Taxing “Windfall Profits”

I have a few essays in the queue (including a nifty biodiesel story), but I thought I would comment on an article in today’s Deseret News out of Salt Lake City. The article was entitled “Will U.S. Slap Tax on Big Oil Profits?”. (1) A few excerpts from the article, followed by my comments:

Republican Sen. Arlen Specter said Sunday that the U.S. Congress should consider taxing the “windfall profits” reaped by oil companies as a result of surging crude oil prices.

I understand the frustration with high gas prices even as oil companies rake in record profits. But what is Specter trying to accomplish? Does the good senator believe this will magically bring the price of oil down? Will it cause OPEC to open the taps, flooding more oil into the market? Or is the real purpose to punish oil companies for making money, so he can boast about it during his reelection bid? Would he stipulate that the money be allocated to somehow reducing our demand for oil, which is the real issue?

Specter, of Pennsylvania, earlier this month introduced legislation to strengthen antitrust enforcement of the oil and natural gas industry to counter the consolidation of production and refining operations. Sen. Byron Dorgan, D-N.D., is proposing a 50 percent excise tax on profits from oil sold at more than $40 a barrel.

Let’s think about that for a moment. A lot of oil is expensive to extract, and only becomes economically viable as oil prices climb higher and higher. As oil prices climb, the incentive to pump more oil increases. If more oil can actually be pumped, it should eventually result in an oversupply situation, and prices will come back down. (This is why the oil industry is cyclical). If more oil can’t be pumped, then prices won’t come down.

However, neither situation is helped by slapping a tax on oil over $40 a barrel. In fact, such moves decrease the reward for marginal producers, which may lead them to shut in production. Since foreign producers won’t be paying that tax, what do you think is going to happen? U.S. production will decrease further, imports will increase, and oil prices will remain high. If high oil prices are the objective, then this is a way to accomplish that objective.

“Windfall profits, eliminating the antitrust exemption, considering the excessive concentration of power are all items we ought to be addressing,” Specter said Sunday on CNN’s “Late Edition” program. “Anybody up for election this year ought to be working very hard, taking it very seriously.”

Oh, I bet they are. That’s why they ignore the real reasons for rising oil prices, and aren’t doing anything to address those issues. They are posturing and pandering, trying to make sure they get themselves reelected. The founding fathers would be rolling over in their graves if they saw the level of mediocrity that permeates our government today. Nobody has the guts to stand up and tell the truth.

Sen. Carl Levin, D-Mich., said President Bush should call oil company executives to the White House and tell them he’ll support a new tax on their profits unless they lower prices.

“I’ll bet that the price of gasoline would come down within a matter of days,” Levin said on the CNN program. “We need a windfall profits tax because these profits have been absolutely obscene.”

Wow! Is Levin this uninformed? Does he think oil company executives set the price of oil? Does he not understand that oil is a global commodity, and if China or India are willing to pay more for oil than we are, then that is going to drive the prices up? That’s sort of like asking a company to lower the value of their stock, because you want to buy some, but think it’s too expensive. It’s the price it is because that’s what buyers and sellers in the open market have agreed upon for a value. Oil company executives do not set the price of oil. This only happens in politician’s dreams.

Bush, in California over the weekend to promote his initiative on alternative fuels, said a lack of refining capacity in the United States and the thirst for oil in emerging economies such as China and India are contributing to increased energy costs. He said he recognized the price of gasoline is hurting consumers and warned that the price is likely to go higher.

Like him or hate him, Bush is correct about this. I bet even the good senators would agree with this. So, let’s pose a question. A lack of refining capacity is a problem that is putting a lot of pressure on gasoline prices. Expanding refineries takes lots of capital. If we extract more money from the oil companies in the form of punitive taxes, are they likely to spend more money or less money on capital projects? Now, is this likely to make the refining bottleneck better, or worse? Again, if your goal is to have gas shortages and drive the prices even higher, then they are on the right track. Like I have said before, we tried this already and it didn’t work. (2) From a 1990 Congressional Research Service report:

“The windfall profits tax reduced domestic oil production between 3 and 6 percent, and increased oil imports from between 8 and 16 percent. This made the U.S. more dependent upon imported oil.”

