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Oil company profits are not the cause of the rise in energy prices

par Cécile Philippe
mardi 10 janvier 2006.

Article published exclusively on the Institut économique Molinari’s website.

The significant increase in the price of petrol, gas and domestic electricity since 2002 has made a lot of people angry. In order to appease public opinion and to answer the vested interests of some categories of workers, governments in many countries such as the United States, Great-Britain, Belgium and France have announced concessions, promises of subventions and with recurrence they threat oil companies to tax their profits.

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The significant increase in the price of petrol, gas and domestic electricity since 2002 has made a lot of people angry. In order to appease public opinion and to answer the vested interests of some categories of workers, governments in many countries such as the United States, Great-Britain, Belgium and France have announced concessions, promises of subventions and with recurrence they threat oil companies to tax their profits. Oil companies were already denounced on a near-daily basis, with President Jimmy Carter claiming in 1977 that oil companies were "ripping off" consumers, and that the best way to hold down oil prices was to hold down oil company profits. In the same manner, the French Finance Minister Thierry Breton threatened on 9 September those oil companies who did not behave correctly over the rise in petrol prices by subjecting them to an "exceptional tax". Recent "hearings" in the US Congress on the topic of gasoline prices were just another illustration of this debate.

Profits received by oil groups in 2004 and in beginning of 2005 have indeed attained an amazing record (65 billions euros or 85 billions dollars in 2004.) However high these profits no government can solve the problem of the consumer’s purchasing power and the rise in energy prices by instigating a new tax on profits made by oil producers. On the contrary, such a decision would aggravate the problem by further increasing the price of ‘black gold’.

The push to tax the profits of oil companies is surprising because in the past two decades, as research has clearly shown, the profitability of oil companies has been below average when compared with other firms in the Standard & Poors 500 Index. Thus, if oil companies owned the market power that the critics have claimed, then it would be difficult to understand why petroleum executives have permitted their companies to perform so poorly when their "power" could have dictated otherwise.

Taxation of profits is not only surprising but also economically inefficient. This assertion certainly seems shameless for many readers who feel oil profits to be a real irritant. This is no less true. For the tax on profits to be effective, it would be necessary for high oil prices to be caused by the receipt of high profits. However, a profit does not exist because it was decided a priori by the producers. It is known only afterwards, when consumers have accepted to spend enough to release one.

Profits also result from the fact that certain companies have succeeded better than others in anticipating consumer demand, whether this relates to oil, lipstick or soap. If a producer obtains a profit, it means retrospectively that other contractors should have launched themselves out in production. Purchasers of the same factors of production, they would have drawn prices upwards, reducing much of the potential profit. The producer who makes a profit is simply a more clear-sighted businessman than the others.

The daily press cascades us with figures on the huge benefit of companies such as Esso or Total. They certainly benefit from the high price of oil and profits insofar as others omitted, to their own detriment, to invest resources in this sector. Does this mean that they harm consumers because the latter must pay a higher price in order to profit from services made possible by petrol ? Insofar as this high price is due to the mistakes of those who did not invest in the sector, certainly not. If one deplores the fact that some companies did not correctly anticipate consumer demand for petrol, it is necessary to rejoice that certain others were excellent speculators. Without them, the price of petrol would have been even higher.

This leads us to speak about the aberration that exists of wanting to tax the profits of a company, at least from the point of view of the consumer. The individual or the company who obtains a profit due to anticipating better than others consumer demand, is the one which serves them best by investing resources where they are most urgently required. To tax a successful production amounts to sanctioning the consumer because taxation constitutes a barrier to competition.

When a sector records important profits, it becomes of interest to other companies, for example in related sectors and where more modest margins are recorded, to modify their production and to thus respond to the exceptional demand. In the search for profits, these new entrants will increase the availability of goods and thus reduce their price. It is this process a tax on profits can compromise. The higher these taxes are raised, the less businesses can react to the presence of profits and respond to the most urgent needs of consumers. The more the entry on to the market is blocked by taxes, the less the importance of the production and the higher the price.

While the French consumer could celebrate that Thierry Breton had abandoned this tax, one hopes that the American consumer will not have to suffer such a tax. A new rise in price will then be avoided. Now, it should be realised that governments have at their disposal a simple means to bring about a reduction in the price of oil. If new taxes can only draw the price upwards, it follows that the reduction of existing taxes is a factor in lowering the price. Oil production and consumption are already prone to a specific taxation which is particularly high. A price drop is immediately possible if governments do not delay in abandoning this tax.

Cécile Philippe, Director of the Molinari Economic Institute




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