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Are We Evil for Owning Oil Companies?

Are We Evil for Owning Oil Companies?

Wow, I didn’t know I was evil for buying Exxon and BP for Gracor portfolios.  But after watching the Senate hearing with the big 5 oil companies, I came away feeling, at a minimum, “greedy.”  However, Benjamin Graham teaches us that true investing is not about feelings, so I took a look at the details of the accusations.

The accusations appear to be centered around “tax breaks,” “loopholes,” and “subsidies.”  The implications appear to be that the oil companies get something special that no one else gets or that they got these benefits by less than fair dealings.  Unfortunately, the accusers are not forthcoming with specifics.

Having studied this industry since the mid 1980s I was fairly sure that oil companies didn’t enjoy any enriching government mandates – certainly none that rise above the materiality threshold.  Also, the most recent information I have read indicates that the industry pays an effective tax rate of 48.4% versus 28.1% for all other S&P industries.

If the government really wanted to ease our burden at the pumps, my alternative target would be to correct the Federal Reserve’s weak dollar policy, which has sent prices for commodities prices like oil soaring.

But the point of this exercise is to ensure we are not being evil, so I will focus on the accusations.  I hope this can be a resource to you while the political show continues.

Tax breaks

Here at least the accusers mentioned some specifics like depletion allowance, intangible drilling costs, the Energy Policy Act of 2005, and the Manufacturing tax credit.  The first two are routine accounting issues!  The second two are congressional acts.  Let’s look briefly at each.

Depletion is a term used in accounting by which costs of natural resources (a wasting asset) are allocated to match them with the revenues they generate.  Depletion expenses are also a big factor in the mining and timber industries.  This expense falls under the matching principle of accounting and is very similar to the deprecation expense for other assets.  Expenses are deducted from revenues to determine profit, which in our tax system is what is taxed.  Technically, depletion has been in the our tax code since 1926, and the matching principle is one of the corner stone principles of accounting dating back to the days of Pacioli (Summa… published 1494).  Therefore, my decision is that the use of depletion expenses are legitimate tax expenses and NOT evil.

Intangible drilling costs are a confusing because the word “intangible” is not used properly.  These are costs for developing a well before actually operating it.  Included costs are labor, survey work, supplies, taxes, power, and equipment rentals, all of which are quite real, but they are classified as intangible because they have no salvage value.  Accounting for these costs is governed primarily by the timeless accounting principle of asset/liability measurement, and again, are handled in the same way plant assets are.

The tax code, however, does allow the exercise of some judgment in deciding if the costs should be immediately expensed or capitalized and matched with revenues over time.  The accusers could probably argue against the expensing method, but it should be noted that these are deductions have been in the tax code since 1913.  My verdict is they are defiantly not evil deductions, although some debate on fine tuning the ability to use judgment might be possible.

P.S.– before anyone jumps on the word “judgment,” let me state that judgment is part of the modifying conventions in The accounting theory model – and has been forever.  Between theory and practice, people must make judgment calls (accountants and management).  Modifying conventions help resolve these questions.

Energy Policy Act of 2005. I used my super-secret-Wall-Street connections (Wikipedia) to read the actual law signed by President Bush.  Not really fun reading, but it only took me five minutes to determine that at least 81% of all the “tax reductions” went to competitors of the oil companies: advanced nuclear reactors, wind, wave, tidal power, geothermal, clean coal, alternative motor vehicles, bio-fuels, and government agencies for renewable energy projects.  The rest went to the oil companies for some sort of ethanol blending.

This was anything but a partisan, this act of Congress!  The final vote was 64% in favor in the House and 74% in the Senate.  Perhaps most importantly to my worry about being evil is the fact that the then-senator from Illinois, Barrack Obama, voted for the act.  My verdict?  For no other reasons than those in this last paragraph, I find the accusations hurled at the oil companies relating to the Energy Policy Act of 2005 silly!  It’s certainly not clear that what the oil companies got from this act was material, and if Congress wants to take away what they gave, so be it.  But accusations of greed and evil?

