API statement - continued from page one
The Market Works
Because the market does remain healthy and competitive, it is imperative that it be permitted to continue functioning as freely of artificial restraints as possible. As we have consistently maintained, the answer to our energy situation is to increase supply, reduce demand and expand and diversify infrastructure.
In attempting to meet the challenges we face, it is also important to do no harm. The worst thing Congress could do now would be to repeat the mistakes of the past by overriding the structures of the free marketplace. Imposing new controls, allocation schemes, new taxes on industry, or other obstacles will only serve to make the situation much worse.
Company Earnings in Perspective
It is evident that much of the renewed focus on industry consolidation is a result of both the higher prices of various fuels as well as the perception that the industry is reaping windfall profits. It is our hope that a better understanding of those earnings and how they compare with other industries will discourage potentially harmful action on the part of our national leadership. The oil and natural gas industry is among the world's largest industries. Its revenues are large, but so are its costs of providing consumers with the energy they need. Included are the costs of finding and producing oil and natural gas and the costs of refining, distributing and retailing it.
The energy Americans consume today is brought to us by investments made years or even decades ago. Today's oil and natural gas industry earnings are invested in new technology, new production, and environmental and product quality improvements to meet tomorrow's energy needs. Oil & Gas Journal estimated that the industry's total U.S. spending in 2005 was $85.7 billion, compared with $80.7 billion in 2004 and $75.5 billion in 2003. It also estimated that exploration and production spending in the U.S. grew 6 percent and that total upstream oil and gas spending in the United States was nearly $66 billion.
The industry's earnings are very much in line with other industries and often they are lower. This fact is not well understood, in part, because the reports typically focus on only half the story – the total earnings reported. Earnings reflect the size of an industry, but they're not necessarily a good reflection of financial performance. Earnings per dollar of sales (measured as net income divided by sales) provide a more relevant and accurate measure of a company's or an industry's health, and also provide a useful way of comparing financial performance between industries, large and small.
For the third quarter of 2005, the oil and natural gas industry earned 8.2 cents for every dollar of sales compared to an average of 6.8 cents for all U.S. industry. For the second quarter of 2005, the oil and natural gas industry earned 7.7 cents for every dollar of sales compared to an average of 7.9 cents for all U.S. industry. Over the last five years, the oil and natural gas industry's earnings averaged 5.8 cents compared to an average for all U.S. industry of 5.5 cents for every dollar of sales. (Chart 10 and Chart 11)
It is also important to understand that those benefiting from healthy oil and natural gas industry earnings include numerous private and government pension plans, including 401K plans, as well as many thousands of individual American investors. While many shares are owned by individual investors, firms, and mutual funds, pension plans own 41 percent of oil and natural gas company stock. (See Chart 12) To protect the interest of their shareholders and help meet future energy demand, companies are investing heavily in finding and producing new supplies and in new refinery capacity.
Questions About Royalties
We would also like to briefly address the question of royalties paid by the oil and natural gas industry to the federal government because the issue has been in the news lately. By statute, royalties are paid on “value of production,” a wellhead concept, which may be different than the final selling price that increasingly occurs downstream from the wellhead. When this occurs, the costs of certain post-production costs such as transportation and processing must be deducted to arrive at the “value of production.”
It is important to understand that the Gulf Coast – where much of this country’s oil and natural gas production occurs – was hit by two major hurricanes that crippled production for months and caused the loss of more than 100 million barrels of crude oil production and more than 500 billion cubic feet of natural gas. If production is down, it is only natural that royalty payments would also be down. In addition, the hurricanes seriously disrupted electronic reporting toward the end of 2005.
In short, MMS sets the rules and companies comply with these rules. It is impossible to obtain a true picture of the royalties paid by the industry simply by looking – as recent news articles have done – on invalid assumptions and comparisons, misinterpreted government data and incomplete information.
Because the potential for misunderstanding of royalties is so great, the industry has strongly urged the adoption of an expanded RIK program, as authorized in the Energy Policy Act of 2005. The payment of royalties through the RIK program simplifies royalty obligations and ensures that government gets appropriate royalties. Expansion of this program would help eliminate any questions as to what the value of the fuel should be.
Solutions
We should focus on increasing supplies and encouraging conservation. The Energy Policy Act of 2005 signals a first step in a much-needed effort to enhance energy security and ensure the reliable delivery of affordable energy to consumers. Nevertheless, much remains to be done.
