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:

Company

2007 Net Income

JPMorgan Chase (NYSE: JPM  )

$15.4 billion

Bank of America

$14.8 billion

Goldman Sachs (NYSE: GS  )

$11.4 billion

AIG

$6.2 billion

Citigroup

$3.6 billion

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:

Company

2007 Net Income

ExxonMobil (NYSE: XOM  )

$40.6 billion

Chevron (NYSE: CVX  )

$18.7 billion

ConocoPhillips (NYSE: COP  )

$11.9 billion

Valero (NYSE: VLO  )

$5.2 billion

Marathon Oil (NYSE: MRO  )

$4.0 billion

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.

What do you think about this touchy subject? Feel free to chime in using the comment section below. If you don't have a free account, it'll take you only a second to get one.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. The Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (31)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 30, 2008, at 1:57 PM, LEW81631 wrote:

    Take a look at returns on invested capital-the oil companies all have BILLIONS invested in assets-the financials are virtually zero.Similarly, look at the tech companies-this whole situation truly shows the truly unbelievable incompetence of our country's leadership.

  • Report this Comment On June 30, 2008, at 2:17 PM, voelkels wrote:

    The problem with finding oil in the U.S. is the politicians and environmentalists that won’t allow drilling and/or production off of the Atlantic and Pacific coasts, the artic and the Florida Gulf coast. I have a DIL on the Left Coast that told me 6 or 5 years ago that she didn’t want “her viewscape“ polluted by having an offshore rig off of “her” coast. Now she is crying because she can’t afford to fill up her SUV with gas to go to the beach. Boo Hoo. ;-(

    C.J.V. - retired petroleum engineer, me

  • Report this Comment On June 30, 2008, at 4:55 PM, lowfiron wrote:

    Horse crap. Big oil is subsidized to explore and drill. Since Reagon and the idiots that decided to forgo anti-trust laws now there is no competitive pressure to keep costs down. I also do not believe there's any reason for oil companies to to invest in alternative energies unless kicked in the butt.

    Oil does nothing unless it's good for oil. They are not patriots.

  • Report this Comment On June 30, 2008, at 4:57 PM, moon32 wrote:

    I see this issue like a five card poker hand, OPEC is raising the stakes and we can't call the bluff. If we declare the ANWR and off-shore open for drilling by U.S. oil companies the OPEC prices would drop as they did when China raised domestice prices on fuel. As long as we toss our cards in without calling the bet we will continue to pay ever increasins prices (lose). Based on the Democratic Parties stated position we can anticipate $8-10 per gallon gasoline by 2011 if such programs are implemented. The wake-up call came during the Carter Administration but Congress turned off the alarm and went back to politics as usual.

  • Report this Comment On June 30, 2008, at 8:03 PM, turnipseedtales wrote:

    OPEC appears to be maxed out, at least for light, sweet crude. Drilling offshore and ANWR would be helpful, but have little impact in the next 7-10 years. The best way to lower the price in near future is conservation. And the quickest way to dreduce consumption is a national 55 mph speed limit. Not very likely.

  • Report this Comment On June 30, 2008, at 9:46 PM, bigoillaugh wrote:

    This cracks me up. First of all, realize the OIL REFINERS are getting pinched and are not making the "windfall profits" everyone is whining about. Oil is $140/barrel. Gas is $3.50/gallon (sans taxes) which is $147/barrel (there are 42 gallons in a refining barrel, not 55 gallons). A few weeks ago, gas was cheaper than the oil used to make the gas. This happens a lot more than one would think. This is the first time in my memory that it has happened during the summer. Just like the retailer that depends on banking 75% of his annual profit during the Christmas season, refiners have their "Christmas" during the summer and fight to break even the rest of the year.

    The only companies making money now are the OIL PRODUCERS. The Chevrons, Exxon/Mobil, etc are big oil companies "fortunate" enough to be in both producing and refining - offsetting profits and losses - making money when oil rises and when oil drops. The OPEC companies were raking it in at $15/barrel, and its $140 now. Direct your anger there if you must.

    Anyway, since when is making money wrong? That's what is so great about capitalism. Where there is a way to make a buck, someone will. Just because its a lot of work and complicated doesn't make it the responsibility of oil companies to discover it. Technology will prevail, as it always does, as long as there is money to be made.

    Why would you expect the oil companies to come up with an alternate solution that would ultimately put itself out of business? Why expect the oil companies to refine at a loss to lower the price of gas so you can drive your 12 mile per gallon SUV to Disneyland?

    Patriots? Get real.

  • Report this Comment On July 01, 2008, at 2:32 AM, kurtisj wrote:

    "Technology will prevail, as it always does, as long as there is money to be made."

    You're kidding, right? Science is the handmaiden of technology, and technological prowess is simply an extension of political might.

    All this whining over the battery duration being the reason consumers didn't want GM's electric car (even big oil bought patents to kill effective battery implementations)...

    http://en.wikipedia.org/wiki/Who_Killed_the_Electric_Car%3F

    And here you have the incredibly popular Toyota Prius. Doesn't have the maker/big oil-imposed driving range, all with an extremely simple solution:

    http://www.toyota.com/prius-hybrid/

    Down with big oil and worthless american auto execs that destroy innovation to put profit their own pockets at the expense of healthy capitalism and industry! Bring in Japanese innovation! They aren't quite as tainted by big oil.

    The article above is naive at best.

