Oil Profits Under Fire

In the same marble-walled hearing room where Watergate witnesses were grilled last summer, high-ranking executives of the nation's seven biggest oil companies lined up last week behind a long, bare table for a harsh interrogation. Seated across from them were their inquisitors: nine members of the Senate's Permanent Subcommittee on Investigations. From the moment Chair man Henry M. Jackson called the meeting to order, it was obvious that the oilmen were in for a rough time. They found themselves under fire for accomplishing what has long been considered the goal of the U.S. economic system: making a high profit.

In other times, the ability of Exxon, Mobil, Texaco, Gulf, Standard Oil of Indiana, Shell and Standard Oil of California to ring up nine-month 1973 profits that averaged 46% above 1972's comparable period would have brought on considerable praise. But, at a time of oil shortages and sharply rising prices, the great increases fed suspicions on Capitol Hill that the oilmen were using the scarcity as an excuse for jacking up prices and making extortionate profits. Charged Connecticut Senator Abraham Ribicoff: "While the consumer is suffering, the industry seems to be receiving a bonanza."

Arab Embargo. Those suspicions were heightened by the annual income statements released last week by the three biggest oil companies. During the last quarter of 1973 -- which roughly coincides with the Arab embargo against oil shipments to the U.S. -- Exxon's profits were up 59% over the comparable period in 1972. For the full year, its profits also jumped 59%, to a record $2.44 billion. Large increases were also reported by other large companies (see box, facing page). The profits amid scarcity, said Exxon Chairman J.K. Jamieson, have reduced the public image of the oil companies "to a particularly low ebb right now." Jamieson even held an unusual press conference to proclaim "We aren't making windfall profits."

Nothing the oil executives have said or done has softened the hostility on Capitol Hill and the Senate hearing produced many sharp clashes. Jackson, who is campaigning hard for the Democratic presidential nomination, took advantage of the inept performance of Exxon Vice President Roy A. Baze. When Baze could not recall the size of Exxon's 1972 dividends, Jackson snapped: "I guess we're going to have to start slapping subpoenas on some of you." Then, in a grandstand play, Jackson phoned a stockbroker and announced that the dividend was $3.80 a share.

At another point, Ribicoff accused the international oil companies of engaging in a "conspiracy" to create a "panic situation" in the U.S. He had no discernible proof for the charge. By week's end Jackson conceded that "these hearings have not turned up any hard evidence that the major oil companies deliberately created the crisis." After the buffeting by Jackson and his colleagues, the oilmen were sore and furious. "They made me feel I was at a criminal trial," said Gulf Oil Co. U.S. President Z.D. Bonner.

Underlying the occasional demagoguery in Congress was the serious issue of how, if at all, oil prices and profits should be further controlled. Jackson has proposed that Congress roll back uncontrolled prices of "new oil" from a recent high of $10 a bbl. to $7, and Federal Energy Chief William Simon said that his office would not oppose some price reductions. Congress is also considering several bills aimed at depriving oil companies of any "excess profits" that might result from rising prices.

Punitive Tax. A bigger worry for oilmen is that Congress will hastily enact a punitive excess-profits tax without having any idea of what an excess profit is--or where the companies' great earnings came from. They did not come from price gouging in the U.S. but largely from big sales overseas, where demand is even higher than in America. Exxon, for example, reported an 83% increase in profits from oil that it bought, refined and sold in Europe and elsewhere in the Eastern Hemisphere v. only a 16% increase from its business in the U.S. Domestic operations have been relatively less lucrative, in part because the Federal Energy Office controls most prices for petroleum products. But rising worldwide prices of crude also have pushed up domestic prices. Imported oil is free from F.E.O. regulation, and the companies charge as much for it as the market will bear.

Despite their rich profits last year, the oilmen contend that their earnings have been modest over a longer period. "In seven of the last ten years," says Texaco Senior Vice President Annon Card, "the rate of return on investment in the petroleum industry was below that of all manufacturing companies." In 1972, Card notes, the oil companies' rate of return on investment was only 10.8%, compared with a 12.1% average for all manufacturing concerns. But if the profits are computed as a proportion of sales, the oil industry ranks far above the average for all U.S. manufacturing industries; in 1972 the margins were 6.6% v. 4.2%.

The oilmen argue persuasively that they need even richer earnings to finance the heavy costs of stepping up exploration, leasing new oil fields and building refineries--a point that they are emphasizing in a quickly mounted advertising barrage. The Chase Manhattan Bank estimates that by 1985 the industry will pump an awesome $800 billion into such ventures.

