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Q&A on Bush's energy proposals

ASK THIS | April 27, 2006

Skyrocketing prices are seen, finally, as leading drivers to conserve some gas and reject SUVs. But no serious government action is expected until public outrage gets a good bit higher.

By Martin Lobel

In the wake of soaring gasoline prices, President Bush has ordered that purchases to fill the Strategic Petroleum Reserve be stopped and that there be an investigation into possible price gouging. He proposed changes in tax breaks for oil companies and the easing of regulations to encourage building of new refineries; the opening the Artic National Wildlife Refuge to drilling, and steps that he said were aimed at reducing American dependency on oil. [Click here for a San Francisco Chronicle report spelling out Bush’s proposals.]

Q. Will not filling the strategic petroleum reserve help cut the price of crude oil?

Marginally. At most, such an action will increase available crude oil by 1%. This is too small to significantly affect world supply or prices. Government statistics on the current supply of crude oil indicate that it is not a shortage of crude oil that is driving up the prices. That may not be true in the future if demand keeps growing and production doesn’t. Unfortunately, the OPEC nations do not appear to be increasing their production capacity to meet increasing world demand. And no conceivable increase in domestic production could be enough to matter. [Note: Click here for a San Francisco Chronicle report spelling out President Bush’s latest gasoline and energy proposals.]

(See other NiemanWatchdog.org items on gas prices.)

Q. Will the president’s energy plan and recent statements stop the speculation in oil prices?

No. Nothing in the President’s proposal will diminish speculation that the price of oil will increase. According to oil analysts, between $10 and $25 of the price of a barrel is attributable to speculation by hedge funds and other financial institutions betting that the situation in unstable oil producers like Iraq, Venezuela and Nigeria could significantly cut back supplies of crude and make oil much more valuable. Indeed, some have argued that the President’s foreign policies are exacerbating this speculation.

Q. Will the president’s proposals encourage significant new domestic oil production?

No. Even if we agreed to produce oil from the North Slope of Alaska today, it would not significantly lower oil prices. It would take several years to get that oil to market after permission is given and, in any case, there is not enough Alaskan oil to make a difference. As long as OPEC and the oil companies keep producing just enough oil to meet demand, there will be no downward pressure on prices. It is interesting to note that when the oil companies were effectively vertically divested by the OPEC nationalizations, oil behaved like any other commodity with wide swings in prices as new supplies came on the market. Since oil prices no longer appear to behave like commodity prices should, are there any antitrust remedies that we should be exploring?

Q. Are the oil companies’ profits too high?

Whether oil company profits are too high is in the minds of the beholders. The oil companies’ ads compare their profits as a percentage of cash flow so that banks and pharmaceuticals appear to earn more than they do, but most analysts agree that the key measure is return on capital and those figures for the oil industry are extraordinarily high. Exxon’s rate of return on upstream drilling and production was 46% and “only” 32% for refining and marketing last year. Those figures are so high that Exxon claims that the $400 million plus buyout package of its former CEO was reasonable.

Q. Will the president’s proposed elimination of $2 billion in tax breaks for the oil companies affect the price of oil?

No. But, more accurately, the President is not proposing to eliminate the tax break; he is proposing to stretch it out from 2 to 5 years.  He is not proposing to eliminate the $13.5 billion in tax breaks in the last energy bill that he signed into law, although he does recognize that with $70 a barrel oil they really don’t need any tax incentives. This appears to be more than the leaders of the House recognize, since they are opposing cutting any of the oil company subsidies. Perhaps they feel that Exxon’s $36.13 billion in profits last year weren’t enough and that consumers should pay more.

Q. Will the investigations by the FTC and Department of Justice result in lower prices?

Unlikely. In the past, most of their investigations went looking for a smoke-filled room in which oil company executives sat down to fix prices. Of course, that may have happened, but it is far more likely that the companies devised ways to structure the market in order to maintain prices. The only serious analysis of that in recent years was done by the Senate Permanent Investigations Subcommittee which concluded that the current structure of the gasoline market made it easy for the companies to discourage price cutting competition. It is far more likely that State Attorney Generals, unfettered by such a narrow focus, will take action against the oil companies for price gouging and violating the antitrust laws. But, their resources are stretched thin and the President’s proposal calls for their action without providing any additional resources.

Q. Would a windfall profits tax redress some of the injury to consumers?

No. Windfall profits taxes inevitably become very complex and much too easy to evade. We’ve tried them in the past and the only thing they accomplished was to pay for a whole bunch of lawyers and accountants grandchildren’s education.

Q. What about price controls?

We’ve tried price controls in the past and they have only exacerbated the problem. The free market is the way to go. Higher gasoline prices have already begun to encourage conservation. People aren’t so anxious to acquire a macho massive SUV to commute. People are taking fewer trips by combining errands. Ridership on mass transit is up. Alternative energy sources are far more attractive investments.

Q. How can we mitigate some of the damage caused by high oil prices?

The President is right that high oil prices act as a tax on the economy. Right now that money is going to the oil companies and oil producing countries and is being recycled by these countries’ purchase of U.S. Government bonds issued to fund our deficit which is growing at a record pace because the Administration has cut taxes on the rich and allowed earmarked funding for special interests to grow exponentially. This means that countries like Saudi Arabia are benefiting twice. They are collecting consumers’ money now and will collect from our children and grandchildren when those bonds become due.

A far better solution would be to tax some of those excess profits and use the revenue to either lower the deficit or improve education or our infrastructure. However, given our complicated international tax structure, which allows multinational companies like the oil companies to evade taxes, domestic companies must pay, tinkering will not work. We need to do something dramatic, but simple. The multinational oil companies are required to report their profits to the SEC under oath. Why not accept their sworn testimony as to their profits and impose a tax on that amount? That would be effective and easy. But because such a proposal would outrage the companies as well as the members of the Ways and Means and Finance Committees, it is unlikely to be proposed, let alone passed, unless public outrage rises much higher.

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