WAR, PROFITS, AND 'WINDFALL' TAXES

With war under way in the Middle East and oil companies reporting sharp earnings increases for the fourth quarter of 1990, perennial oil industry antagonists are calling for a new "windfall profit" tax. Although the effort probably won't succeed, oil companies must not ignore the threat.

Feb. 4, 1991

3 min read

If Congress takes the proposal at all seriously, companies will have to scramble to their energy policy battle stations. It will mean that the nation has learned little from two decades of hard, sometimes self-inflicted, energy knocks. And it will portend another round of bad choices as policy makers and legislators take their turns with a national energy strategy now-properly-on a war-time White House's list of secondary priorities.

EASY POLITICAL POINTS

Current windfall profit tax proposals come from lawmakers for whom "punishing Big Oil" scores easy political points. The petroleum industry can hope that a more sophisticated legislative majority will dismiss the idea as bluster from a demagogic fringe. But it may be wishful thinking.

The U.S. is just now settling into its disturbing realization that war with Iraq will last more than a few days and create more than a few casualties. And it's just now learning about oil companies' high fourth quarter earnings. Hence the war profiteering suspicions. Even if the demagogic fringe fails to enact a new windfall levy, it might generate enough antioil sentiment to hurt the industry in other issues.

So far, companies have explained their fourth quarter results well. They've pointed out that increases from fourth quarter 1989 were unusually large because fourth quarter 1989 profits were unusually low-in many cases nonexistent. They've cited the crude oil price jump that elevated upstream earnings and took a partly offsetting toll downstream. And they've noted that market conditions have changed: Crude and product prices have subsided since the fourth quarter. If profits stay high through the first quarter of 1991, it will be for different reasons.

Those explanations should make sense to anyone willing to listen. They should refute charges of windfall profiteering. But companies shouldn't stop there. They should focus on the context of fourth quarter 1990 profits: a classic market adjustment that, notwithstanding the price rise, helped consumers by protecting supply.

Profits rose last quarter because crude prices jumped in response to an extraordinary supply interruption. Product prices rose, too-not by as much as crude prices but enough to get consumers' attention. And because prices rose, demand fell and new supplies quickly replaced exports from embargoed Iraq and Kuwait. The market sustained a 4.3 million b/d supply jolt, yet there was no shortage.

Yes, prices jumped. Yes, economies suffered. But consumers received something in return: uninterrupted access to essential fuels. Higher upstream profits for oil companies are part of the process that kept oil flowing in volumes sufficient to meet demand. What's punishable about that?

SECURITY OF SUPPLY

The U.S. should know from experience that windfall profit taxes do nothing but hinder market processes. By discouraging exploration and production, they limit domestic supply and force consumers correspondingly to rely on insecure foreign oil.

The U.S. also should know that oil prices aren't everything; security of supply matters, too. To the U.S. and its allies in the Middle East, it's worth a terrible war. It certainly should be worth a more balanced approach to energy policy than the U.S., with its windfall profit taxes and other mistakes, has employed so far.