No Profits, No Oil

If a product is in short supply and if you really wanted more to be produced quickly, would you want companies to think that they could earn a lot of money making it?

You would think that the answer is pretty obvious: No profits, no oil. To encourage more production, companies need to think that there are more profits to be made. With all the anger over high oil prices, more production to lower prices would seem to be a high priority.

But outside of most congressional Republicans, particularly those in the Senate who successfully filibustered a new wind-fall profits tax on oil companies, no one wants to admit what profits do.

Unfortunately, both the Democrat and Republican presidential candidates are both attacking oil company profits. Barack Obama promises, "We've got to go after the oil companies and look at their price-gouging. We've got to go after windfall profits." John McCain says, "I am very angry, frankly, at the oil companies. Not only because of the obscene profits they've made, but their failure to invest in alternative energy to help us eliminate our dependence on foreign oil."

Not to be outdone, congressional Democrats are just as upset. New York’s Senator Chuck Schumer claimed: "Oil companies are racking up obscene profits left and right while American families are stretched to the limit by skyrocketing gas prices. It's time for Big Oil to pay its fair share . . . ."

The defense of oil companies has been much to, well, defensive. Some pundits and those in the industry point out that energy companies aren't really making that much money. While the energy companies during the first quarter of this year had an average profit margin of 7,4 percent, the average Dow Jones Industrial Average company earned 8.5 percent. For example, ExxonMobil, which Obama has singled out for particular criticism, made an “obscene” $40 billion in profit, but that is on $404 billion in sales.

Much of the discussion concerning record high profits is misleading as it focuses on the dollar amount of the profits not the profit rate. As sales have also gone up over time, of course total profits have gone up, too. Nor are looking at just a couple of years particularly useful.

Others point out federal, state, and local governments have made more from gasoline taxes than the large U.S. oil companies have earned in total U.S. profits.

But all this assumes that companies should prove that their profits aren’t “too large.” That high profits aren’t good. Do customers want more gas? Higher profits increase production, driving down both prices and profits.

Ironically, at the same time politicians are complaining about corporate greed, they understand the importance of incentives. If Obama didn’t think that companies responded to incentives, why else would he propose that $150 billion be spent by the government on developing alternative energy?

McCain’s anger about the failure of oil companies “to invest in alternative energy” neglects to ask why companies aren’t investing enough in this on their own. Why do we need massive subsidies, as proposed by both Obama and McCain? The answer is simple: those alternative energy sources cost more than the benefits that they produce. If they were profitable, no subsidy would be necessary.

Would you take money from investments that are currently making a 9.7 percent return and putting them into projects that generate a negative return? Presumably not, and neither would Obama nor McCain if his own money was at stake. It would make you poorer, it would make him poorer.

Besides the politicians who are bashing the oil companies and pushing for wind-fall profit taxes understand that more oil would mean lower prices. Senator Schumer insists that "If Saudi Arabia were to increase its production by 1 million barrels per day that translates to a reduction of 20 percent to 25 percent in the world price of crude oil . . . “ Schumer is so angry that he is blocking selling military supplies to Saudi Arabia until they increase production.

Unfortunately, all this oil company bashing means that prices will rise even if wind-fall taxes are never imposed. Just the threat of the taxes will dissuade some oil companies from drilling today.

Despite all the concerns about reducing our dependence on foreign oil producers, the last things many politicians seem to want is more oil production by American oil companies. While forcing firms to apologize for their profits is bad enough, the Democrats push for a wind-fall profits tax seems to prove that they have no desire for more oil production and no desire to do what they can to lower prices.

*John Lott is the author of Freedomnomics and a senior research scientist at the University of Maryland.