The Truth About Big Oil's Windfall Profits

The debate over whether Big Oil has ruined your life rages on. Sen. Richard Durbin of Illinois recently commented, "The oil companies need to know that there is a limit on how much profit they can take in this economy." Rep. Maxine Waters of California, while scrutinizing a panel of Big Oil executives, went a step further and said she'd "be all about socializing ... basically taking over and [having] the government running all of your companies."

Political ambitions aside, the question of whether corporations are making obscene profits off your misery is at a critical juncture. Not only is the cost of gas eating up a chunk of your paycheck, but millions of homeowners have also found themselves in the catacombs of foreclosure after holding mortgages whose particulars would make Enron look legitimate.

Big Oil, meet Big Financial
That brings up an interesting topic: How obscene are Big Oil's profits when compared with those of "Big Financial?" The answer to whether either has engaged in price gouging is sketchy at best, but let's focus on something that isn't debatable: net income.

Here's the net income of the five largest American financial companies for 2007:

That's a total of $51.4 billion. How about Big Oil? Here's the net income of the largest five American-based oil companies for 2007:

That comes out to $80.4 billion, or about $29 billion more than Big Financial. But, of course, Big Financial didn't have the rosiest of years. That's where things get really interesting.

What's net income look like for 2006, when Big Financial was having a field day? The same group of financial companies made a combined $80.4 billion, compared with Big Oil's $82.9 billion. Hence, you get quite a predicament: Big Financial made as much money in 2006 as Big Oil did in 2007.

Follies of fairness
You never hear a peep about profit penalties for financial companies. Quit the opposite. The past year has been headlined by a chorus of government-backed bank bailout programs, coming just months after many banks logged huge profits riding a debt market that most have accepted was completely delusional, if not downright fraudulent.

But let's stop pointing fingers at seemingly backwards policy. Think about why windfall-profit taxes weren't imposed on banks and why so many bank bailout and assistance programs have been implemented in the past year: Because any severe fallout in the banking sector could cause the rest of the economy to implode. It often makes sense for the government to lend a hand to banks in crisis situations, to ensure that things don't degenerate into a full-fledged meltdown.

Think if, a few years back, federal regulators had sat down with the banking industry and said: "We know you're making a lot of money. Congratulations. But we see big problems on the horizon. Let's work together now before things get really bad." Things might look quite a bit better today. Now how about if regulators had said: "Shame on you for making so much money. We're taking half of your profits away. End of story." Odds are, banks would have just pushed through more time-bomb mortgage products to make up the difference and exacerbate the long-term problem.

That's how free markets work
Punishing Big Oil isn't much different. Imposing windfall taxes will probably only encourage oil companies to forgo exploration and development that would have been more lucrative with lower taxes. Whatever the solution to the energy crisis is, it's not just going to come galloping in on horseback in the next few months. The reality is that our economy is going to rely on oil for many, many years to come while innovation and discovery take place.

Obviously, Big Oil is eons away from needing a bailout. I'm not implying that Big Oil needs any help. But that isn't the point. What Big Financial's boom and bust can teach us about Big Oil today is that when the hatchet drops, you need the cooperation and commitment of the biggest and most influential companies to get the economy back on its feet. Or, more importantly, you need their cooperation before the problem turns into a disaster. The reason Big Oil is making a lot of money is that oil is scarce -- and that's probably the worst time you should give the oil companies less incentive to find more oil. So punish now, or forever hold your peace.

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For related Foolishness:

• Big Oil Ruined My Life
• Why You Should Embrace $4 Gasoline
• Who's Making Windfall Profits?