    Btw, there is an entire political movement called libertarianism that is all about pissed off at the banking industry and the federal reserve:

    http://www.ronpaul2008.com/articles/?tag=Federal%20Reserve

  • Report this Comment On July 01, 2008, at 1:09 PM, starmannate wrote:

    It is very sad to see our politicians have so miserably failed Economics 101. Worldwide demand for oil has been increasing for years and they continue to do everything possible to decrease domestic supply. Whether it is the ridiculous number of gasoline blends required, the ethanol subsidies boondogle (remember MTBE), the continuous effort to exclude federal or coastal lands from drilling, or adding prohibitively expense environmental regulations. These same politicians want to add "carbon offsets" to all our energy usage (read huge tax increase on gas and coal).

  • Report this Comment On July 01, 2008, at 3:29 PM, pkrishna wrote:

    "That's how free markets work "

    If that's how free markets work, to the detriment of the people at large, then "Free Markets" is an ass, to paraphrase Charles Dickens.

    People wax eleoquent about the country and its constitution. The country is constituted "to promote the general welfare of the people". A corporation only to promote the welfare of the shareholders in theory, but just the welfare of the management in practice.

    So, when the general welfare of the people is in danger by the colossal greed of the corporation, one of two things will happen; either the government which is again constituted for and entrusted to promote the general welfare of the people will step in and make some changes in the financial "rules of engagement", or the masses will revolt, either overtly or covertly to check the excesses of the corporate bosses.

    Does Lee Raymond deserve $400 million in retirement? Does Grasso? Does Jack Welch?

  • Report this Comment On July 01, 2008, at 9:14 PM, Imshaken wrote:

    If you seriously care about reducing greenhouse gas emissions into the environment high oil prices are the best way to ensure a reduction of of the use of oil! Certainly oil consumption is not elastic in the short term, but in the longer term people will move to more efficient vehicles to reduce consumption.

    Diesel costs me $4.70 a gallon right now. It costs so much I wouldn't feel it if the government added a 50 cent per gallon tax on each gallon. Those funds could be used to develop commercially viable alternative energy solutions at a more rapid pace than currently exists.

    Imagine the reaction from OPEC when oil use plummets and their revenue dries up. Imagine the changes in American foreign policy. We wouldn't have Presidents who feel compelled to invade countries like Iraq to stop terrorism. wink. wink.

    The upshot is there can actually be long term benefits to high energy prices even if it does hurt the economy in the short term.

  • Report this Comment On July 04, 2008, at 7:24 PM, givemeabreak217 wrote:

    There's PLENTY of places the oil companies could be drilling right now; there's just no incentive for them to do it because it lowers "their profits"... "Demand" is the only thing that is going to lower oil prices immediately and everyone of us can do something NOW by carpooling, taking public transportation, biking, walking, etc. just ONE day a week. If U.S .automakers had been more interested in building fuel efficient [and affordable] cars ten years ago, instead of all these gas guzzling hummers, big trucks and SUVs, we wouldn't be having this discussion today. Guess who'll be bailing out these companies when they declare bankruptcy.

  • Report this Comment On July 05, 2008, at 12:30 AM, arcticman wrote:

    This article misses an even bigger point. If you look at the 10 U.S. companies that had the highest profits last year there is an important story to tell. The important metric to look at is profits as a percentage of revenue. This factors in the costs associated with running a business.

    The first link is to the list of highest corporate profits in 2007. The second is for the companies by highest revenue.

    http://money.cnn.com/magazines/fortune/fortune500/2008/perfo...

    http://money.cnn.com/magazines/fortune/fortune500/2008/full_...

    Exxon Mobil had the highest profits at $40.6 billion. Their revenue can in at a whopping $372.8 billion and doing a little math gives you a return on revenues of 10.9%. The other oil and gas companies in the top 10 are Chevron at 8.9% and ConocoPhillips 6.7%.

    Taking a look at a few more companies on the list gives GE at 12.6%, JP Morgan at 13.2%, Bank of America 12.6%, Microsoft at 27.6%, Berkshire Hathaway at 11.2%, Walmart at 3.4%, and AT&T at 10.1%.

    This means that Exxon Mobil the most profitable company in the U.S. only makes about 10 cents in profits for every dollar in revenues. Microsoft on the other hand makes 28 cents on the dollar and no one is talking about windfall profits taxes. Oil companies make such large profits because they invest in such huge projects. Just something else to think about.

  • Report this Comment On July 05, 2008, at 8:06 AM, darkbarley wrote:

    Those who complain about the "obscene" profits of the oil companies don't seem to understand just who benefits from these profits.

    1) Anyone who has money invested in these companies, either directly or through a mutual or index fund. This includes most pension funds and retirement accounts. Look at the losses sustained because of the problems in the financial industry. If other sectors such as energy did not perform well to offset some of these losses, where would the S&P be now.

    2) The 100s of thousands of Americans who rely on these companies for employment, both directly and through smaller companies that provide services for the oil companies. Look at how many people are losing their jobs in the financial industry. Why would you penalize an industry that still provides good paying jobs and has the potential to provide many more? I work for a large transportation company and am happy to see my employer making money. More profits mean my job is secure and I benefit through the employee stock purchase program.

    I believe the majority of our politicians understand these facts, and most of this talk of a windfall profits tax is nothing more than election year rhetoric.

  • Report this Comment On July 07, 2008, at 1:27 PM, drmagnus wrote:

    I think there was one thing left out of the analysis. On absolute terms tere is no doubt a big difference between $40 billion and $15 billion. However that is not an apples to apples comparison of two companies. I think the following 4 numbers can offer some valuable insight:

    '07 Exxon Net Margin: 11.32%

    '07 Chevron Net Margin: 9.16%

    '07 JP Morgan Net Margin: 21.52%

    '07 Bank of America Net Margin: 21.99%

    (I used Interest Income for JPM and BAC, which is arguable)

    Although these numbers are not drastic, I can not imagine that a company working on an 11% net margin should be taxed higher than a company working on a 20% margin regardless of the absolute value of their Income/Profit.

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