Case in point: Eliminate big oil’s subsidies and royalties and reap the rewards.


With unleaded gas prices rising into the $4/gallon range; it is no wonder that Exxon and other oil companies are unleashing record 1st Quarter profits.

A Natural Resources staff review of recent earnings announcements by the five largest oil companies operating in the United States shows that this industry has generated outsized profits that undermine the necessity for continued tax subsidies and royalty-free drilling access.

Hugely profitable multi-national oil and gas companies are set to enjoy $53 billion in royalty-free drilling over the next 25 years and $36.5 billion in taxpayer subsidies over the next decade.

In his State of the Union speech, President Obama called for an end to these tax subsidies:

“I’m asking Congress to eliminate the billions in taxpayer dollars we currently give to oil companies. I don’t know if you’ve noticed, but they’re doing just fine on their own. So instead of subsidizing yesterday’s energy, let’s invest in tomorrow’s.”

Tax Breaks and Royalty Relief Ridiculousness

The President’s remarks have focused renewed attention on the impact that outdated legacies of the tax code and failed royalty-relief policies have on our current energy system.

Most oil and gas subsidies have been on the books in the United States for many decades. They represent an era when oil and gas exploration was in its infancy, and when resources were plentiful but remained largely unexplored.

Intangible costs of exploration generally include wages, costs of using machinery for drilling, and the costs of materials like drilling muds, chemicals, and fuel that get used up during the process of building wells.

Since 1968, this program has cost the U.S. Treasury $78 billion. Ending this tax subsidy would raise nearly $8 billion over the next decade.

Tax breaks that allow oil and gas companies to use the “percentage depletion allowance” were first put in place in 1926. Rather than writing off the actual costs of the property over its useful life, like most businesses must do, some oil companies get to simply deduct a flat percentage of gross revenues.

Under this method of accounting, total deductions regularly exceed the actual capital invested to acquire and develop the reserve.

When this program was started, stimulating massive exploration around the geologically unknown United States was so important that oil and gas companies were allowed—through this preferable tax treatment—to recover amounts in excess of their investment.

Since 1968, this program has cost the U.S. Treasury $111 billion. Ending this tax subsidy would raise more than $10 billion over the next decade.

Subsidies to Oil Companies Do Not Benefit the Public

The oil and gas industry argues that the tax breaks they enjoy encourage them to develop more oil and gas deposits, which lead to increased oil and gas supplies and lower energy prices.

The Natural Resources Committee Staff’s analysis suggests otherwise for two primary reasons:

1. Depending on the reservoir and the physical characteristics of the hydrocarbon, the cost of producing oil can range from as little as $2 per barrel in the Middle East to more than $15 per barrel in some fields in the United States, according to the Energy Information Administration.

The profit incentive to explore and produce new supplies for this lucrative market dwarfs any marginal benefit that existing federal tax breaks for oil exploration or production could provide.

As President George W. Bush said in 2005, “With oil at more than $50 a barrel, by the way, energy companies do not need taxpayers’-funded incentives to explore for oil and gas.”  Now that oil prices have risen to $100 barrel, the same logic still applies.

2. In recent years, higher oil company profits have increasingly been redirected into dividends and stock purchases, not exploration. Among the Big 5 oil companies, less than 10 percent of profits are reinvested into exploration of new oil deposits.

Net profits directed towards dividends and stock repurchases for the Big 5 oil companies were 58 percent in 2005, 73 percent in 2006, and 72 percent in 2007, 71 percent in 2008, and 89 percent in 2009.

Dumping profits into stock buybacks drives up share prices for remaining shareholders by concentrating ownership, and, in the process, acts to increase the values of stock options for executives.

It also reduces the amount of capital available for new exploration and improvements in drilling safety. The current tax treatment does not incentivize oil and gas companies to diversify into clean energy alternatives.

While some oil companies tout their commitment to research into alternative energy resources, a review of actual corporate investments in research and development (R&D) reveal a business model which appears wildly averse to innovation.

While companies in high-tech sectors like pharmaceuticals and semiconductors regularly invest 15-18 percent of their revenues in R&D, U.S. energy companies invest less than one quarter of one percent of revenues in R&D.

Repealing the oil industry’s tax subsidies will not impact gas prices for American consumers. Oil, the main input and primary cost driver of gasoline, is traded in a global market and oil companies get paid the going market price for the oil they produce.

On the oil market, there is no difference between an unsubsidized barrel of oil that costs $10 to produce and a subsidized barrel that costs $9.50 to produce. Each barrel will sell for the same price, almost $100 on the oil market. Oil companies that receive tax subsidies pass on that benefit to their shareholders, not to consumers.

Reduce the Foreign Dependency

American consumers are price takers when it comes to buying oil. When oil markets react negatively to unfavorable political events or when OPEC decides to cut production, American consumers must simply pay more at the pump.

The world has little spare production capacity that can be tapped during supply crunches, and what does exist lies almost entirely in Saudi Arabia and other OPEC countries.

Expanded domestic drilling will not significantly change that dynamic, as the United States lacks sufficient oil reserves and production capacity to offset OPEC production decisions.

Put the Oil Profits Back into the Pockets of the Taxpayer

ExxonMobil, BP, Chevron, Shell, Conoco Phillips and many other companies are now drilling for free on public land offshore and will continue to do so for the life of these leases no matter how high oil prices climb.

The Government Accountability Office (GAO) has estimated that the federal government and American taxpayers stand to lose up to $53 billion in foregone royalties over the next 25 years.

Ranking Member Ed Markey has authored legislation that would recover these royalties rightfully owed to the American people.

The House has repeatedly passed Rep. Markey’s legislation, including as part of H.R. 3534 that passed the House on July 30, 2010, but the Senate has never taken action.

Oil Profits lay with the Shareholders, not Big Oil operations.

The oil companies and their representatives frequently suggest that their high publicly reported profit numbers are misunderstood because only 7 cents of every dollar in sales is profit, which is similar to other American industries.

However, intensely competitive industries like retail and food service are lucky to earn 1 or 2 cents of profit per sales dollar. The real measure of the oil industry’s financial health is how much profit they generate with the money shareholders have invested. Over the last two years, the Big 5’s average annual return on equity was 21 percent. The U.S. Treasury bond, in contrast, yielded about 3 percent during this same period.

The oil and gas industry’s very high profitability has provided a financial a bonanza for shareholders over the last decade. A $10,000 investment in the Big 5 in 1990 is worth $100,000 today. In contrast, the same investment in an S&P 500 index fund is now worth $60,000. Big difference.

The oil and gas industry is a mature and highly profitable sector that is no longer in need of generous tax breaks or royalty-free drilling access. The $36.5 billion in subsidies that the industry is set to receive over the next decade will not help consumers with rising energy prices.

These subsidies will not strengthen America’s energy independence or help to develop alternatives to oil. Allowing hundreds of billions of dollars to go to an industry who is clearly not in need of the subsidies is a fiscal misstep that must be corrected.

Redirecting a portion of the money saved from the subsidies and royalties into alternative energy while using the rest to pay down our monstrous national debt, would be the best way to start addressing the the US’s financial and environmental concerns.

Copyright (c) February 5, 2011. All rights reserved.

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