The tax bill recently signed by President Trump should be a boon to corporate America. The bill will drop the corporate tax rate from the current 35% to 21%.
But energy companies, which have historically had a higher tax burden than other companies, stand to benefit the most.
The Highest-Taxed Sector
According to the corporate tax calculator at MarketWatch, the energy sector’s median tax rate for the past 11 years was 36.8%, far above the 30% average tax rate for all S&P 500 companies.
Companies at the top of the list, like Marathon Oil Corporation and ConocoPhillips, pay taxes at a rate of nearly 50%. That’s primarily because they have significant foreign operations, and incur foreign taxes that in some cases are much higher than U.S. taxes. In addition, they usually have to pay severance taxes for oil and gas they extract.
Even most of the lowest-taxed companies on the list pay more taxes than the average S&P 500 company. But energy companies are getting two major breaks in the new tax bill.
Two New Tax Breaks For The Energy Sector
The first break is the obvious drop in the corporate tax rate from 35% to 21%. This will benefit energy companies across the board, but some will benefit more than others. More on that below.
But one more significant item in the tax bill will immediately boost the fortunes of the entire energy sector. The energy business is probably the most capital-intensive sector. Each year, companies across the sector invest billions of dollars into new projects.
For instance, Chevron Corp. recently announced a 2018 budget for capital and exploration spending of $18.3 billion. ExxonMobil made $22 billion of capital expenditures this year.
Under current tax law, these expenditures can’t be deducted in the year they are incurred. But the new law allows capital expenditures to be deducted in the year of their occurrence. This change will further lower the tax burden for the energy sector while encouraging more capital spending.
Higher Earnings Ahead
Energy companies should benefit across the sector, but refiners are projected to benefit the most. One reason for the increased benefit to refiners is they have consistently enjoyed positive pre-tax income in recent years (in contrast to many of the oil and gas producers).
Bloomberg recently calculated that refiner Phillips 66 could see its earnings next year increase by 16% from the tax change. Andeavor’s per-share earnings were projected to increase by 20%.
At the other end of the spectrum, Master Limited Partnerships (MLPs), which consist primarily of midstream companies, are already exempt from corporate tax for earnings that are passed through to unitholders. Thus, since they already receive favorable tax treatment, they will see less benefit from the tax reforms.
Prepare For A Rally
Energy companies have rallied since August as oil prices have climbed higher. But because the new tax law will disproportionately benefit the energy sector, all else being equal the sector should outperform the S&P 500 because of expectations for higher earnings.
Of course, oil and gas prices are other variables that must be accounted for, but that won’t be an issue unless prices sharply drop. Expect the overall energy sector, but especially the refining sector, to emerge as the most significant sector winner from the tax reforms.