How Big Are Big Oil's Profits?

It is one thing to accuse the oil companies of a profits rip-off and quite another to prove it. Time and again, critics of the industry have denounced Big Oil's profits as everything from exorbitant to obscene. But not even Senator Henry Jackson, the industry's arch-opponent, has succeeded in making the charge stick.

The basic industry argument is that in spite of a nearly fivefold rise in world oil prices since 1972, oil-company profits last year accounted for a smaller share of gross revenues than they did before OPEC began jacking up the price (4.7%, v. 6.4% in 1972). After-tax profits are admittedly huge--$14.6 billion for the industry last year. But so is the industry's cost of earning those profits. Last year's industrywide return on investment of 9.6% was not nearly as good as the automakers' 14.6% and barely better than the 9.5% earned by chemical companies. Over the past seven years, according to Data Resources Inc., a firm of economic analysts, domestic oil companies have averaged slightly less than a 9.4% return on investment, about on a par with the nation's 600 largest manufacturing firms.

During the 1973 Arab oil embargo, the nation's major international oil companies did engage in some shortlived and frantic price gouging. That happened when OPEC prices began their dizzy upward spiral and the companies marked up the selling price of imported oil that had been brought into inventory before the prices rose. As much as $5 billion in windfall profits resulted. This happened at a time when the rest of the economy was plunging headlong into the worst economic downturn since the 1930s, and such cynical profit taking gave the oil companies a black eye. Few can forget how, in their annual reports for 1974, the oil companies showed hefty increases in their profits over the preceding year: Exxon up 28.6%, Gulf up 33%, Mobil up 23.3%.

No one seems to get quite as sore when other industries achieve such profit increases. But the aftertaste of this episode has inspired the industry's critics to charge that the oil companies have made price gouging a way of life. Moreover, it is a fundamental reason why both President Carter and his Energy Secretary, James Schlesinger, continue to insist that the oil companies cannot be trusted to put the nation's interests ahead of their own. They argue that domestic oil prices, which are today set at a Government-regulated price of about $8.52 per bbl. as a result of complex price regulations, must be allowed to rise to a world level of about $13.50 in order to discourage consumption and give the oil companies added incentive to explore for fresh petroleum sources inside the U.S. But they are convinced straightforward deregulation will amount to nothing more than a replay of 1974.

It is for this reason the Administration has decided that the price hikes should be brought about by a wellhead tax. The yield from the tax would be enormous--as much as $12 billion a year by 1985. The oil industry has been lobbying Congress intensively all summer either to drop the tax or to hand all such revenues back to the oil companies for new investment in developing fresh oil sources. But the Administration remains skeptical of the industry's motives.

Yet oilmen, insist that they need increased incentives to boost their exploration activities. The oil industry contends it already spends 30% to 35% of its after-tax profits on exploration. But because all the easy-to-reach oilfields have been discovered, the drillers must now sink deeper and more expensive wells in more inhospitable regions, like Alaska's North Slope or the U.S. outer continental shelf. Since 1973 oil companies have increased the number of wells drilled by a dramatic 63.4% in the U.S. alone, but even at that, new finds have been disappointing, and proven reserves continue to decline.

The cost of this exploration is high.

Three years ago, it took $87,000 to drill an average exploratory well--on land or offshore--and now it requires $112,000. Five of every six wells drilled are dry, and of the few with oil, roughly one out of 50 proves commercially profitable. Industry critics reply that much of the increased drilling activity is in areas where only small deposits are thought to exist but the chances of finding them are good. Clearly, adequate exploration incentives are needed if enough new oil is to be found to keep pace with even the Administration's target of a modest annual 2% growth in the nation's energy consumption; just as clearly, the dispute over what is "adequate" will not be resolved easily.

Natural gas producers also want deregulation of gas prices, now fixed at $1.47 per 1,000 cu. ft. for gas sold across state lines. The Administration wants to keep controls, but at a higher price--of as much as $2 or so per 1,000 cu. ft. The White House argues that a hike of such magnitude would provide ample incentive to increase production, since natural gas is plentiful. But gas producers remain reluctant to press ahead with rapid development of new fields. If these fields were brought on-stream now, they would be subject to price control. If the producers wait, they reason, controls may be relaxed--and prices are bound to be substantially higher.

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