A windfall profits tax for profiteering?

In a free and competitive market, price always allocates scarce resources and directs production. When allowed to function freely, the U.S. oil industry is a shining example of this dynamic.

Oil is a driving force in the global economy that most of us take for granted.  Petroleum fuels our cars, heats our homes, and is found in thousands of daily-use items from hearing aids to computers. About 80% of all oil consumed in America is produced by small U.S. entrepreneurial ventures.  Without oil, our standard of living, life expectancy and potential for a brighter future would be greatly reduced. 

Drilling for oil to produce gasoline is one of America’s best risk-taking success stories. Drilling for oil places large amounts of capital at risk acquiring permits, finding customers, building pipelines, etc.  Oil entrepreneurs will take risks if they are confident in the potential outcomes. However, even at today's higher prices, many in the oil industry are not confident in expanding operations due to the Biden Administration’s restrictive energy policies.

GOVERNMENT RESTRICTS MARKET AND WANTS TO SEIZE SCARCE RESOURCES

Recently, U.S. Senators  Warren (D-MA) and Sanders (D-VT) proposed a windfall profits tax on U.S. petroleum as West Texas Intermediate Crude recently reached  $130 a barrel – about $17 shy of its 2008 record  – and gasoline realized an all-time high. The average national price for a gallon of gasoline on March 13 hit a record $4.32 (up from $4.01 the week before, $3.48 a month ago, and $2.85 a year ago) helping consumer inflation reach a year-over-year 40-year high of 7.9% in February.

Misguidedly, high prices for petroleum and record high gasoline prices have many thinking a windfall profits tax is a good idea, including former Michigan governor and U.S. Secretary of Energy Jennifer Granholm and President Biden who insist U.S. oil companies stop “profiteering” from high oil prices. What does this mean?

ARE U.S. OIL COMPANIES TRULY EARNING WINDFALL PROFITS? IS A WINDFALL PROFITS TAX BAD POLICY?

Data sets below from Professor Aswath Damodaran’s work as Professor of Finance at The Stern School of Business at NYU show a windfall profits tax on oil is a bad idea, citing the actual performance of the Oil and Gas sector as it relates to Total Market performance from 2008-2021 (representing over 7,000 publicly traded companies across 90 industries).  The data sets represent publicly traded U.S. companies (sources: Bloomberg, Morningstar, Capital IQ and Compustat). Due to a timing lag of data availability and posting, financial data for each year comes from the October-September timeframe (12 months combined).  We used average net margin (net income as a percentage of revenues) as our point of comparison. The Total Market performance for the 14-year period revealed an annual average net margin of 7.18% among 7,035 companies.  The Oil/Gas Production and Exploration industry produced an annual average net margin of –10.6% across 266 companies.  The Oil/Gas Distribution industry showed an annual average net margin of 5.05% (38 companies).  The Oil/Gas Integrated industry produced an annual average net margin of 6.09% (12 companies).  The data shows the Oil/Gas industry underperformed the Total Market.  From 2008-2021 the Total Market never recorded an average net margin loss, however, the Oil/Gas sector recorded large average net margin losses multiple times.

Using data from company annual reports and 10k filings, if you compare the top eight U.S. oil producing companies to just the top eight technology companies, the variance is even greater. Average net margins in 2021? … Top eight oil companies – 7.37%; top eight technology companies – 27.98%, or nearly four times greater. This follows 2020, a tough year for oil due to Covid-19, the emerging remote workplace and the enactment of many government travel restrictions, where the top eight oil companies showed an average net loss of 11.75%, while the top eight technology companies showed an average net margin of 21.33%.

If there was a windfall profit, it certainly was not earned in the U.S. oil industry since 2008.

Also, we predict when 2021-22 income is realized and profit is calculated for the U.S. petroleum industry, it will show short-term price spikes based on changing supply and demand conditions. This does not equate to profiteering – period.

CONCLUSION

Finally, we analyzed gasoline prices adjusted for inflation from 2008 through 2021 (in 2021 inflation adjusted dollars). We found gasoline averaged $3.11 a gallon, with less than a $0.20 fluctuation over the period  based on Bureau of Labor Statistics (BLS) data. This indicates a stable and dependable market for consumers regardless of short-term fluctuations due to world crises or regulation.

Enacting a windfall profits tax at any time is wrong. We believe the market process, driven by the forces of supply and demand, works.

The irrefutable financial data on and the dynamic economic structure of the U.S. petroleum industry compels us to conclude a windfall profits tax on petroleum is indefensible.

About the Authors: 

Dr. Timothy G. Nash is director of the McNair Center at Northwood University.

James M. Hop is chair of the Entrepreneurship program at Northwood University.

Lisa McClain is a member of the U.S. Congress from the 10th District of Michigan.