The Oil Company Blues

The seven oil executives who testified on the energy crisis before Senator Jackson’s subcommittee in January claimed that Jackson was picking fights with the oil witnesses, was making unsubstantiated accusations, and was generally acting like a politician seeking his party’s presidential nomination. Many journalists and editorial writers seem to share some of the industry’s misgivings. The Jackson hearings and the oil companies’ rapidly intensifying public relations campaign may have left the public more confused than ever about the current energy shortage. The consumers know they are paying higher and higher energy prices. But are the gains enjoyed by the oil companies fair and equitable, or not?

To evaluate fairly what the oil companies have gained, it is necessary to examine their recent record, or at least what we know of it, since they have been more secretive about their operations than most other industries. According to the Consumer Price Index, calculated by the US Department of Labor’s Bureau of Statistics, the price of gasoline rose 19.7 percent during 1973, while the price of fuel oil rose 46.8 percent. Some petroleum products such as propane, used for home heating in the South and crop drying in agricultural sections of the Midwest, have increased in price by 300 percent.

In recent weeks the price of gasoline has continued to climb at an accelerated pace without any sign of leveling off. Spot shortages in a number of cities, particularly in the Northeast, have led to price gouging and long waits for motorists who are allowed to buy a limited amount of gas on each visit to the stations. Naturally, these rising prices have been reflected in higher profits for the oil industry. Profits for the top ten companies this year will total $7.8 billion—up 51.2 percent over last year’s figure.

In the face of these rather disturbing statistics, the oil companies argue that their higher profits are needed to provide the capital necessary to search for new sources of oil and gas around the world. In fact, the industry estimates that between now and 1985 more than $800 billion in investment capital will be needed in order to keep pace with the US demand for fossil fuels (assuming that the demand for these fuels continues to grow at the current rate).

However, these claims about the need for higher profits for investment are somewhat suspect in view of the oil industry’s unwillingness to go into debt to find new capital. Traditionally the oil industry—and it is nearly alone in this respect—has depended heavily on retained earnings for investment. For example, during the third quarter of 1972, according to the Federal Trade Commission, for every five dollars invested from profits for all US manufacturing the companies also borrowed two dollars, a ratio of 2.5:1. For the oil industry, however, the ratio was closer to 6:1, a figure reflecting the oil industry’s reluctance to borrow.

The most convincing test of the oil industry’s seriousness about reinvesting profits for exploration and development of new sources of oil would be its willingness to retain earnings and not increase dividends as profits go up. The evidence, although preliminary and incomplete, suggests that many of the oil companies may plan to increase dividends relatively more and reinvestment less. Exxon has already announced a 12 percent increase in dividends. Mobil and Standard of California, Standard of Indiana, Texaco, Union, Continental Oil, Getty, Murphy Oil, and Ashland are all increasing their dividends. As corporate profits continue to grow, further increases in dividends will tell much about their real intentions to develop new sources of energy in the public interest.

In addition to arguing that higher profits are needed, the oil industry, in its latest round of newspaper advertisements, is claiming that 1973 profits should not be compared to the previous year’s profits or to profits in the last few years, since oil profits have, in the past, been too low.

It is true that at the beginning of this decade the oil companies fell on relatively hard times so far as profits are concerned. Although sales went up 6.2 percent in 1970, the profits of thirty-eight integrated oil companies actually went down 1.9 percent. The Tax Reform Act of 1969 reduced the oil companies’ depletion allowance from 27.5 percent to 22 percent and on August 15, 1971, the President imposed Phase I economic controls freezing the price of petroleum products at a low profit level.

By the fall of 1972, the Nixon Administration became concerned about fuel supplies for the coming winter in view of the industry’s sluggish production. According to officials at the Cost of Living Council, the oil industry could, under controlled prices, have made what government officials believed was a reasonable profit on #2 home heating oil. But the oil companies did not produce as much as needed. According to one staff member of the Office of Emergency Preparedness, CITCO—the fifteenth largest oil company—acknowledged that it was deliberately producing less fuel oil, for “economic reasons.”

Apparently, the oil companies in the fall of 1972 could have made a profit by producing fuel oil; but they felt that the size of the profit and profit margin were unsatisfactory. Later the Office of Emergency Planning calculated that if the oil industry had maximized production during the autumn, a surplus of 4 million barrels of fuel oil would have been produced. Instead, production lagged and there was a 26 million barrel deficit.

Nothing in the industry’s apparent hesitance to produce fuel oil suggests any collusion on the industry’s part; but it says something about the impotence of the government. The Nixon Administration thought there was enough profit for the oil companies to produce at maximum output; but when they did not do this the government was unable (or unwilling) to do anything about it.

