Why A Windfall Profit Tax Would Be A Disaster For US Oil

The Biden administration has made no secret of their disdain for traditional energy sources that derive from petroleum sources, favoring instead, so-called “green energy” alternatives. In fact on the campaign trail, Candidate Biden was explicit in his desire to end the oil industry in America as it presently exists-

“Number one, no more subsidies for fossil fuel industry. No more drilling on federal lands. No more drilling, including offshore. No ability for the oil industry to continue to drill, period, ends, number one.”

Politifact

On another occasion, Candidate Biden went so far as to say that he would put fossil fuel executives in jail.

Over the past year in pursuit of their goal of forcing an energy transition to “clean energy”, the administration has implemented additional steps designed to make it more onerous and expensive for oil and gas producers in America. Among them-

  • Sweeping changes to oil and gas leasing on federal lands.
  • Reversed Trump Era methane rules.
  • Canceled the Keystone XL pipeline
  • Put in place decision makers at key federal agencies (SEC, Treasury, FERC) who are attitudinally biased against the oil industry. And, who wants to promulgate regulations that impair its ability to gain financing, or impose harsh fines, and with use of expanded carbon impact definitions, make it impossible to obtain permits.
  • Attempted to introduce carbon price offsets in the stalled “Build Back Better” tax scheme.

Even as the Biden administration has scrambled to replace Russian oil and gas after banning them last week, they have steadfastly refused to consider reaching out to US producers to encourage the development of new supplies. As I discussed in a prior Oilprice article, the president has sent emissaries to Venezuela, openly discussed buying oil from Iran, and attempted to exhort Saudi Arabia into increasing its production. All to no apparent avail.

On a recent trip to Fort Worth, Texas, to visit veterans at the Regional VA hospital, near the heart of oil and gas country, the president chose not to meet with oil and gas execs to try and bridge some of the distance between them. Overall, the Biden antipathy toward the domestic oil and gas industry has been termed a War on Fossil Fuels. With legislation now being drafted, it appears to be intensifying as opposed to letting up as America reels under gasoline prices that have in many cases tripled from a year ago.

Last week, a couple of Senators sympathetic to the administration’s goals began drafting a legislative proposal that would revive a decades-old tax scheme to expropriate what they term are “ill-gotten” gains from the current high price era. Senators, Ron Wyden-D, Oregon, and Senator, Elizabeth Warren-D, Massachusetts unveiled their proposal that would strip away 50% of the profits from oil companies, and rebate them to low-income taxpayers while maintaining gas prices at or above their current levels. The Wall Street Journal summed up this Wind Fall Tax-WPT, proposal in an article last week-

“The windfall-tax proposal shows that Democrats do not want US companies to produce more oil so gasoline prices fall. They want higher gas prices so reluctant consumers buy more electric vehicles. They can not say this directly because it would be politically suicidal in an election year with the average gas price above $ 4 a gallon, so they do it indirectly via taxes and regulation. ”

WSJ

In the rest of this article we will take a quick look back at the last iteration of this idea from the 1970s and ’80s and draw some conclusions as to what it might portend in the modern era, should it become law.

The Windfall Profits Tax of 1980

Following the Arab oil embargo of 1973, prices rose to historic highs and concerns began to rise that oil companies were making unjust profits. President Nixon introduced Price Controls on oil in 1974, which led to the era’s famous gas lines from shortages. In 1980 President Carter took steps with the Windfall Profits tax to remedy the supply situation but ensure that oil companies did not make unjust profits. As with most federal intervention in the markets, the WPT fell short of its goals and produced further unintended consequences that harmed American companies. Among its chief flaws-

  • It was actually an excise tax due when a barrel of affected oil was produced, and before any profits were taken.
  • It created classes of oil domestically, as it really just extended the thinking of price controls.

