Eek! Profits

From IBD:
Posted 4/27/2006

Oil: Exxon Mobil has just reported first-quarter net income of $8.4 billion. OK, call it a windfall. But do you really want the government to tax it away?

In saner times that question would not even have to be asked. But the planets of politics and economics have aligned in such a way as to produce an outbreak of dubious ideas. Among these are a revival of the "windfall profits" tax and a threat, heard this week from Republican Sen. Charles Grassley, of opening the income-tax records of Big Oil firms to "make sure the oil companies aren't taking a speed pass by the tax man."

Time for some plain talk about profit — what it means and what it does. You won't hear it in Congress these days, so we'll try to offer some here.

First, it's easy to answer Grassley's suggestion that oil companies may have been avoiding their fair share of taxes: The firms' tax payments are on the record and they're ample. Exxon Mobil paid $7 billion in the first quarter of this year, almost as much as the $8.4 billion left over for the shareholders. So score one for profit: The public gets a nice, fat share of it.

Second, profit is not the same as executive compensation. Confusion on this point has helped stoke the anger against Exxon Mobil in particular.

The retirement package received last year by the company's retiring CEO Lee Raymond was certainly generous, though nowhere near as outrageous as slapdash news reports made it seem. But pay and benefits, as corporate expenses, work to reduce profits. If a CEO is overpaid, the real victims are the shareholders, not the buyers of the company's products.

Third, profit today is product tomorrow. Or to put it in the form of a question: Where do you think the money to make gasoline comes from? It comes mostly from the corporations, with a minor boost from depletion allowances and other tax breaks that mainly help independent drillers rather than the big, integrated companies such as Exxon Mobil, Chevron, Shell, BP and ConocoPhillips.

Think about the process of getting crude from deep out of the ground or the sea floor and converting it to fuel that even now is cheaper per gallon than bottled water. It's always something of a gamble, and never cheap. Exxon Mobil spent $4.8 billion on capital and exploration costs in the first quarter alone.

The price at the pump includes these costs, plus a profit to reward investors for risking their wealth in a company. Some of that profit is paid out in dividends, but most of it is added to the company's capital, which in turn funds more exploration, production and, in the end, more gasoline. This is how free enterprise works. And in most industries outside the oil business, profit is not only accepted but applauded.

Is there any alternative to this business model? Of course there is, just as there's an alternative to private enterprise in general. It's state ownership, exemplified in Mexico's PEMEX, which sits on vast reserves that it cannot tap because it lacks the capital to explore and exploit them.

The industrialized world knows better than to go that route, and politicians in this country should know better than to weaken a productive, efficient industry by attacking the profits that make it run.