Manufacturing tax credit.  This is the silliest of the accusations against the oil companies.  This came from Congress in 2004 as a way of improving the economy.  The definition of manufacturer is so broad that even Starbucks qualifies.  It basically covers any firm with investments in physical capital.  This is clearly not a special privilege for just for oil companies but it is stupid and should be reformed.

Loopholes

These accusations are primarily concerned with American companies that have foreign subsidiaries that relocate operations (jobs) overseas – not exclusively an oil company issue!  The current accusations specifically target the tax code that allows companies to only pay the difference between the U.S. tax rate and the foreign rate WHEN they bring profits back to the U.S.  In other words, the company receives a tax deferral until the money comes back to the U.S., which is similar in nature to an IRA deferral of taxes until money is used for retirement.  It is certainly not a “tax break” or “subsidy.”  Once we expand properly to a global perspective, I believe you will see that the “loophole” accusation will sound too pejorative.

This is not the first time this repatriation-of-earnings issue has come up.  In fact, it is rather obvious that for a long time now the U.S. tax code has been punitive compared to other developed countries.  In most other developed countries, including Germany, Japan, the U.K., France, Spain, Italy, Russia, Australia and Canada, companies can repatriate earnings at a tax rate of 2% or less.  Considering that the U.S. rate is 35% and the average for OECD countries is 19.5%, paying the difference of 15.5% is a true penalty for bringing profits back home (data from the Cato Institute).

As other nations have cut their rates, the incentives for capital to leave the U.S. have become stronger.  Call me simpleminded but why not reduce the penalty to 4% and create what the Wall Street Journal editors called “a privately funded stimulus of up to a trillion dollars”?  Not to mention a quick $40 billion pop for the federal government’s coffers.  Personally I don’t see tax rate competition between countries as a good versus evil argument!

Subsidies?

Monetary assistance granted by a government to an enterprise?  Other than the bit they got in the above-referenced Act of 2005, I don’t know what “subsidies” they get.  At any rate, they receive none that cross the materiality threshold or cause the oil companies to be “hugely profitable” or “profoundly out of touch.”  Verdict: this is a non-sequitor – or at the very least – a poor choice of words by the accusers. 

 

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14 Responses to Are We Evil for Owning Oil Companies?

  1. joecortopassi says:

    Aurelio, any chance you are one of our vistors from another country? Google analytics shows me countries but doesn’t show which comment comes from which country (or I haven’t figured it out yet). Love to see people sing with country of origin!

  2. joecortopassi says:

    Thanks for noticing James! Part of my directions to my friend who built the website was to make it load like Google, and in general, to use the K.I.S.S. method (the last “S” being me not my friend). I believe you are the first person to pick up to that.

  3. I have a wordpress blog and I would like to remove everything (it’s hosted on my own domain and hosting) because I would like to delete my site. How can I save my blog posts in a folder or something in my documents (offline) because I don’t want to delete everything completely. Can I do that in one go, if I can even do it ? Thank you !.

  4. Does your site have a contact page? I’m having problems locating it but, I’d like to send you an e-mail. I’ve got some ideas for your blog you might be interested in hearing. Either way, great website and I look forward to seeing it grow over time.

    • joecortopassi says:

      Yes it does, on the home page just above Blog, “Contact Us”. I am the Joe email address.
      p.s. What language is your website?

  5. Greetings I am so thrilled I found your weblog, I really found you by mistake, while I was researching on Askjeeve for something else, Anyways I am here now and would just like to say thanks a lot for a incredible post and a all round interesting blog (I also love the theme/design), I don’t have time to browse it all at the moment but I have bookmarked it and also added in your RSS feeds, so when I have time I will be back to read a great deal more, Please do keep up the excellent job.

  6. joecortopassi says:

    Sorry, I’m not much help on technical stuff. However, Potrzeba jest matka wynalazków (hope I got that correct).

  7. joecortopassi says:

    The bleeping Euro Debt Crisis has really kept me busy – and now -its Christmas time. One of my New Years resolutions is to get back to writing. Talk soon, Joe

  8. joecortopassi says:

    Sweden? Could you give your name and city please?

  9. joecortopassi says:

    Name and town please!

  10. Rozrywka says:

    I think you have mentioned some very interesting points , thankyou for the post.

  11. joecortopassi says:

    No hackers yet but lots of spam.

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