In today's world, there are two kinds of debates. One kind involves multifaceted issues even reasonable and clear-headed people can disagree about. The other involves issues so obvious a reasonable person can only conclude that half the world is intellectually dishonest.
The latest instance of the latter is the call to implement a windfall tax to cap oil companies' profits. This shortsighted policy has been advocated in part by everyone from Virginia Gov. Tim Kaine in his Democratic response to the State of the Union, to normally sober Republican Sen. Arlen Specter, Penn., who has threatened to subpoena oil executives. Their motivation is clear: Millions of Americans are angered that oil companies are making so much money at a time consumers are experiencing a degree of sticker shock not seen since the 1970s.
Indeed, it may seem unjust to many that Exxon Mobil's 2005 profit was the same size as the Gross Domestic Product of Croatia. Politicians and students alike associate these record profits with high gas prices and assume that they are being ripped off by evil corporate suits. However, the economic reality is that it would be hard to think of a better way to ensure high oil costs for the foreseeable future than to cap profits. In a market economy, profits play a crucial role in sending signals about what kind of commodities consumers desire. Profits direct firms as to where they should invest. They are the link that ensures goods brought to the market will be of the type and quantity that consumers demand, rather than those that tickle the fancy of a politician or bureaucrat.
Firms will not invest in the necessary equipment to remove more oil from the ground if they think their return on investments will be limited by artificial profit caps. Without new oil rigs, drilling platforms and site exploration, supplies will not be able to keep pace with the surge in demand from China and India, and prices will go through the roof.
The potential effect of a price cap is exacerbated by the natural boom-bust cycle of the oil industry. Despite high prices, oil executives are leery of investing too much in needed infrastructure and exploration today because they remember the "bad years" when crude oil was at $10 a barrel (versus $66.36 at close on Feb. 1), and it was cheaper to buy a gallon of gas than a bottle of water. From 1981-1995, a nearly 15-year bull market when the broad stock markets tripled, shares of oil giant British Petroleum remained flat. It is absurd to think investors will continue putting their capital at risk in such a volatile industry if they are not allowed to receive adequate compensation during good years.
Yet the most ridiculous aspect of the tax proposal is that profits do not even materially affect the price of oil in the short term. According to The Seattle Times, the average profit margin for the oil and natural gas industry is 8.2 percent of revenue. In contrast, last year McDonald's reported a profit margin of 12 percent, and Coca-Cola a whopping 22 percent. One might wonder why Kaine isn't railing against the grave injustices of McDonald's dollar menu. In any case, cutting an 8.2 percent margin in half would be the equivalent of a 9 cent reduction in the price of a gallon of gas, saving the average commuter student just enough on a tank to buy an "overpriced" Coke.
What is even worse is where this meager savings would come from. Politicians like to talk about Exxon Mobil's profits like they are going straight into the pocket of a cartoonishly evil oil tycoon. Reality is not quite so sinister. Lee Raymond, CEO of Exxon Mobil, is the company's largest individual shareholder. Yet, he controls less than one-tenth of 1 percent of all outstanding shares. Over half the total outstanding shares are held by institutions, such as pension funds and mutual funds. If there were a windfall tax on oil, the real losers would be the millions of dependent on those pension funds for their retirements.
Yet many politicians choose to ignore simple logic and rail against "profiteering" anyway. Proponents of this windfall tax are merely the latest addition to a growing cabal of protesters, ranging from anti-globalization nutcases to advocates of fair-trade coffee; each is seemingly incapable of differentiating an emotional value judgment about what is right from a rational argument about what is best.
Alex Frey is a senior electrical engineering major. He can be reached at frey@umd.edu.
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