Investors are wary of sinking money into an industry whose most visible asset--access to foreign crude oil--is threatened with nationalization. They are reluctant to risk their savings in an industry that attracts heated criticism --and invites price rollbacks--when it rolls up an unusual profit. Moreover, the oil companies are falling deeper into debt. A top Manhattan banker reports that 37 of the largest U.S.-owned oil companies have been forced to finance an increasing portion of their capital expansions by going into long-term debt because of difficulty in raising funds through the preferred method of selling common stock. Texaco's Card estimates that, to get financing for its heavy capital needs between now and 1985, "the industry would have to achieve an annual growth rate in net earnings of 18%" --double the annual growth rate of the past decade.

Despite these strong arguments, the industry's critics in Congress remain unsympathetic. A main reason for their hostility is that the oil industry enjoys lucrative tax preferences. They are, in ascending order of importance:

ALLOWANCES FOR INTANGIBLE DRILLING COSTS. These "I.D.C.s" are the noncapital costs of drilling an oil or gas well, including wages for workmen and rental fees for equipment. Oilmen can deduct these costs from their taxable income immediately, rather than spreading the deductions over the years that the well is in operation. The Treasury Department figures that, in 1972, I.D.C. deductions saved the oilmen $600 million in federal income taxes.

DEPLETION ALLOWANCES. These permit an oil or gas producer to deduct from his taxable income up to 22% of the gross revenues derived from his well.

Depletion allowances aim to compensate the owner for the decreasing value of his well as oil is pumped out of it, and in 1972 they saved the oil industry $1.4 billion in taxes. Since the price of crude oil on which the size of the depletion allowance is based has doubled over the past year, the write-offs will be even greater in 1973. Most of these deductions come from domestic oil production, but oilmen can also use the depletion allowance to reduce U.S. taxes on their foreign income.

FOREIGN TAX CREDITS. These permit a company to deduct from the U.S. taxes due on its foreign income the income taxes that it pays to foreign governments. The aim is laudable: to prevent double taxation. But there is a catch. Many oil-producing countries mislabel part of the royalties that they charge on each barrel of oil as taxes, in order to create a U.S. tax credit for the oil companies. If the oil companies were forced to treat the disguised royalty as part of the cost of doing business--as other companies must--they would be able to deduct only 480 from their U.S. taxes for every dollar that they put out, instead of writing off the full amount.

An aroused Congress will change oil-company taxes this year. The only question is by how much. Except for an excess-profits tax, most of the proposals before Congress would do little to increase the tax liabilities of international oil companies. President Nixon has proposed that Congress repeal the U.S. depletion allowance for oil wells located abroad. The companies, however, generate such huge tax write-offs from other sources--mainly the foreign-tax credit --that they rarely need to use the foreign depletion allowance. More important it is likely that the domestic depletion allowance will be abolished or substantially reduced. But the depletion allowances are cherished by the oilmen, who still have powerful friends in Congress.

Have the oil companies been profiteering from the energy crisis? Based on the evidence to date, the answer is no. Despite the suspicions, no convincing proof has been presented that the petroleum shortage is phony or that the companies conspired to contrive it to raise prices and profits. In a time of high demand, they have been charging as much for their products as the law allows --but no more. Their behavior in attempting to maximize their profits is absolutely consistent with the purpose of corporations in a capitalist society: to make money for shareholders, millions of whom are middle-income people.

There is no question, however, that the industry benefits from unusual tax breaks, which should be coolly reexamined. In a sense, the write-offs subsidize not only the oil companies but also ordinary consumers of petroleum products: everyone who drives a car or heats his home with oil or gas. By granting the industry special tax benefits, the U.S. has shifted some of the cost of the nation's oil bill from actual consumers to the public at large. If the benefits were eliminated, oil prices would have to rise to cover the increased tax bill. One effect of the tax subsidy has been that energy prices have long been so low that the U.S. has become, as William Simon says, a nation of "energy wastrels."

The tax breaks are also poorly designed for the nation's current needs. The depletion allowance, for example, is more an incentive for oilmen to pump from existing wells than an inducement to explore for new sources of petroleum. A better way to encourage exploration would be to enact a tax designed to accomplish that specific goal.

Both Congress and the industry face some hard decisions. Congress has to choose between either rolling back oil prices or eliminating some oil tax shelters. It cannot do both and expect the industry to provide the nation with enough energy. For its part, the industry has to choose between retaining high prices and preferential tax treatment. It cannot expect the public to tolerate both. Most important in the months ahead, these choices are not likely to be made wisely by people who are looking for scapegoats instead of solutions.

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