The U.S. Senate on November 17, 2005 voted to impose nearly $5 billion in taxes on oil companies in response to record oil company profits. The Senate rejected three amendments that would explicitly assess “windfall profits” taxes on the oil industry, but nevertheless changed longstanding accounting rules in ways that are expected to add $5 billion to the oil companies’ tax burdens over the next two years.
Unlike all other U.S. firms since the 1930s, the major U.S. oil companies will no longer be able to use the Last-In, First-Out (LIFO) method to calculate business costs and taxable income. This would result in a new $5 billion tax penalty that critics of the move characterized as a windfall profits tax by another name.
Tax Proponents Cite Record Profits
In the third quarter of 2005, the major U.S. oil companies–Exxon Mobil, Chevron, ConocoPhillips, BP America, and Shell Oil Company–collectively earned almost $26 billion in profits, an all-time record. In September and October, gasoline prices also hit historic highs, exceeding $3.00 per gallon in many locations.
Many politicians, pundits, and activists accused oil companies of price gouging and urged Congress to impose windfall profits taxes on the majors. “To my constituents, today’s hearing is about shared sacrifices in tough times versus oil company greed,” said Sen. Barbara Boxer (D-CA). “Working people struggle with high gas prices and your sacrifices appear to be nothing.”
While the congressional hearings were timed to coincide with peak gasoline prices and peak energy profits, experts do not expect either prices or profits to maintain their autumn 2005 highs. According to a November 2005 Standard & Poor’s analysis, “U.S. Oil and Gas Sector Hard Pressed to Repeat 2005’s Stellar Performance in 2006,” gas prices and oil company profits will likely decline in 2006.
Standard & Poor’s expects U.S. oil demand to flatten and even decline by 0.8 percent in 2006, which would be the first oil demand drop since 1990. This will work to soften U.S. gasoline prices and oil company profits. Even with potential supply and demand issues–U.S. refining capacity still is limited, Standard & Poor’s reports, and global demand is more unpredictable than U.S. demand–U.S. gasoline prices and oil company profits are expected to drop in 2006.
By January 2006, nationwide gasoline prices had already dropped approximately 25 percent from their fall 2005 highs.
Boom Brings Overreaction
Oil prices are very unpredictable, and oil companies that suffer bust cycles when prices are low must be allowed to make substantial profits when prices are high, said Jerry Taylor, director of natural resources studies at the Cato Institute. Taylor pointed out that oil companies posted substantial losses in the late 1990s when oil prices fell under $10 per gallon.
“When prices dropped under $10 per gallon, nobody was proposing a law to give oil companies windfall losses rebates,” Taylor said. “And neither should they have. Similarly, we should not seek to help ourselves to oil company profits during this current cycle of profits. Let the market do its work, and American consumers will ultimately benefit.”
In a written statement submitted to the Senate on November 9, Exxon Mobil Chairman Lee Raymond pointed out that in the second quarter of 2005, U.S. oil companies earned about 7.7 cents for every dollar of sales. That is slightly below the average for all U.S. industries (7.9 cents), and considerably below the earnings rates of several other industries, including banks (19.5 cents), pharmaceuticals (18.6 cents), software and services (17 cents), semiconductors (14.6 cents), diversified financials (11.3 cents), and household and personal products (10.9 cents).
Third quarter oil industry profits rose to 8.1 cents per dollar of sales–still in line with the U.S. industry average, Raymond testified.
Oil industry profits are large in absolute terms, Raymond demonstrated, because the customer base is large. The amount of money the industry earns per gallon of gasoline sold is relatively small–a profit of 9 cents per gallon in the third quarter of 2005. Oil companies achieve profits by making modest per-unit returns on gigantic sales volumes.
Raymond also answered critics’ assertions that oil companies siphon out excessive profits while failing to invest enough in future production. He pointed out that during 1995-2004, Exxon Mobil’s annual average capital expenditures–$14 billion–slightly exceeded the company’s annual average profits of $13.8 billion.
Oil Taxes Already High
Supporting the argument that oil companies should not be singled out for new and higher taxes, Jonathan Williams and Scott Hodge of the nonpartisan Tax Foundation released a November 9 paper citing Exxon Mobil’s third-quarter financial statement reports that the company’s year-to-date tax payments total $72.9 billion–almost triple the $25.4 billion the company earned in year-to-date profits.
“The past year has clearly been a good year for oil companies,” Tax Foundation President Hodge said in an interview for this article. “However, these profits pale in comparison to the staggering amount of taxes the oil companies pay each year. In the oil industry, government is the largest profit-taker.”
Marlo Lewis ([email protected]) is a senior fellow at the Competitive Enterprise Institute.
For more information …
Exxon Mobil Chairman/CEO Lee R. Raymond’s November 9 testimony to a joint hearing of the U.S. Senate Subcommittees on Energy and Natural Resources and Commerce, Science, and Transportation is available online at http://exxonmobil.com/corporate/files/corporate/lrr_testimony_11-09-05.pdf.
The November 9 Tax Foundation report by Scott Hodge Jonathan Williams, “Oil Company Profits and Tax Collections: Does the U.S. Need a New Windfall Profits Tax?” is available online at http://www.taxfoundation.org/publications/show/1168.html.