Wednesday, January 26, 2005

Well, it was bound to happen. I'm actually surprised it took this long, considering the sustained strength of energy prices and energy company earnings. Critics in the UK have started calling for a windfall profits tax, at least on domestic natural gas production, citing the level of oil company earnings exemplified by Lord Browne's comment in the Sunday Times that BP's profits for last quarter and last year would be "staggering."

We've been down this path before, and having started in oil trading just as the old system of price controls and oil windfall profits taxes in the US was being wound down, I saw first-hand how poorly such regulations work, and the kind of gross inefficiencies and distortions they promote. (Some other time we can get into "old oil" vs. "new oil" and how that was exploited by unscrupulous middlemen.) However, I must say with equal vigor that the industry is currently doing itself no favors in this regard by its conservative approach to capital investments.

It would be easier to quiet this chorus, which will only grow louder should prices rise again this year--or at least not moderate noticeably--if energy firms were seen to be reinvesting most of the cash flow thrown off by high prices. They need to increase their reserves and expand their production bases to keep pace with the growth in current and anticipated demand. Share buybacks and special dividends do little to dispel the notion that the industry is effectively taxing the entire economy and ought to be taxed in turn.

If capital spending doesn't soon pick up in line with market expectations of sustained high prices and demand, the oil companies are going to be in a major PR battle over where the money should go, instead. Wake up and smell the coffee, folks.

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