Why Oil Companies Should Support Higher Taxes

August 26, 2015 | 00:00
Why Oil Companies Should Support Higher Taxes
Why Oil Companies Should Support Higher Taxes
The Organisation for Economic Cooperation and Development (OECD) has been advising countries around the world to increase tax revenues from their “largest taxpayers”. It has recommended closer monitoring of the tax affairs of large corporations and High Net Worth Individuals (HNWI), to reduce tax avoidance and evasion, and also raising taxes specifically for these categories of tax payers.

The major players in the oil industry are not known to be strong supporters of ideas such as these. In the United States, for example, the major oil companies strongly resisted recent attempts by the Federal Administration to increase taxation on the oil & gas industry, arguing they already are the largest tax payers in the country because of the high effective tax rate on their industry. Further tax increases, the US oil industry argued, would reduce investment, job creation and economic growth.

However, since the high oil price environment of recent years has now definitely ended and the oil industry is facing the possibility of 20 years of oil prices in the modest $50 to $60 per barrel range, the oil companies should reconsider their position regarding taxation.

In fact, in todays low oil price environment they should consider supporting increased taxation for the “largest taxpayers” across the board (not just the oil companies), since this is one of the few things that could substantially lift oil prices in a sustainable manner.

The reasons for the oil price drop: supply and demand

Most analyses of the recent drop in the oil price have focused on the increases in supply the last few years, primarily the increase in production from US tight oil reservoirs.

These explanations focus on the fact that US tight oil production has added some 3.5 million barrels to the daily supply since 2008, and the fact that this time round OPEC did not reduce its production in order to keep prices stable. Instead, OPEC decided to focus on securing its market share, maintaining production and allowing prices to adjust downwards.

What is largely ignored in this line of argument is the impact of demand on the oil price.

The investments in US tight oil that lead to the increase in production were all based on oil demand projections which never materialized. Since oil demand is directly related to economic growth, in part this is due to agencies like the International Monetary Fund consistently overestimating future growth since the start of the Global Financial Crisis back in 2008. (The IMF has been adjusting downward its future growth forecasts essentially continuously since then.)

The realization that the anticipated demand did not materialize, and hence that the increase in supply would not be met by an increase in demand any time soon, was effectively the trigger for the oil price adjustment back in the summer of 2014. The OPEC decision to not adjust its supply in light of all this, during November of that same year, just drove prices further down.

In other words, there is a glut in oil supply because there is lack of energy demand…

The future of the oil price, today

There are no indications that the current oversupply of oil will be reduced any time soon. The US tight oil producers have been able to drastically cut operating expenses, keeping most of their production profitable even with oil prices in the range of $40 to $60 per barrel. Meanwhile, the OPEC countries are scrambling for cash, making any reduction in OPEC production highly unlikely. In fact, supply is likely to increase over coming years, following the lifting of sanction on Iran.

At the same time, there are no indications that global economic growth will be picking up in a way that will correct current the supply/demand imbalance.

When this year started there wasn’t too much hope for a sudden recovery of demand. Ever since, the United States has lowered its growth forecast while Europe has reported nothing but bad news (European GDP remains below the 2008 level).

For as far as the BRIC countries are concerned, which lead the growth in oil demand this century, Brazil has gone from boom to bust, partly under the weight of the Petrobras corruption scandal involving top politicians. Russia’s economy is shrinking due to the sanctions over Ukraine. Regarding India opinions are mixed. But China’s devaluing of the yuan is yet another sign that its growth is slowing down more than expected as well.

The outlook for the oil price is bleak, therefore. Earlier speculations that oil could go as low as $20 per barrel appear less unlikely today – in fact, this price range will be the future if the current supply/demand imbalance persists.

Addressing the demand issue

There is now growing recognition of the fact that income inequality impacts economic growth. Recent IMF research found, for example, that if the income share of the richest 20 percent increases, GDP growth declines, while if the income share of the poorest 20 percent increases, GDP growth increases.

The reason for this noted effect lies in what economists call the propensity to consume. Poor people tend to consume a larger share of their income than do rich people, simply because the basic human necessities (food, housing, clothing) eat up most of their income. In other words, rich people have more “spare income”, i.e. income that remains after expenditure on the necessities, and they are therefore more inclined to save than are poor people. In the language of economists this means the poor have a higher propensity to consume than the rich.

The consequence of this difference in propensity to consume is that if a society transfers wealth from the rich to the poor, aggregate demand and thus economic growth in that society will increase, with the opposite resulting if wealth is transferred from the poor to the rich.

Unfortunately, the IMF research also found that income inequality has been increasing globally. In the developed world the gap between the rich and poor is now at its highest level in decades. This means that there exists in the world economy today a large reservoir of potential demand, which could be tapped and transformed into additional actual, effective demand if some of the existing wealth and income was transferred away from the (super)rich to the poor and the middle classes.

A reform of corporate and personal income taxes as recommended by the OECD could achieve this. According to Nobel-price winning economist Joseph Stiglitz a more progressive tax system would raise aggregate demand simply by improving the distribution of income.

If, in addition, the tax system were to provide the (super)rich corporations and private individuals, who at present store a large fraction of their wealth because the (projected) demand to justify investment is not there, with tax credits for investment, aggregate demand in the world economy could be raised to levels that would support $80 to $100 per barrel again.

In the end, therefore, raising taxes might just be in everyone interest – not least the oil companies.

Andreas de Vries works as a Strategy Consultant in the Oil & Gas industry.

Image: Taxes by 401kcalculator.org. CC-BY license.
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