This report should be required reading for legislators who think a windfall profits tax is a good idea.

Specter has focused his attention on oil industry consolidation and competition. “We have allowed too many companies to get together to reduce competition,” he said.

There were more than 2,600 mergers in the oil industry in the 1990s, according to James Wells, director of natural resources and the environment for the Government Accountability Office. A study by the GAO, Congress’ research arm, found that concentration of market power may have added as much as 7 cents to the price of fuel, he said.

As much as 7 cents? I think Senator Specter has identified the culprit. Gasoline prices are “as much as” 7 cents higher than they would be had they stopped those mergers. This is clearly the source of spiraling gas prices. If it was “as much as” 7 cents, I wonder what the lower estimate was. It really sounds like Specter is on a wild goose chase.

While politicians pander, I am still waiting for someone in government to have the guts to suggest that a potential solution to this problem is to encourage Americans, somehow, to conserve. I am waiting for someone to explain that cheap oil is not an American birthright, and as long as China and India compete for the same oil, there will be no more “cheap” oil. Of course more expensive oil will enforce conservation eventually. Maybe the politicians are much smarter than I think, and this is part of the plan. If we adopt the policies they are advocating, oil prices will spiral out of control, gas will no longer be affordable, and we will finally start conserving. Maybe there is a method to their apparent madness.


1. “Will U.S. Slap Tax on Big Oil Profits?”, Deseret News, April 24, 2006.

2. Glassman, James K., “Windfall Profits” Tax on Oil Companies, Capitalism Magazine, September 26, 2005.

18 thoughts on “Taxing “Windfall Profits””

  1. Well, I guess the government figures its an easy way to get some money while looking like they’re on the job. They tax and, in the eyes of the public, thereby punish the bad guys. The bad guys realize the error of their greedy ways and lower prices. I’m not saying that it will work that way – only that it will play well in Peoria. We’re vengeful animals.

  2. I don’t think we need to worry about the oil companies not having their interests aggressively defended.

    Perhaps a windfall tax would just about balance out the windfall subsidies they are scheduled to receive (NY Times Feb 13):

    “The federal government is on the verge of one of the biggest giveaways of oil and gas in American history, worth an estimated $7 billion over five years.

    “New projections, buried in the Interior Department’s just-published budget plan, anticipate that the government will let companies pump about $65 billion worth of oil and natural gas from federal territory over the next five years without paying any royalties to the government.

    “Based on the administration figures, the government will give up more than $7 billion in payments between now and 2011. The companies are expected to get the largess, known as royalty relief, even though the administration assumes that oil prices will remain above $50 a barrel throughout that period. “

    This story has gotten very little play.

    my best, bart

  3. If we adopt the policies they are advocating, oil prices will spiral out of control, gas will no longer be affordable, and we will finally start conserving. Maybe there is a method to their apparent madness.

    Got it in one.

  4. I agree on a windfall profits tax. Share the love. Have it cover a reduction in the payroll tax so working Americans aren’t losing out.

    That, or have it pay for renewable energy research, public transportation, and the creation of walkable communities.

    At any rate, my rowhome in a good part of town is going to go up in price if only for the fact that I’m less than a mile than everything, and within walking distance of everything except a beer distributor.

  5. Perhaps a windfall tax would just about balance out the windfall subsidies they are scheduled to receive (NY Times Feb 13):

    The thing is, they have already testified that they don’t require these subsidies. Senator Feinstein summarized it in a press release:

    At the joint Senate hearing last week, at which the CEOs of ExxonMobil, Chevron, ConocoPhillips, BP, and Shell testified, Senator Wyden asked them if, given the fact that oil prices are above $55 per barrel, they needed these Federal tax incentives. They all responded “No.” In fact, Lee Raymond of ExxonMobil stated this: “No and I don’t think our company has asked for any incentives for exploration.”

