It’s easy to hate Goliath. The U.S. oil majors are certainly big compared to the minors and compared to most other U.S. firms. But why are they big? They have to be to meet the daily fuel needs of 300 million Americans. Which, incidentally, also explains why oil companies make so much money. If you refined millions of gallons of petroleum every day and made two cents profit on each gallon sold, you’d make billions of dollars too!

A point oil bashers conveniently forget to mention, though, is that in the global marketplace, U.S. majors are the Davids, not the Goliaths.

One way to assess the claim that Big Oil’s profits are exorbitant is to compare oil industry profits per dollar of sales with those of other industries. As you can see, there’s nothing out of line here.

Similarly, the oil industry is about average in terms of cents of net income per dollar of sales.

Oil industry return on investment also hovers around the S&P average.

To repeat, what makes oil different is the volume of sales. America is not “addicted to oil,” but human beings highly value mobility. Until somebody comes up with a motor fuel that beats petroleum on the basis of cost and performance, oil will remain the preeminent commodity of the world’s biggest mass market. That’s life, Sen. Menendez, get over it!

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