Oil

CGA

  • Further, it disadvantaged American production against global sources. Capital for drilling fled (North Sea and nascent Deepwater GoM which had significant royalty relief) then, and will again to greener pastures.
  • Production declined during the original WPT for a lot of reasons, and will again if this iteration grows legs and walks. Thanks to a rapid buildup of Alaskan crude, US production actually increased for a short period during the WPT. Alaskan oil peaked in 1985 though and US production began a slow decline to the early 2000s while foreign imports soared. Then, with the advent of fracking and the rise of deepwater production, US production began to rise to all-time highs.

EIA

EIA

The path forward for the WPT and the implications of its passage

This tax proposal will be opposed by every Republican, on the Senate subcommittee of Taxation and IRS oversight, where in the normal course of events it would first be discussed and marked up, and voted out of the committee to the full Senate. There are miles to go before it could be considered, and there is scuttlebutt that it has no chance of making it out of committee. Our take is that the party in power now has another 10 months to pass it, if you count the lame-duck session and assume Republicans will regain control of Congress. Otherwise, they have years and will pass everything they have dreamed about for decades. It’s a long road with a lot of twists and turns.

We now have some of the details of this legislative proposal. It will be a nightmare to administer, and since it is modeled at higher rates than the original 1980 version, it will bring back many of the same flaws. Like the other, it will definitely reduce production and imports to this country. Oddly, it attempts to address the tax advantage that imports had under the old system by treating imports the same as domestic production.

Foreign producers are very unlikely to allow the US government to capture a “windfall” and will adjust their sales prices to include the tax, raising the final prices to consumers still higher. Count on it. We have an example to go by.

The Brazilian IPI is a good example. It scales up to 55% on imported vehicles with an engine displacement of more than 2-liters. The noble goal is the protection of their domestic auto production, which coincidentally sells at the import price levels, raising prices for all Brazilians. The Sheikhs will do the same to protect their industry. The result will be less oil and gas for Americans and will play right into the handbook of the green new deal movement, making the final product more expensive.

On the domestic side, fewer prospects will meet Internal Rate of Return (IRR) and Rate of Capital Efficiency (ROCE) thresholds, scrutiny that prospects compete for capital under, meaning they will not go forward. Capital does not idle. It seeks a return and will flee. Oil companies, having learned the private equity and venture capital lesson from a few years ago, will only fund what cash flow will bear. Increasingly they will look beyond our shores to deploy their capital where it is more appreciated. US production will inevitably wither in this scenario.

Drivers will pay more. One of the goals of this administration is to make fossil fuels prohibitively expensive to accelerate the “transition to renewables.” Renewables are a hollow promise as the world is learning on a daily basis. That won’t keep the government from spending “confiscated” oil money on green dreams, like “stimulus” checks.

People love stimulus checks and usually love the politicians that provide them. To many with a check in hand, the connection between it and higher prices for everything is elusive. Hence the current brouhaha over inflation. Pumping $ 6-trillion into the money supply in a year a half made it predictable. Now, with the stimulus checks gone, and the price of gas at record levels, people are upset, and the politicians would like to soothe them. With another check.

Your takeaway

As I have noted in prior Oilprice articles, thanks to underinvestment in upstream energy sources, we are transitioning to an era of less available, and more expensive energy. The oil industry can produce more, but it needs to be incentivized to do so, not harassed. It remains to be seen if leadership can step back from the green energy narrative to engage with producers who supply the great balance of the world’s energy sources. There was some reason for encouragement last week at CERA week in Houston, when some lower-level Biden bureaucrats met with energy folks. Vinai Thummalapally, acting director and chief operating officer of the US Trade and Development Agency commented after the meeting-

“I envision this particular situation as a fire in the kitchen, which helps finance energy projects overseas. We will extinguish it. It will be extinguished. We need to move on with dealing with the rest of what the house is dealing with in terms of all the priorities. ”

Politico

If you unpack that ‘word salad’ of mixed metaphors it does not reveal much reason for optimism, but at least they talked. Progress of a sort.

By David Messer for Oilprice.com

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