Why Big Government Should Stop Picking On Big Oil

The U.S. government, egged on by critics of Big Oil, is again trying to squeeze more tax revenues out of the oil companies. On Jan. 24, the government published new regulations in the Federal Register that will force the companies to pay an extra $100 million annually in production royalties. Bureaucrats have decided to change the rules governing royalty payments to the government for oil produced on federally owned land.

Historically, royalties have been based on the wellhead price--the price of oil as it comes out of the ground. The government wants to base the royalty on the price of oil on the New York Mercantile Exchange. This price is usually higher than the wellhead price because it includes transportation costs. Moreover, the government wants to make this retroactive and to stick the companies for more than $1 billion in additional royalties for oil drilled in past years.

The royalty payment has long been based on the wellhead price and would seem to be an implicit contract not subject to unilateral alteration that favors one party. Moreover, bureaucrats should not be acquiring the power of the purse through regulations. But don't expect any public outcry. The public's attitude toward oil can be summed up in three words: suspicion, scrutiny, and mistrust. The fortunes oil has produced have made it a mark for populist ire, and the high ratio of value to price has made it easy for government to tax.

WATER BARONS? The public's antipathy toward the oil companies is hard to justify when one considers how well the industry has done by the consumer. Consider, for example, the price of a gallon of gasoline, which requires complex technology and massive capital investment to produce. If the state and federal excise taxes that apply to gasoline were removed, a gallon of regular would cost about 80 cents, less than a gallon of drinking water in the local grocery store and one-third the price of a gallon of milk.

Excises are not the only taxes reflected in the price of gasoline. Oil companies pay taxes on their assets and their earnings. Americans for Tax Reform, a Washington-based nonprofit organization, calculates that 54% of the price of gasoline is accounted for by taxes. If it were not for taxes, we would be paying about 55 cents or 60 cents for a gallon of gasoline. The low cost is extraordinary considering the costs of locating, recovering, and transporting oil, refining it into gasoline, transporting it again, and retailing it to the customer. No other product used by so many comes even close in providing high value for such a low price.

The men who built the oil industry and those who run it today never had an easy time of it. Because of the high stakes, oil has been no industry for the weak of heart or stomach. No less a figure than John D. Rockefeller contended that "all the fortune that I have made has not served to compensate me for the anxiety." Recurrent supply uncertainties and price fluctuations have provided an excuse for political attacks and regulation of oil, and unfounded expectations of gasoline shortages have resulted in mandated fuel economy standards.

THE COMING CRUNCH. In the 20th century, recurrent predictions that the world is running out of oil have time and again been proven false by the ingenuity and dedication of oil entrepreneurs. The growth in Western living standards owes much to the balance that has been kept between oil supply and demand. Demand factors could cause this balance to be lost in the 21st century. Socialism and communism curtailed the world demand for oil by killing economic activity everywhere but in North America, Europe, and Japan. This unnatural prolongation of poverty and backwardness has ended with the collapse of Soviet communism and the abandonment of socialism in Latin America and Asia. The productivity of labor and capital in these vast areas is likely to rise, and the growth in living standards will mean a sharp increase in the demand for oil.

Unless new reserves are discovered and brought into production, a rise in the real price of oil will take a toll on living standards in the older, hydrocarbon-based industrialized economies. Political abuse and public hostility are not conducive to the strength and morale of an industry that more than any other is the basis of our economic life. If we compare the government's proclivity to waste money with the oil industry's ability to deliver low-cost hydrocarbons, it seems obvious that the public would be much better served by leaving the $100 million a year in the hands of the oil industry and not with government bureaucrats.