Thursday, October 26, 2006

Big Worries for Big Oil?

From today's WSJ, a staff editorial on oil companies, profits and oil prices:

Our favorite headline this week has to be "Big Worries for Big Oil," reporting that oil company profits are under pressure as oil prices decline. Exxon Mobil, Royal Dutch Shell, BP and other members of the vast energy conspiracy may have a hard time keeping their run of profit growth going now that oil prices have fallen to $60 or so a barrel from upwards of $80.

Imagine that: Oil companies are subject to market forces. They may make big profits when the price of oil rises, but those profits invariably fall back down to Earth when oil prices decline. This is also what happened in the 1990s, as oil crashed below $20 a barrel after the heights reached in the 1970s. The companies and their shareholders swallowed those declines, as they should have.

This cycle is typical of commodity markets, and is part of the risk of doing business. The run-up in oil prices over the past couple of years was rooted in worries about supply related to hurricanes, Middle East tensions and low stockpiles, as well as growing demand in a strong global economy and the Federal Reserve's easy money policy. As supply fears and demand have ebbed and the Fed has tightened, prices have fallen back down, albeit still to higher levels than a decade ago.

The recent price decline is also proof of the folly of a "windfall profits" tax or similar punitive measures against Big Oil favored by so many politicians. Only this week, however, Democratic Leader Nancy Pelosi repeated her pledge to soak the oil companies if her party takes over the House next month.

Her policy seems to be that when oil prices decline, oil company shareholders must absorb all the market risk and the lower profits. But when oil prices rise, the companies must hand over a cut of their profits to Members of Congress to spend as they like. The only "windfall" is for the political class.

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