Are Oil Industry Profits Really Excessive?

With gasoline prices at $4.15/gallon or so, politicians have been calling for investigations into the pricing of a barrel of oil, which feeds into the price of a gallon of gasoline.  But are the industry’s profits really excessive?

It is instructive to look at the revenues, expenses, taxes and profits of a variety of industries to determine whether or not “big oil” is, in fact, as profitable as the politicians seem to think. 

When reviewing the information below, it is helpful for the reader to understand the definition of each of the line items, so a definition of each is as follows: Revenues (also referred to as Sales) is defined as all sales to end customers.  Expenses includes all expenses of the company except for interest payments on debt and taxes.  Pre-tax Income is income after all Expenses are deducted from Revenues, except for taxes.  Taxes includes all income taxes plus any other taxes that might be charged (for example, taxes levied by political subdivisions that an oil company must pay for each barrel of oil extracted from oil fields located in each political subdivision).  Net Income is the income after all Expenses, Interest and Taxes are deducted from Revenue, and is the amount available for shareholders for dividends payments, stock buybacks and reinvestment into the business.

Take, for example, four well-established companies:  Exxon Mobil, Wal-Mart, Johnson & Johnson and Intel Corporation.  Revenues, taxes and profits for 2010 (and fiscal 2011 for Wal-Mart), are shown below (all amounts are in billions of dollars):

Wal-Mart: Revenues $421.8, Expenses $398.3, Pre-tax Income $23.5, Tax $7.6, Net Income $16.4.

Wal-Mart’s Expenses were 94.4% of Revenues, Pre-tax Income was 5.6% of Revenues, Taxes were 1.8% of Revenues, and Net Income was 3.9% of Revenues.  Wal-Mart’s tax rate was 31.7% of Pre-tax Income.

Johnson & Johnson:  Revenues $61.6, Expenses $44.6, Pre-tax Income $16.9, Income Taxes $3.6, Net Income $13.3.

Expenses represented 72.4% of Revenues, Pre-tax Income represented 27.4% of Revenues, Income Taxes represented 5.8% of Revenues and Net Income represented 21.6% of Revenues.  Johnson & Johnson’s tax rate was 21.3%.

Intel Corporation:  Revenues $43.6, Expenses $28.0, Pre-tax Income $16.0, Income Taxes $4.6, Net Income $11.5.

Expenses represented 64.2% of Revenues, Pre-tax Income represented 36.7% of Revenues, Income Taxes represented 10.6% of Revenues and Net Income represented 26.4% of Revenues.  Intel’s tax rate on Pre-tax income was 28.8%.

Exxon Mobil:  Revenues $383.2, Expenses $294.2, Other Taxes $36.1, Income Before Income Tax  $52.9 (which is after Other Taxes), Income Taxes $21.6 and Net Income $31.4.  Pre-tax income before any taxes are applied:  $89.1.

Exxon Mobil’s Expenses in 2010 were 76.8% of Revenues, its combined taxes (Other Taxes and Income Tax) represent 15.1% of revenues and its Net Income (the “bottom line” available to shareholders) is 8.2%.  Another way to look at this is that Taxes represent 64.8% the income before any taxes are applied!  It is hard to fathom how politicians can believe that Exxon Mobil is the one profiteering, when various governmental entities take almost 2/3 of the pre-tax profits!

So to summarize:  Wal-Mart’s Revenues exceed Exxon Mobil’s by $38.6 Billion. Wal-Mart’s Income Tax is 1.8% of Revenues as compared to Exxon Mobil’s 15.1%.  Johnson & Johnson’s tax rate on Pre-tax Income was 21.3% as compared to Exxon Mobil’s 64.8%.  Intel’s Net Income as a percentage of Revenues is 26.4% as compared to Exxon Mobil’s 8.2%.

Exxon Mobil’s Net Income figure seems large because it is a large company, not because it is gouging motorists at the pump.  Exxon Mobil needs large amounts of capital to drill oil wells, and the company spends many years developing these properties before it receives any payback in the form of oil and gas flowing from the completed wells.  Government’s take is extraordinarily large, which takes capital from the company when it could be reinvesting those dollars in finding more oil and gas to alleviate the supply and demand imbalance that is driving up gasoline prices.

Implications for your investments: If you own an S&P 500 index fund, Exxon Mobil represents 3.2% of your money invested, and Energy stocks (many of which are paying a similar percentage of their profits to the tax collectors), represent 11.8% of the S&P 500 index.  The taxes levied on these companies are being levied, indirectly, on you.