3 Why Oil Companies Don't Drill

U.S. oil companies are pushing hard to get Congress to allow the current Administration to issue more oil leases before its term expires. In response, skeptics have noted that three-quarters of the 90 million-plus acres of federal land already leased for oil drilling are not being worked. Oil companies deny this. Regardless of who is right, the number of operating oil rigs in North America declined across the course of 2007.

In the meantime, OPEC has raised its quotas by only 20% since 1998 – a measly 2% per year. World GDP grew by about 85% over the same period. The International Energy Agency reports that non-OPEC oil countries are also underproducing and predicts that they will continue to do so.

Everyone seems to be holding back.

Why?

The most likely answer is very simple.

Goldman Sachs has predicted that the price of oil may move past $200/barrel within the next 6 to 24 months. OPEC's chief and EU’s energy commissioner have also both warned that prices in excess of $200/barrel are possible in the near future.

Suppose you owned a source of oil. Would you sell that oil now for $140/barrel? Or would you wait for two years and sell it for $200/barrel?

Obviously, you would wait.

Nor is it clear that oil prices will peak at $200/barrel. If world GDP rises another 85% over the next decade and oil production increases by only 20%, we may come to view $200/barrel oil as dirt cheap.

So what to do?

On the tax side, Congress has done almost all it can do to stimulate U.S. production.

A 2005 Congressional Budget Office study concluded that the effective 2002 U.S. tax rate on profits from petroleum and natural gas structures was the lowest imposed on any type of corporate capital asset: 9.2%. Profits from computers, by contrast, were taxed at an effective rate of 36.9%.

A 2000 study by the Institute on Taxation and Economic Policy concluded that in 1998, of all U.S. industries, petroleum and pipeline companies were taxed at the lowest effective rates: 5.7%. Health care companies, by contrast, were taxed at an effective rate of 32%.

If tax incentives were going to induce U.S. oil companies to drill, they probably would have done so by now. Interestingly, Sen. McCain and Sen. Obama both propose to eliminate oil production tax incentives. After all, if oil companies are not responding by increasing production, those breaks are just gifts from you and me to Exxon.

Perhaps there is another question we should be asking: Are the oil companies right?

Remember that prices are a measure of value. If oil prices are going to be much higher 10 years from now, that means oil will be more valuable then than it is now. Valuable to us.

If so, should it really be our policy to drain U.S. reserves as quickly as possible? Or should our policy be to save at least some of those reserves for the day when gas is $10/gallon?

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