For its part, the industry maintains that its rate of return on equity—i.e., on total net investment—is too low. Since 1969 the average rate of return has been approximately 10 percent, which, the companies argue, is considerably lower than the rate of return on equity in manufacturing. Interestingly, according to the Federal Trade Commission, the rate of return on equity for manufacturing since 1969 has, on the average, been the same as the rate of return on oil (both exactly 10.3 percent). It was only in 1972 that the oil industry’s rate of return lagged (8.5 percent as compared with 12.0 percent for manufacturing). But it is estimated that in 1973 both the oil and other manufacturing industries earned about 12 percent on their investments. In short, the oil industry’s claim that their rate of return has fallen below other industries simply is not justified by the facts.

More important, measuring the oil industry’s profits on the basis of rate of return on equity only creates a distorted and incomplete picture of oil industry profitability. A more accurate picture of profits is provided by measuring profit as a percentage of sales. By this standard, the oil industry’s average in the last two years has been well above the average for all manufacturing. During the first three quarters of 1972, oil industry profits were 6.5 percent of sales, compared to 4.2 percent for all manufacturing. The gap widened during the first three quarters of 1973 when oil industry profitability reached 7.4 percent and all manufacturing profitability was 4.7 percent. Dramatically increasing gasoline prices this year will obviously have their effect, and first quarter 1974 profits on sales for the oil industry should be spectacular.

Any analyst should consider both rate of return on equity and profit as a percentage of sales in analyzing the profits of a major industry. But, in an industry with a rapid turnover in sales, such as gasoline marketing, profit as a percentage of sales is a much more convincing measure of corporate success. Some analysts completely discount the measure of rate of return on equity as irrelevant to the profits of the oil industry. They point out that the return on investment in normal manufacturing such as automobile production will appear quite quickly on the corporate balance sheet. But return on investments in the oil industry for exploration and development may not appear on the books for decades either because actual production does not take place immediately or because the value of the new oil acquired cannot be fully estimated in the short run. This time lag in realizing gains in real dollars makes rate of return on equity a less accurate measure.

Although the oil companies’ claims that they must have higher profits are not very persuasive, their attitude is typical of the attitude many large businesses take toward government: when it is in their best interest to be treated as part of the “free enterprise system,” they insist on being treated that way. But when it is to their advantage to be considered wards of the state they forget their dedication to free enterprise.

The oil companies want to be treated like any other business when they oppose price and wage controls, resist new environmental standards, and fight government efforts to restrain the mergers and mutual price agreements and discrimination against independent gas stations that prevent the industry from being competitive. But the oil companies also want to be treated like wards of the state when it comes to subsidies in the form of tax breaks or import quotas. The oil import quota system was established during the Eisenhower Administration, ostensibly on the grounds that oil is an important national resource and the US must have its own supply. In fact the quotas blocked the entry of cheap foreign oil into the US and kept the domestic price from falling. Not only did this policy hurt consumers but it resulted in a system of “drain America first.” But import quotas are what the oil companies wanted, and only when the price of Mideast oil was already rising did the Nixon Administration relax them in 1973.

Similarly, the oil industry avoids an estimated $1.5 billion per year in taxes because of the 22 percent depletion allowance and an additional $325 million in taxes from deductions derived from so-called intangible drilling expenses, on the grounds that these promote further exploration and greater supplies. Moreover, the Treasury Department estimates that US oil corporations will claim nearly $3 billion in credits against their 1974 income taxes on the basis of taxes paid to foreign governments—another special privilege. The fact that supplies of oil are a little short—because of the oil companies’ own actions, including their failure to expand refinery capacity—does not deter them. The oil companies will still argue that they must have the depletion allowance and foreign tax credits because of the need to find new sources of energy.

The government’s position toward the oil companies has been to encourage free enterprise so far as economic, controls are concerned but to provide public welfare in matters of tax policy and imports. This goes a long way toward explaining why the Nixon Administration has been able to do so little about the current crisis. The government has a hands-off policy that provides a carrot for the oil industry; but it has no stick.

It is time for American citizens and the Congress to decide: Are the oil companies to be treated as part of the free enterprise system they claim to defend or are they not? If they are, then all of their special tax and other privileges should be abolished; our policy should be to break up the oil industry, above all by requiring that the functions of production, refining, transport by pipeline, and marketing each be performed by independent companies. If this were done, real competition would provide the stick and we could expect both a lowering of prices and intensive efforts in the industry to open up new sources of energy.

On the other hand, Congress and the nation could decide that energy is so important that the oil industry should truly be a ward of the state—that in the public interest the oil industry must be subject to strict government control in its pricing, its effects on the environment, and its planning for the future. In that case nationalization, or something approaching it, should be our policy. Then the government would control the stick.

To make either of these choices will be immensely difficult for American politicians. One need only take account of the millions of dollars in campaign contributions by the oil companies to candidates in both parties to see just how difficult both choices are. The oil companies and their officers and directors, for example, made legal and illegal contributions of more than $4.9 million to Mr. Nixon’s 1972 campaign. But as the oil industry bears more and more heavily on every aspect of economic life this is the kind of choice our political system will have to face.