Musings: Can't People Find A New Way To Regulate O&G Industry?

On January 18th, Representative Denis Kucinich (D-Ohio), along with five liberal Democrats in the House of Representatives, introduced a bill that displays not only a lack of understanding about the basics of business, but also champions some of the most failed government economic policies of the past 40 years. The bill, H.R. 3784, otherwise known as the "Gas Price Spike Act of 2012," would, as its preamble sets forth: "…amend the Internal Revenue Code of 1986 to impose a windfall profit tax on oil and natural gas (and products thereof) and to allow an income tax credit for purchases of fuel-efficient passenger vehicles, and to allow grants for mass transit." For this group of politicians, profits are as dirty as the crude oil they are derived from. While the preamble sets forth the premise of regulating energy industry profitability, the proposed mechanisms in the bill demonstrate the worst of a social engineering mandate. 

The "Gas Price Spike Act of 2012," would, as its preamble sets forth: "…amend the Internal Revenue Code of 1986 to impose a windfall profit tax on oil and natural gas

The premise of the bill is the mantra that fossil fuels are bad and the "excess" profits they produce should be confiscated by the government and handed over to the buyers of politically-correct, fuel-efficient vehicles and the operators of mass transit systems.  What's worse about the policy is that not all fuel-efficient vehicles would benefit, only those assembled in this country by union labor. 

So just what are "excess" profits, or for that matter "reasonable" profits? To answer those questions, we would have to await the determination by the Reasonable Profits Board, which would be a three-member board appointed by the president for three-year terms.  (Sounds like Rep. Nancy Pelosi and Obamacare.) Once they figure out what is an acceptable profit for the oil and gas industry, the law would levy an excise tax of 50% of the excess profits between 100% and 102% of that reasonable profit measure. For excess profits between 102% and 105%, the excise tax would be 75%, and anything above 105% would be taxed at 100%. 

One of the requirements to serve on this board is that you don't work in the industry. We would hope, however, that the members would at least understand business and the respective measures of profitability. That might stand in contrast with many of President Obama's economic and cabinet appointees. What should be the test of "reasonable" profits?  Should it be the absolute dollars? Or maybe it should be the company's profit margin percentage. There is also a case to be made that profitability should be measured based on return on equity. Whichever measure is used, there will be problems in determining what's reasonable, since reasonableness should be based on the capital needs of the industry. 

We would hope, however, that the members would at least understand business and the respective measures of profitability

Exxon Mobil Corp. (XOM-NYSE) generated a 9.1% profit margin last year, but that was over two percentage points below the margin of Chevron (CVX-NYSE).  More importantly, while those oil company profit margins exceeded those of GM (GM-NYSE) and Ford (F-NYSE) at 6.6% and 5.1%, respectively, Apple (AAPL-NYSE) had a 25.8% margin, Microsoft's (MSFT-NYSE) was 32.6%, and Google's (GOOG-NYSE) was 25.7%. So why should oil companies be punished given their low profit margins? Just because ExxonMobil earned $41.1 billion last year and Chevron $26.9 billion, admittedly very large numbers, they were nowhere near as profitable as some of our high tech powerhouses. If you look at return on equity, Apple (45.6%) and Microsoft (41.7%) were way more profitable than ExxonMobil (26.8%) or Chevron (11.4%). 

We know, we'll devise a new "Buffett rule." Berkshire Hathaway (BRK.B-NYSE) for the twelve months ended September 30, 2011, earned $11.6 billion in net income. The problem is that its profit margin was only 8.2%, only besting the beaten up auto companies. On a return on equity measure, Berkshire Hathaway only mustered a 7.6% performance, coming in last among all these companies. No Buffett rule here. Even GM had a 26.2% performance through September, but then again it had all its debt stripped away by the Obama administration's restructuring (we won't use the term bankruptcy). A recent article in The Wall Street Journal pointed out how GM hopes to report profits of $8 billion for 2011, a nice recovery, but then again the article pointed out that the company is not paying any taxes as a result of its bailout. (Above figures from Yahoo Finance.) 