We can no longer afford to place off limits vast areas of the Eastern Gulf of Mexico, off the Atlantic and Pacific coasts, and offshore Alaska. Similarly, we cannot afford to deny Americans consumers the benefits that will come from opening the Arctic National Wildlife Refuge and from improving and expediting approval processes for developing the substantial resources on federal, multi-use lands in the West. In fact, we do have an abundance of competitive domestic oil and gas resources in the U.S. According to the latest published estimates, there are more than 131 billion barrels of oil and more than 1000 TCF of natural gas remaining to be discovered in the United States.
Much of these oil and gas resources – 78 percent of the remaining to be discovered oil and 62 percent of the gas – are expected to be found beneath federal lands and coastal waters. The amount here is enough oil to power 55 million cars for 30 years AND heat 24 million homes for 30 years. And there is enough natural gas to heat 60 million homes that use natural gas for 120 years.
Federal restrictions on leasing put significant volumes of these resources off limits, while post-lease restrictions on operations effectively preclude development of both federal and non¬federal resources. Addressing these restrictions is critical.
And, while we must focus on producing more energy here at home, we do not have the luxury of ignoring the global energy situation. In the world of energy, the U.S. operates in a global marketplace. What others do in that market matters greatly.
For this country to secure energy for our economy, government policies must create a level playing field for U.S. companies to ensure international supply competitiveness. With the net effect of current U.S. policy serving to decrease U.S. oil and gas production and to increase our reliance on imports, this international competitiveness point is vital. In fact, it is a matter of national security.
Beyond easing the way for greater development of oil and natural gas, we must also address the nation's refinery capacity challenge. The record-high gasoline prices, while primarily caused by increased crude oil prices and exacerbated by Hurricanes Katrina and Rita, have underscored the fact that U.S. demand for petroleum products has been growing faster than – and even exceeds – domestic refining capacity. While refiners have increased the efficiency, utilization and capacity of existing refineries, these efforts have not enabled the U.S. refining industry to keep up with growing demand.
The U.S. refining industry has been expanding a little more than 1 percent per year over the past decade – the equivalent of a mid-size refinery being built each year. In order to create the opportunity for increasing the growth of U.S. refinery capacity, government policies are needed to create a climate conducive to investments to expand domestic refining capacity.
In addition, many of the steps the federal government could take to help the refinery capacity situation are covered in the December 2004 National Petroleum Council (NPC) study, Observations on Petroleum Product Supply – A Supplement to the NPC Reports “U.S. Petroleum Product Supply – Inventory Dynamics, 1998” and ‘U.S. Petroleum Refining – Assuring the Adequacy and Affordability of Cleaner Fuels, 2000.”
The NPC study suggested that the federal government should take steps to streamline the permitting process to ensure the timely review of federal, state and local permits to expand capacity at existing refineries.
For example, new-source review (NSR) requirements of the Clean Air Act need to be reformed to clarify what triggers these reviews. Some refineries may be able to increase capacity with relatively minor adjustments, but are unsure if the entire facility’s permit review would be triggered – a burdensome and time-consuming process. In addition to the administrative issues deterring new refining capacity investments, there are financial constraints as well. Attracting capital for new refinery capacity has been difficult with refining rates of return historically averaging well below the average for S&P Industrials. Over the 10-year 1994-2003 period, the return on investment for the refining and marketing sector was 6.2 percent or less than half as much as the 13.5 percent for S&P Industrials. In only one year between 1977 and 2003 did the average return of refiners exceed the average for the S&P Industrials.
While taking these factors into account, it is important to remember that the oil and natural gas industry operates in a global marketplace. Many oil and gas companies are global companies, whose U.S. investment decisions compete not only with decisions as to how to allocate capital investments in the U.S. among various sectors of the industry, but also with competing demands and investment needs overseas. In a global marketplace, companies will make the best economic investment decisions in order to bring affordable petroleum products to consumers. Imports may be the more economical option than new U.S. refineries, but that is a decision to be left to the global marketplace. Government policies must encourage, not interfere with, the global marketplace.
Conclusion
The industry recognizes the frustration and hardship felt by consumers as a result of higher prices and a basic misunderstanding of industry earnings and the causes and effects of industry mergers. The market is healthy and very competitive. Policymakers must resist efforts to override the structures of the free marketplace. Imposing new controls, allocation schemes, new taxes on industry, or other obstacles will only make the situation worse. Enactment of new tax measures on the oil and natural gas industry is counterproductive. Increases in taxes directly reduce investments in our nation’s oil and natural gas resources, hamper the expansion of refining capacity, and put U.S.-based companies at a competitive disadvantage with foreign national oil companies, who control more than 90 percent of the world’s oil and gas resources.
Addressing the nation’s energy problems is an enormous long-term challenge. If we all do our part—industry providing energy products, government removing barriers and increasing access to supplies, and consumers using fuel more wisely—America will be able to sustain its economic growth.
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