    Link: Feinstein Press Release

    There is a world of difference between removing an incentive they say they don’t need, and slapping on a punitive tax that has been demonstrated in the past to depress oil production in the U.S.


  6. I agree on a windfall profits tax. Share the love. Have it cover a reduction in the payroll tax so working Americans aren’t losing out.

    That’s the whole point, though. That’s not what will happen. If the objective is to reduce gas prices, which is what the politicians seem to be after, a windfall profits tax is not going to work.

    If, on the other hand, the objective is political, then I am sure it will score points. The downside is that it will drive prices even higher, and give rise to potential gas shortages.

    Finally, you know they wouldn’t dedicate the money to addressing the real problem. I have argued before that if they really do go through with a windfall profits tax, they need to direct that revenue directly toward giving rebates to people who purchase high fuel efficiency vehicles. But that money would just go into the general revenue stream, and will have done nothing to address our high energy consumption (which is the real problem).


  7. A “windfall tax” is a politically expedient excuse so that politicians don’t have to blame the real problem–consumers and their love of the SUV, and driving in general.

    Why am I supposed to blame the oil companies for making money and feel sorry for the person who is on the news complaining about high gas prices when she just bought an SUV THREE WEEKS AGO? Why am I supposed to feel sorry for people who spend $400 a month in gas to drive back and forth to work when they live 4 blocks away from a train that will take them into the city for half that, in the same amount of time?

    Americans just can’t handle being told that they might have to make compromises in their life.

  8. The LA Times reports today (April 25, 2006) that a 2% surtax on ‘so-called windfall profits from pretoleum producing, refining, and sales activities’ garnered the minimum 4 votes to move to its next committe. The tax is estimated to bring in $190 million annually.

    A proposed Clean Alternative Energy Act taxing extraction in the state would generate $380 million a year to fund research on how to end our addiction to oil.

    Give me just one million dollars and I will say ride bikes, use transit, turn SUVs into housing for the poor, grow food locally, be nice, say thank you, give your mother a smile.
    The world will be a better place and I’ll be a millionaire. Sweet.

  9. Nothing novel to say here, but I am extremely impressed with your blog. You explains your points perfectly, especially to us non-science thinkers.

  10. I saw some comments in an AP story today that echo the point in my essay:

    Andy Weissman, an energy analyst at FTI Consulting in Washington, said members of Congress would be making an unfortunate mistake if they were to attempt to curry favor with voters by holding public hearings and lashing out at short-term oil industry profits rather than working behind the scenes on genuine solutions to the country’s energy crisis.

    “It’s not going to make us better off in any fundamental way five years from now if there is a windfall profits tax on producers and it could hurt if it discourages production,” Weissman said. “What is going to matter is a plan for reducing consumption and adding supply, and I think Congress has so far failed to live up to that.”


  11. Oh, and thanks for the compliment, Matt. I try to discuss this stuff without going into too much technical detail, because I know people’s eyes start to glaze over if it gets too technical.


  12. Robert, I love your blog and mostly agree with you on windfall profits, but I’d make these points:

    Oil companies share some characteristics of Utilities; they are essential to our current way of life, and due to market consolidation are starting to smell a bit monopolistic. They do not operate in a “free market” in that most of us can not easily choose to not buy gas. As such, some amount of regulation of the industry in the public interest is not unreasonable.

