In a free and competitive market, price always allocates scarce resources and price 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 our complex global economy, improving our daily lives. Petroleum fuels our cars, heats our homes, and is found in thousands of everyday items from hearing aids to computers. About 80% of all oil consumed in America is produced by small U.S. entrepreneurial drilling operations. 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 for exploration, finding customers, building pipelines and so on. Entrepreneurs will take risks and drill for oil as long as 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.
ABSENT A FREE MARKET
Since early 2021, Biden policies have reduced portions of clean U.S. energy from global markets with negative consequences.
His outcomes:
a.)strengthened policy initiatives of unfriendly countries, b.)increased ally’s dependency on unfriendly countries, c.) Increased sales of dirtier energy resulting in less green energy, d.)strengthened the economies of unfriendly nations, weakened the U. S. economy, tax base and energy sector, e.) forced poor countries to burn more coal, and f.) reduced new U. S. energy production, raised global prices; providing additional funding for Putin’s military.
GOVERNMENT WANTS TO SEIZE SCARCE RESOURCES
Recently, U.S. Senators Elizabeth Warren (D-MA) and Bernie 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 Americans thinking a windfall profits tax is a good idea.
WHY A WINDFALL PROFITS TAX IS BAD Policy?
Simply put, the facts below tell us a windfall profits tax is a bad idea. We analyzed the actual performance of the Oil and Gas sector as it relates to Total Market performance from 2008-2021. We utilized data sets from the work of Professor Aswath Damodaran, Professor of Finance at The Stern School of Business at NYU. The data sets were for publicly traded U.S. companies and the source for the data comes from Bloomberg, Morningstar, Capital IQ and Compustat. Due to the timing of when financial data is available and when the data sets are posted, financial data for each year comes from the October-September time frame (twelve months combined). The Total Market performance is the summary of over 7,000 publicly traded companies in ninety industries. We used average net margin (net income as a percentage of revenues) as our point of comparison. The Total Market performance for the fourteen-year period of review showed an annual average net margin of 7.18% based on an average of 7,035 companies. The Oil/Gas Production and Exploration industry produced an annual average net margin of –10.6% based on an average of 266 companies. The Oil/Gas Distribution industry showed an annual average net margin of 5.05% based on an average of 38 companies. The Oil/Gas Integrated industry produced an annual average net margin of 6.09% based on an average of 12 companies. As you see from the data, the Oil/Gas industry underperforms the Total Market. There was not a single year between 2008-2021 that the Total Market recorded an average net margin loss, while there were several years in the Oil/Gas sector that recorded large average net margin losses. The Total Market net average margin outperforms the Oil/Gas industry over this fourteen-year period.
In a direct comparison of the top eight U.S. oil producing companies (from Exxon-Mobile to Occidental) versus the top eight technology companies (from Apple to Hewlett Packard) (using data from company annual reports and 10k filings) the variance is even greater. In 2021, the top eight oil companies had an average net margin of 7.37% while the technology companies showed an average net margin of 27.98% – or nearly four times greater. In 2020, a tough year for oil due to Covid-19 concerns and the enactment of many government restrictions on travel, 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%.
CONCLUSION
We do not advocate windfall profits taxes on any business or industry at any time and have faith that 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 windfall profits on petroleum is perhaps the least likely industries where a windfall profits tax could ever be justified.
In addition, 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 reveals a stable and dependable market for consumers, regardless of short-term fluctuations due to world crises or regulation.
We applaud the U.S. ban on Russian energy. And, encourage Washington decision-making to be driven more by the market with less political intervention. Energy prices and the cost of living would decline, leaving Americans more in this challenging economy.
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.