In considering a price cap for oil and gas (windfall profits tax), a review of how price signals work in a market is highly instructive.
If you offer ten cents a month to workers to clean capital hill toilets, how many workers would sign up? If you offer these same workers $1 million a month to work on a study of Hawaiian beaches on location, how many workers would sign up? That is what price signals do to supply. A higher “incentive” (i.e. price) encourages supply.
This supply response is already underway in the energy markets. The number of drilling rigs in the United States searching for oil and gas has increased dramatically as the price, “incentive” increased. In fact, there are now problems with not enough rigs available on a timely basis as every oil and gas producer with money available wants to try and find more oil and gas to produce.
This shows up too in the projected earnings and capital reinvestment forecasts in studying the industry. The table below shows the estimated per share earnings, and re-invested capital expenditures for several of the oil companies. The estimates are all taken from “The Value Line Investment Survey,” Issue 3, September 16, 2005.
2005 Earnings 2005 Capital
Major Integrated Companies per Share Reinvested per Share
BP $6.25 $4.00
ChevronTexaco $5.95 $4.45
ConocoPhillips $8.30 $6.55
ExxonMobil $4.90 $2.05
Royal Dutch $6.60 $4.30
Re-investment of capital to fund the search for more oil and gas to provide consumers is estimated to take 67% of major integrated oil companies net income in 2005. Capital investment by independent producers (predominantly U.S. production) is even greater. Again from “The Value Line Investment Survey,” Issue 3, September 16, 2005 and Issue 12, August 19, 2005.
Anadarko Petroleum $8.00 $13.45
Apache Corp. $6.80 $ 9.45
Burlington Resources $5.50 $ 4.40
Chesapeake Energy $2.35 $ 6.60
Devon Energy $5.40 $ 7.35
EOG Resources $4.00 $ 6.65
Kerr McGee $9.70 $12.25
Marathon Oil $6.40 $ 7.10
Murphy Oil $4.15 $ 6.50
Occidental Petroleum $9.00 $ 5.20
The estimate for 2005 is that 129% of earnings will be re-invested for the continued search for more oil and natural gas. Re-investment in excess of net income shows that cash flow including depletion is sourcing more drilling activity. This belies the assertion that depletion is merely a tax preference item. In actuality, it helps fund greater production of oil and gas.
Since the increase in earnings is being reinvested and showing up as a higher number of drilling rigs searching for oil and gas, how is supply doing? Looking at U.S. natural gas production from the Department of Energy in conjunction with the increased rig count, this is what we find.
The obvious question is why we can’t get more natural gas production from the higher drilling, and thus increase supply, lowering price. It has to do with geologic maturity of the domestic natural gas basins, and new areas for exploration.
Think of it this way. You are into your fourth hour of filibuster and ask a staffer to get you some water which you very much need. A couple minutes later, she returns to tell you that the usual “onshore traditional basins” vending machine is very nearly sold out and there were several dozen other staffers milling around trying to get their coins in the machine, i.e. she couldn’t get you any water. You respond by suggesting trying another vending machine in a different location. A few minutes later, the staffer returns to inform you that while she believes the vending machine on the second floor “offshore Florida” has plenty of water, the elevators and stairs to the second floor have all been sealed off. Getting ever thirstier, you suggest the other side of the building on the same floor, perhaps that vending machine will have some bottled water. After a lengthy time, the staffer returns and tells you that yes, there is bottled water at the “Federal lands vending machine”, she even saw it, but she still has no bottled water for you. It seems someone has put a turnstile in the way that will cost more than the change originally budgeted for bottled water. In addition, there is an individual that won’t allow her to step up to the turn stile without a written 30-page essay of why she wants the water.
Finally, in exasperation and nearly hoarse needing some water during your filibuster, you hand your staffer significant additional change and suggest going to the vending machine in the basement “deep gas” or next door “outer continental shelf,” but please bring back some water.
Unfortunately, she returns to explain that while there was bottled water at either of those two vending machines and although they were more expensive, she did have the necessary change, but there was a new problem. It seems a gruff, masked figure stepped out of the shadows and took the change, telling the staffer that he had a better use for it than buying bottled water.
Congress must decide its proper role. One choice is a free market response to remove impediments to oil and gas supply so that the increased funds and increased drilling can in time bring new supplies of oil and gas and lower prices and lower inflation and assist economic growth. The other choice is to “mug the staffer” (windfall profit tax) so that there is no bottled water(oil and gas).
Help solve the problem or magnify the problem?? Your call!