Oil and Gas Investments

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Oil and Gas Investments: The Looming Tax Threat That Hurts Their Stocks

By Dr. Mark Skousen, Chairman, Investment U
Thursday, November 3, 2005: Issue #483

Last week, my publisher warned me, “Mark, careful mixing investing with politics in your IU column. We’re not in the business of making enemies.”

But when politics affects your pocketbook, I must speak out.

In the past month, government officials in Washington (in the U.S.) and Ottawa (in Canada) have started talking about imposing new taxes and “excess profits” taxes on oil and gas producers. So what happened?

Oil and gas investments took a sharp tumble, with stocks falling 10-15% in the past month. It could be the beginning of a bear market.

This is a non-partisan attack. Both Republicans and Democrats have bashed big oil for “price-gouging” the public. After Exxon Mobil (NYSE: XOM) declared record $10 billion profits in the most recent quarterly report, Senator Judd Gregg (R-NH) issued a statement calling for an excess profits tax on oil. “With people being forced to pay $3 a gallon for gas and $2.50 for oil to heat their homes, it is infuriating that oil companies are reporting record-breaking profits.”

Senator Byron L. Dorgan (D-ND) agrees. “Big oil companies obviously are experiencing a windfall of excess profits,” he said. “They are profiting in an extraordinary way at the expense of the American consumer.”

Canadian authorities are also getting in on the act. Canadian oil and gas trusts are exempt from corporate income taxes if they distribute their earnings to stockholders. Ottawa legislators want to change that, and impose corporate taxes on these trusts.

It’s time for somebody to speak out and tell the truth about big oil and the so-called energy crisis.

1. First, in real terms, gasoline and natural gas prices are not at record levels. As the chart below demonstrates, gasoline prices have still not reached the level they were in 1980, in inflation-adjusted terms.

Government Need Not Interfere with Oil and Gas Investments: Here are 4 Reasons Why…

Gasoline Price Chart, 1918-2005, adjusted for inflation

2. Gasoline prices have recently declined, thanks to increased supplies (recall my interview with Steve Forbes, who predicted this). Gasoline prices are on average 20 cents lower than they were a month ago.

3. While oil and gas companies are earning record profits, the energy sector is not especially profitable compared to other industries. As the chart below shows, profit margins average only 7.7% in oil and gas, compared to 19.6% for banks, 18.6% for pharmaceuticals, and 17% for software companies. Even stodgy insurance companies have profit margins of 10.7%.

Oil and Gas Profit Margins, compared to other industries

Over the past five years, the oil and gas industry has consistently earned a return on investment lower than the S&P industrials, especially during the 1980s and 1990s, when oil and natural gas prices are artificially low.

But now, after years of under-performing, the government wants to tax them for their excessive returns? As John Stossel would say, “give me a break!”

4. Finally, the record profits that the energy sector is now earning don’t simply disappear into the pockets of greedy CEOs. Almost all of the retained earnings will be pushed back into new technology, new production and environmental-quality investments. According to the latest figures, a remarkable 64% will be reinvested into drilling and exploration – to find new sources of energy to increase supplies and reduce prices.

Lessons in Supply and Demand in an Energy Crisis

In my economics course at Columbia University last semester, I taught my students the dynamics of supply and demand during an energy crisis, and how the free market solves its own energy crisis without the help of government. It’s vital that oil and gas firms keep all their “excess” profits in order to find and invest in new sources of energy and expand output. The worst thing government can do is step in and impose high taxes on these resources. It can only make the energy crisis worse.

It’s time our representatives in Washington and Ottawa take a refresher course in Economics 101. (Since they are unlikely to take the time to become educated, I suggest they obtain a copy of my book, Economic Logic, and read chapter 6, “Case Study: The Energy Crisis,” pp. 140-143.)

On the positive side, at least they haven’t pushed for price controls, which would make matters even worse.

Economics is all about incentives. Prices are market signals that drive consumer and producer behavior. If prices rise, it’s telling consumers to cut back, and for producers to find new supplies and more efficient ways to produce. By imposing new taxes or price controls, government interferes with the market mechanism. And that’s never good.

Meanwhile, your oil and gas investments will be vulnerableas long as the government threatens new tax legislation.

Good trading, AEIOU,

Mark

P.S. I am pleased to announce the winners of our chess problem. The following Investment U subscribers were the first 10 respondents to send the correct answer(s). Congratulations to the victors! Their American Eagle Silver Dollars and copy of my book, Economic Logic, are in the mail

Avery Wang, Palo Alto, CA
David Matthew Birr, Barrington, IL
B. Colety, San Francisco, CA
Bill Kaminer, Asheville, NC
Bruce Deerson, Raleigh, NC
Joe Tamsevicius, Gurnee, IL
John W. Zerdecki MD, Fort Worth, TX
C. Harder, Madison, WI
Dr. Freeman Stanfield, Winterville, NC
Chris Dickey, Portland, OR

And just in case you were wondering, the four possible answers to Investment U Article # 480’s challenge were:

1. White rook to F-6; Black king to D-5; White queen to B-5; Checkmate.
2. White rook to F-6; Black king to D-5; White queen to D-4; Checkmate.
3. White king to D-3; Black king to D-5; White rook to F-5; Checkmate.
4. White queen to A-6; Black king to D-5; White rook F-5; Checkmate.