Taxing oil profits: Proceed with caution

Politicians are dying to get at more of Big Oil's billions, but analysts are torn about what that will do to prices or future energy sources.

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By Steve Hargreaves, CNNMoney.com staff writer

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Politicans want a windfall profits oil tax, but analysts are split over the effects.
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I would most likely take financial advice from:
  • Warren Buffett
  • Donald Trump
  • Oprah Winfrey
  • President Bush

NEW YORK (CNNMoney.com) -- Politicians are eyeing oil profits like a fat juicy glazed ham.

With all the money Big Oil is making - the top five publicly traded firms pocketed over $120 billion in 2007 alone - and with an election on the horizon, it's easy to see why.

The leading Democratic presidential candidates want a windfall profits tax to do various things, and although their plans differ slightly they generally want to use the money to give Americans a break from skyrocketing energy prices and jumpstart research into renewable energy.

House Democrats have also warned of punitive measures if these massive profits continue at the expense of American consumers.

But while the politicians present their plans, analysts are far less sanguine about whether or not a windfall profits tax would actually help soothe steadily rising energy prices and spur R&D for alternative energy sources.

A consumer rights group says that windfall taxes could actually raise gas prices as oil companies might attempt to squeeze refinery production to recoup their lost profit.

"It would have a fairly easy passthrough" to motorists, said Judy Dugan, research director Consumer Watchdog.

Oil industry: Hands off our cash. The industry, of course, doesn't like the extra profit tax.

"If our profits are taxed, that means we'll have less capital to invest in new production" and it could raise gas prices, John Hofmeister, president of Shell U.S., recently told CNNMoney.com.

Oil companies have been investing more in new production lately, but that argument is a little hard to swallow given the disparity between the huge amounts of money the big firms have been returning to shareholders versus the meager new oil discoveries.

Amy Myers Jaffe, a fellow in energy studies at the James A. Baker III Institute for Public Policy just finished a two-year study looking at oil companies and how they spend their money.

The study found that for the five big international oil companies - ExxonMobil (XOM, Fortune 500), Royal Dutch Shell (RDSA), BP (BP), Chevron (CVX, Fortune 500) and ConocoPhillips (COP, Fortune 500) - spending on share buybacks went from under $10 billion a year in 2003 to nearly $60 billion a year in 2006.

Spending on developing their existing oil fields, however, went from about $35 to $50 billion, while spending on finding new oil fields went from about $6 billion to $10 billion.

"These companies are spending a very small amount of their operating cash flow on exploration," she said. "They are spending the majority of their funds buying back stock."

Finding oil: No cheap feat. Recently, oil rich countries like Russia and Venezuela have begun to elbow out foreign companies in order to keep a larger portion of their own energy profits. In the meantime, a shortage of skilled workers and materials has hit the industry, making finding new oil is a challenge.

Oil analysts and the industry itself concede that this turn of events makes it hard for companies to invest profits for new exploration projects and must be redistributed to shareholders.

But it's unlikely this scenario - high oil prices and limited access to resources - will remain static forever, and it's important for oil companies to have access to cash when times change and exploration and development are more achievable, said Antoine Halff, head of energy research at Fimat in New York.

Fields in Mexico, Russia, Venezuela and other places are facing production problems, and its becoming more likely that big foreign firms will be called in to help, said Halff.

Halff said a one-time profits tax probably would have a negligible effect on worldwide production, but a permanent tax would likely hamper the hunt for oil in the future.

What about the Google windfall profits tax? Analysts with energy consultants Wood Mackenzie agree with Halff's take, and introduced a more ideological reason for holding off on a windfall profits tax.

"Do they want to take some from Microsoft too? How about hedge fund managers," asked Wood Mackenzie oil analyst Ann-Louise Hittle, somewhat rhetorically.

It's true that while the oil industry rakes in huge sums of cash in raw numbers, the profit margin for the S&P energy sector, at about 10%, is only slightly higher that the average for the S&P 500.

Google, by contrast, has a profit margin of 25%, yet no one is calling for a special tax on search engines.

Others say there's a big difference between tech and oil companies.

"Their investment decisions affect you and I," said Jaffe. "If Google doesn't make the right investments, it doesn't impact my ability to get to work."

Jaffe also countered that the lack of access and manpower is no reason Big Oil isn't finding more oil now, saying her study showed the next 20 largest oil companies were investing far more in exploration, and finding far more oil.

Government vs. the free market. While the debate about whether or not to tax Big Oil's profit rages on, there's also the debate as to who is best suited to bet on our future energy choices.

The oil companies have been criticized for being shortsighted and not investing enough in renewable resources. Indeed, some want to use a windfall profits tax to fund renewable energy projects.

The counter argument to government sponsored R&D is that when it comes to new technologies, the market picks them best.

"Can [the government] take this capital and do a better job investing it than shareholders can," asked David Kreutzer, an energy economist at the Heritage Foundation, a conservative think tank. 'I'd say no on that one."

Dave Hamilton, director for global warming and energy projects at the Sierra Club dismissed the notion that free markets are the best way to solve the nation's energy challenge, saying capital gravitates towards what's profitable, not what's best for the nation.

"The oil companies are skimming the cream off the nation's economy," he said. "Look where's it gotten us so far. I don't think we've been successful in the last seven years in solving our energy problem." To top of page

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