Exhibit 5. GM Is Making Strong Profit Recovery

What gets lost in this populist assault on the oil and gas industry is its size and capital-intensive nature. Last year, ExxonMobil generated $453 billion in revenues while its major U.S. competitor, Chevron, earned $236 billion. These numbers compare to Apple's $127 billion, Microsoft's $72 billion and Google's $38 billion. The two auto companies – GM and Ford – were similar in size to Apple at $149 billion and $134 billion, respectively, but more importantly, they are comparable to Berkshire Hathaway's $142 billion in revenue.  Because the oil companies are so large, their profit numbers are going to be large even with modest profit margins. To punish them due to their absolute size would be akin to requiring all National Basketball Association players over 6-feet 10-inches tall to have to wear 10-pound ankle weights during games to counter their height and ability to jump. 

Assuming there are excess profits to tax, where would the funds go? First, they would go to buyers of fuel-efficient passenger vehicles.  Buyers would get a $3,000 tax credit for a vehicle with a fuel-efficiency rating within 10% of the most fuel-efficient vehicle. Buy a car with a rating within 5% of the most fuel-efficient and you would get $4,500. But if you buy a car that gets at least 65 miles per gallon, you get a $6,000 tax credit. This latter category would include all the electric vehicles, some hybrids and a select number of very small cars, many of which have been arbitrarily assigned very high mileage ratings. 

The most interesting point in this section of the legislation is the definition of what is a Qualified Passenger Vehicle. While that classification includes measures such as having been purchased after the effective date of the legislation, being first used by the owner and only for personal and not business use, the car has to be American-made. Moreover, as subparagraph B of the section states, a qualified car is one "which is assembled in the United States by individuals employed under a collective bargaining agreement."  Assuming you want this tax credit, your vehicle shopping list will be limited to models from Chrysler, Dodge, Jeep, Ford (F-NYSE) and General Motors (GM-NYSE). You also could choose from Mazda Motors' (MZDAF.PK) Mazda 6 and Tribute models and Mitsubishi's Eclipse. Otherwise, you're out of luck. 

Excess profits would go to buyers of fuel-efficient passenger vehicles

Any left over money collected can be given out by the Secretary of Transportation to operators of mass transit systems to help them reduce fares during gas price spikes. Mass transit means rail and bus systems, but the grants are made on a fiscal year basis and remain in effect until funds are expended. Nowhere in this bill is there a definition of a gas price spike – so we guess it has already happened. Without a definition, we wonder what happens if oil and gas prices decline? 

The Lima News in Lima, Ohio editorialized that Rep. Kucinich's bill would do little but guarantee the return of gasoline lines such as the nation experienced in the 1970s. Those lines came partly as a result of the shocks to the petroleum system from the quadrupling of crude oil prices following the Arab oil embargo after the Six Day War in 1973, and the Iranian Revolution and capture of American hostages in 1978. The reactions to these events prompted politicians to become involved in directing how the flow of oil and gasoline moved in this country and controlling product prices to protect consumers. That meddling in the business produced little more than long lines of cars at gasoline stations and restrictions on the amount one could purchase on a visit. 

The reason for the gasoline lines was that the government relied on population statistics to allocate gasoline volumes.  As these statistics were notoriously late, and especially before the widespread use of computers, gasoline volumes were always allocated based on historical population measures that were out of date. The only question was just how out of date they were. The statistics failed to capture the mass population migration from the Rust Belt states to the jobs Mecca of the oil producing states. As a result, states like Ohio and Michigan had areas swimming in gasoline and no lines while Dallas, Houston and Tulsa, to name a few oil-centric cities, had horrendous gasoline lines and rationing. The experiments of regulating the industry proved that bureaucrats didn't have the ability to anticipate demand changes and their regulations masked the price signals that appropriate allocate petroleum products. 

A different situation occurred in the 1980s after the Iranian Revolution when President Jimmy Carter signed into law the Crude Oil Windfall Profits Tax Act. That law imposed a 70% excise tax on the amount of an oil sale price exceeding $12.81 per barrel. According to the Congressional Research Service, domestic oil output declined by 3%-6% and oil imports rose by 8%-16%.  Due to the recession's impact on the economy, oil demand fell, bringing oil prices down and causing the tax to generate very little revenue. 

With this bill, Rep. Kucinich and his band of followers have committed the folly of planning to repeat history because they haven't taken the time to know their history. As a result, they will prove Albert Einstein's definition of insanity correct – repeating the same thing over and over and expecting a different result. We are not sure which is the worse criticism - the claim of insanity or of ignorance? These politicians clearly don't understand anything about business, only about politics, and for that Americans will suffer. 


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