Oil Industry Posts Record Profits in 2005

Published March 1, 2006

Record profits reported in January by ExxonMobil Corp. and other major oil companies have prompted renewed calls for a “windfall profits” tax on the oil industry … but analysts say such a tax would harm an industry that is spending tens of billions of dollars on capital improvements and pollution controls.

“You need to make money to spend money,” said oil industry analyst John Parry, senior vice president of John S. Herold, Inc. of Norwalk, Connecticut. “If we go back to the 1990s, the oil companies were making less than 5 percent on their capital. If you were to average profits over about a 10-year period, which is the cycle of investment, they have not earned excessive amounts. This is a cyclical industry. You may have seven or eight down years and two or three good years.

“It’s true they are making upwards of 20 percent now,” Parry said, “but this is an industry that is being asked to go through huge expenditures to reformulate gasoline, lower sulfur emissions, and reduce to absurdly low levels emissions from refineries. These all have huge costs.”

American Petroleum Institute senior tax policy analyst Mark Kibbe said, “On the earnings issue, the key message there is that [these] companies are huge. They are dealing with big dollar numbers. What gets reported is aggregate earnings numbers. If you want to compare apples to apples, look at net income on each dollar of revenue. If you do that, we are right around the all-industry average. Our net income is 5.7 cents per dollar of revenue versus 5.5 cents per dollar for the all-industry average over the last five years.”

Schumer, Boxer Lead Demands

New York Sen. Chuck Schumer (D) and California Sen. Barbara Boxer (D) are among a group of federal lawmakers pointing to Exxon’s $36.1 billion profit for 2005 to argue the oil industry should be hit with a windfall profits tax. Schumer and Boxer made similar demands last fall.

“We tried a windfall profits tax in the 1980s and it was a failure,” Kibbe notes. “It caused domestic production to fall. The Congressional Research Service in 1990 said between 1980 and 1986, domestic production was reduced as much as 1.6 billion barrels. Imports increased up to 16 percent over that time, and the CRS attributed this to the windfall profits tax.”

Boxer issued a statement on January 27, just before the official release of Exxon’s profit report, in which she demanded “an end to gouging.” Schumer told reporters on January 30, “the federal government has a responsibility to make sure that these companies continue to innovate instead of just profiting from the status quo.”

Parry said they are innovating by responding to costly government pressures for cleaner fuels and less pollution in the refining process. According to the American Petroleum Institute, the oil industry last year spent about $86 billion on capital expenditures.

Profits Come and Go

Kibbe disputes the idea of windfall profits. “There are no windfall profits,” he says. “In 1999 we had $10 a barrel oil. The oil companies, at least the major ones we represent, weren’t out looking for handouts, were still making incredible investments that far exceeded their earnings. The ExxonMobils of the world are not owned by space aliens. People rely on the earnings and dividends they get from oil companies. They are not nameless, faceless entities that Congress can tax. A windfall profits tax comes out of the pockets of shareholders and consumers.”

Parry agrees. “An awful lot of the profits you see now tend to be the result of a lot of volatility in the market,” Parry said. “To the extent they plow back this money into capital investment, that’s a good thing. And while we talk about Exxon spending $17 billion on capital expenditures and $23 billion on dividends and stock buybacks, that directly and indirectly has a very significant influence on the country.

“Giving that money to widows and retirees and grandmothers is good,” said Parry. “This is a big help to smokestack America, which is holding big pension funds. If they want a windfall profits tax, taking 20 percent off the price of oil stocks, they’re going to drag down a lot of buying power and hurt a lot of people.”

Taxes Already High

Meanwhile, a Tax Foundation study released January 31 shows the oil industry paying high corporate income taxes, undercutting the case for a windfall profits tax, according to the study’s authors.

The Tax Foundation reports Exxon set aside $23.3 billion for income taxes from its 2005 earnings of $59.4 billion, or $3.80 tax per share. That’s an effective tax rate of 39.2 percent on its worldwide operations.

ConocoPhillips reported it expected to pay income taxes of $9.9 billion, or $7.11 per share, from its before-tax profit of $23.5 billion during 2005, yielding an effective tax rate of 42.1 percent. Chevron reported setting aside $11.1 billion from its before-tax earnings of $25.2 billion, or $5.18 per share. That’s an effective tax rate exceeding 44 percent, the Tax Foundation study notes.

“Many who propose taxing energy companies more heavily than other firms, with a ‘windfall’ tax, believe that these firms somehow escape normal taxpaying requirements, leaving other industries to carry a heavier load,” said Scott Hodge, president of the Tax Foundation and coauthor of the new study, in a statement. “But fourth-quarter financial statements show this isn’t true.”

Steve Stanek ([email protected]) is managing editor of Budget & Tax News.

For more information …

The Tax Foundation’s report, “Large Oil Industry Tax Payments Undercut Case for ‘Windfall Profits’ Tax,” is available online at http://www.taxfoundation.org/publications/show/1321.html.