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As Oil Company CEOs Prepare to Testify, Congress Should Pursue Windfall Profits Tax

March 13, 2006

As Oil Company CEOs Prepare to Testify, Congress Should Pursue Windfall Profits Tax

Statement of Tyson Slocum, Acting Director of Public Citizen’s Critical Mass Energy Program

On Tuesday, executives from America’s six biggest oil companies will be defending their record profits before the Senate Judiciary Committee at a time when Americans have been paying record high prices for oil and natural gas. Considering that these record profits are due in part to anti-competitive practices by the major oil companies and that President Bush has said we need to finance alternative energy so we are not “addicted to oil,” a windfall profits tax on oil company earnings is necessary to protect consumers from high prices and to fund alternative energy, conservation and mass transit solutions.

In 2005, the six companies testifying before the Senate Judiciary Committee – ExxonMobil, ChevronTexaco, ConocoPhillips, BP, Shell and Valero – enjoyed profits of $112 billion. Since Bush took office, these companies have accumulated profits of $321 billion.

Oil companies downplay these earnings, highlighting the small profit margins (typically around 8 to 10 percent) that measuring net income as a share of total revenues produces when compared to other industries.

But measuring earnings as a share of revenues is not an accurate calculation of return on investment. In fact, when communicating to Wall Street and investors, companies like ExxonMobil emphasize a completely different methodology to measure profitability, as evidenced by the following excerpt from the company’s 2004 annual report: “ExxonMobil believes that return on average capital employed is the most relevant metric for measuring financial performance in a capital-intensive industry such as” petroleum.

ExxonMobil’s 2005 annual report filed with the Securities and Exchange Commission shows that that company’s global operations enjoyed a 30.9 percent rate of return on average capital employed. The company’s rate of profit in the United States was even higher: domestic drilling provided a 46 percent rate of return on average capital employed, while domestic refining returned 58.8 percent.

This is why a windfall profits tax is justified. It will cost billions of dollars to finance the investments needed to shift our economy away from oil, provide more money to encourage energy efficiency in our homes and cars, and provide more capital for mass transit improvements. All of this can be done with the implementation of a windfall profits tax.

Naysayers argue that the windfall profits tax didn’t work the last time we tried it. The windfall profits tax of 1980-88 was ineffective not because of the tax itself, but because oil prices fell shortly after enactment of the tax due to energy-conserving fuel economy standards that reduced demand and   global events unrelated to U.S. tax policy. Congress enacted the tax in 1980 after U.S. oil company profits surged following the Iranian Revolution and the resulting Iran-Iraq war, which caused oil prices to increase from $14 per barrel in 1979 to $35 per barrel by January 1981. But after 1981, crude oil prices steadily decreased until bottoming out in 1986-87 as demand slackened and other oil-producing countries increased their output. As the value of the commodity subject to tax (oil) fell, the effectiveness of the tax diminished.

But that was then. World oil markets aren’t going to collapse any time soon, because the major oil producers are already producing at full capacity, unlike the 1980s.

A windfall profits tax is also justified because government investigations have found that oil company profits are partially tied to anti-competitive practices. A 2001 Federal Trade Commission investigation revealed evidence of unilateral withholding, which occurs when an oil company controls such a large share of the market that it doesn’t even need to collude with other companies to manipulate supplies and prices – it can do so on its own.

And big oil companies certainly do control the market. In 1993, the five largest U.S. oil refining companies controlled 34.5 percent of domestic oil refinery capacity while the top 10 companies controlled 55.6 percent. By 2004, the top five companies – ConocoPhillips, Valero, ExxonMobil, Shell and BP – controlled 56.3 percent, and the top 10 refiners controlled 83 percent. So as a result of all of recent mergers, the largest five oil refiners today control more capacity than the largest 10 did a decade ago.

The time for Congress to act is now.