Last week, Members of Congress called big oil executives to the stand to defend the high profits their companies are making. Some in Congress are using high oil profits as a reason to propose eliminating what they label “oil subsidies,” despite the fact that what they call subsidies are broadly available tax breaks. You can get a breakdown in this paper: “What’s an Oil Subsidy?”
President Obama did the same in his weekly address. Even actor Leonardo DiCaprio is getting into the action, recently tweeting, “Big oil is making huge profits & getting billions in US taxpayer subsidies. End #oilsubsidies.”
The irony of course is that DiCaprio, a successful beneficiary of our system of free enterprise, ignores its strengths and virtues by demonizing profit. These attacks are misinformed and off-base. Demonizing profits ignores why profits matter and the ways free enterprise benefits all Americans. It also ignores the fact that oil and natural gas industry earnings, against their sales, are in line with other manufacturers and are in fact below the manufacturing average.
So while it’s easy for some politicians and outraged denizens of Hollywood to blast high profits for oil companies at a time when families are struggling, the reality is that profits are an integral part of our economy, including the oil industry.
- Profits act as a rainy day fund. All companies have good years and bad years. High profits in one year can cushion the blow in another so a company won’t have to move through bankruptcy or ask for a government bailout. Oil profits vary from year to year with the price of oil. The price of oil is global; it goes up and down based on many factors. In 2008, oil prices were high, and companies made higher profits. The opposite holds true for 2009. According to the Energy Information Administration, “Oil and natural gas production continued to be the most profitable business segment, contributing $42 billion in net income, but this was a decline of 43 percent from 2008. Return on net investment in place (ROI) fell to 7 percent in 2009 from 13 percent in 2008.” Increased demand for oil as countries recover from the global recession is driving the price of oil—and consequently profits—back up. If and when the price falls in the future, firms can use these profits to tide them over.
- Profits encourage new investment. In Russ Roberts’s book The Invisible Heart, Sam, an economics teacher, pulls out a dollar on the first day of class, sets it on the front desk, and tells the class that the first person who gets to the dollar gets to keep it. It takes a second before a student rushes up to claim the dollar, but when Sam does it again, half the class jumps out of their seats. The simple lesson is that profit opportunities motivate effort. In the energy industry, profits motivate oil companies to take risks and make new investments in newer and more efficient equipment. Companies invest so they can extract oil and gas from the ground in ways that are safer and more cost-effective. Profits reward good investments just as losses punish bad investments (unless they receive a government bailout). Profits also allow businesses to hire more workers and increase wages.
- Profits help people. The adage “people, not profits” is a ridiculous one. When politicians attack the billions in profits that oil companies make, it’s important to remember who owns these companies and where that money goes: to the American people. According to the American Petroleum Institute, mutual funds and other firms hold almost 30 percent of oil stocks. Pension funds hold 27 percent, individual investors hold 23 percent, 14 percent is held in Individual Retirement Accounts, other institutional investments hold 5 percent, and corporate management holds just 1.5 percent. Increasing the supply of oil not only helps lower prices and produce jobs—it also helps boost stocks, mutual funds, IRAs, and pension funds owned by millions of Americans.
Profits play a critical role in our economy and reward producers for creating value for consumers. In a new video entitled “The Morality of Profit,” the Atlas Network’s Vice President for International Programs Tom Palmer asks, “Did Bill Gates violate anyone’s rights when he organized Microsoft and brought computer programs to billions of people? No, he offered customers value and free exchange.”
The same is true for oil. Consumers value oil and will move away from it when a better alternative exists. Politicians who demonize profits are missing the nature and the importance of the profit–loss system.