    Our country has a very unhealthy budget deficit. While I could certainly come up the needed spending cuts if you made me dictator (I mean decider), that isn’t going to happen, so we need more revenue. I think taxes should do as little damage to society as possible. They should not impoverish the middle class, for example. They should not quash entreprenurialism. But when a mature, established industry makes enourmous, heretofore unheard-of profits, without having done anything to improve the lot of this nation other than conducting business as usual, that seems like a situation where some taxation would not kill the goose. Who would it actually hurt? Some overcompensated oil industry management and well-heeled energy investors. (I include myself in the latter category)

  13. George,

    If the consensus is that a tax should be enacted, it needs to be a higher gasoline tax, and not a windfall profits tax. A windfall profits tax is guaranteed to limit supplies, and could lead to gas shortages. A higher gasoline tax would provide increased incentives to conserve, which would stem demand and make our oil supplies last longer.

    Neither solution is going to bring gas prices down. Nothing is likely to accomplish this, short of a gigantic new discovery. But higher gas taxes would address the root of the problem – excessive consumption. Of course it is political suicide to suggest increasing gas taxes, so it is not seriously considered.

    Finally, just what constitutes a windfall profit? Oil companies have lower profit margins than many other industries. It is their sheer size that makes the overall profits so huge. But people don’t look at profit margins, only profits. If Citibank makes a 20% profit margin on sales, and ExxonMobil makes a 10% profit margin on sales, who is making excess profits? ExxonMobil, because they are so much bigger than Citibank? Windfall profits taxes don’t make any sense when they completely ignore the actual profit margins. If Company A is five times as big as Company B, then I expect that Company A may make more money.


  14. Robert – What about reports that Exxon (don’t know about the other majors) spent more buying back stock than on exploration and r&d in 2005? I’m sympathetic to your argument that windfall profits tax would be conterproductive, but if they are spending more on shares than exploration, it’s seems hard to accept that a windfall tax would curtail anything other than maybe share buy back.


  15. If only the oil from pre-2004 wells (drilled under the assumption of $25/bbl oil) was subject to the tax, it would affect exploration not at all.  It would be a straight transfer from the petroleum shareholders (and management) to the US treasury.

    This would be great politics for the Democrats, because the oil companies appear to be mostly run by, and supporters of, the Republicans.  If I didn’t despise the idea of taxation as a political weapon I could go for this whole-heartedly; on the other hand, it could be considered just adequate payback for the damaging energy policies enacted at the behest of those same oil companies and their execs.

    This is quite the moral dilemma for a libertarian.

  16. Ana-

    Maybe the majors know something the rest of us don’t, such as domestic exploration wouldn’t yield very much new supply and thus isn’t an option that should be pursued. Offshore in say Florida or Virginia is currently off limits, so what’s to explore? Global market price determines what’s economical to produce, and I’m pretty sure the geologists have scanned much of the globe in 4 dimensions. Also, what form of R&D would grow domestic supply, short of improving the ability of deepwater rigs to withstand Cat 5 hurricanes in the Gulf, or something along those lines?

  17. Hello Ana,

    I am not going to defend XOMs use of their profits. I don’t know enough about their specific situation to do so. I would say that if I, as CEO, felt that my company’s shares were significantly undervalued, I think buying back shares is fine. If I am buying them back because I have nothing better to do with the cash, then that is a red flag.

    I did just post something related to this topic over at The Oil Drum. When ConocoPhillips CEO Jim Mulva testified before the senate last fall, he said:

    ConocoPhillips has been investing its earnings back into maintaining and expanding supplies. We had 2005 earnings of $13.5 billion – about $1 billion a month, but our capital investments also were close to $1 billion a month. In fact, over the last three years, ConocoPhillips’ earnings were about $26 billion while investments were just over $27 billion. ConocoPhillips expects to grow its base with continued high levels of investment. In 2006, we intend to maintain our higher investment rate to increase supply of crude oil, natural gas and refined products.

    So, not everyone is spending the majority of their cash flow on share buybacks.


  18. If only the oil from pre-2004 wells (drilled under the assumption of $25/bbl oil) was subject to the tax, it would affect exploration not at all. It would be a straight transfer from the petroleum shareholders (and management) to the US treasury.

    But it would dimish present day cash flow, which is used to fund future exploration and capital projects. See COP CEOs comments above.


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