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Tuesday, July 26, 2011

Oil Industry Financial Performance and the Windfall Profits Tax

Robert Pirog
Specialist in Energy Economics

Molly F. Sherlock
Analyst in Economics

Over the past 13 years, surging crude oil and petroleum product prices have increased oil and gas industry revenues and generated record profits, particularly for the top five major integrated companies, ExxonMobil, Royal Dutch Shell, BP, Chevron, and ConocoPhillips. These companies, which reported a predominant share of those profits, generated more than $104 billion in profit on nearly $1.8 trillion of revenues in 2008, before declining as a result of the recession and other factors. From 2003 to 2008, revenues increased by 86%; net income (profits) increased by 66%. Oil output by the five major companies over this time period declined by more than 7%, from 9.85 million to 9.12 million barrels per day. In 2010 the companies’ oil production was 9.4 million barrels per day. Being largely price-driven, with no accompanying increase in output resulting from increased investment in exploration and production, some believe that a portion of the increased oil industry income over this period represents a windfall and unearned gain. A windfall income is not earned as a result of additional production effort on the part of the firms, but due primarily to record crude oil prices, which are set in the world oil marketplace.

Since the 109
th Congress, numerous bills have been introduced seeking to impose a windfall profits tax (WPT) on oil. An excise-tax based WPT would tax only domestic production and, like the one in effect from 1980-1988, would increase marginal oil production costs. Theoretically, such a policy could reduce domestic oil supply, which could raise petroleum imports, making the United States more dependent on foreign oil, undermining goals of energy independence and energy security. By contrast, an income-tax based WPT would likely be more economically neutral (less economic distortion) in the short-run. Sizeable tax revenues could potentially be raised without reducing domestic oil supplies. Neither the excise-tax based nor income-tax based WPT are expected to have significant price effects. Neither tax would increase the price of crude oil, which means that refined petroleum product prices, such as pump prices for gasoline, would likely not increase.

In lieu of these two types of WPT, an administratively simple way of increasing the tax burden on the oil industry, and therefore recouping some of any excess or windfall profits, particularly from major integrated producers, would be to raise the effective corporate tax rate. One option would be repealing or reducing the domestic manufacturing activities deduction under IRC § 199. The 112
th Congress voted on this measure as part of the Close Big Oil Tax Loopholes Act (S. 940). Going forward, in the context of deficit reduction, the 112th Congress may continue evaluating various methods for increasing taxes on the oil and gas industry to address concerns surrounding possible windfall profits.

Date of Report: July 13, 2011
Number of Pages: 25
Order Number: RL34689
Price: $29.95

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