John Malcolm Blair, The control of oil (hardcover), 1976
p.316
It has been repeatedly pointed out that profits cannot be legitimately criticized by ignoring the investment required to generate them; Edward Symonds of the First National City Bank made a statement to this effect in 1969:
People outside the petroleum industry are apt to suffer from an optical delusion ── that oil is “the most profitable American industry.” By a kind of optical foreshortening, they see clearly that industry earnings add up to a huge total. According to our tabulations, the U.S. industry declared net earnings after taxes totalling more than $6 billion, and they have been rising ... by some 8 percent annually.
But many observers perceive dimly, if at all, that, to generate these earnings, the companies had to sell goods and services which last year were valued at more than $60 billions. To maintain their pace of activity, these petroleum companies ── most of which have been in business 50 years or more ── have had to build up net assets totalling some $47 billion and yet received a rate of return of 13 percent .... 35
pp.316-317
The oil industry was certainly not the most profitable of these nineteen (19) important fields of production, that honor ── as had been true for many years ── being reserved for the drug industry. The profit performance of the top eight (8) oil companies was also surpassed in 1971 by the eight leading firms in cigarettes, malt liquors, and motor vehicles. AT the same time, the average rate of return for the eight leaders in oil was more than twice that of the leading firms in machine tools, steel, broadwoven fabrics and yarn, aircraft, radio and television, nonferrous metals, and pulp and paper.
(The Control of Oil., John Malcolm Blair 1914─, 1. petroleum industry and trade., 2. petroleum industry and trade──United States., 3. energy policy──United States., HD9560.6.B55, 338.2'7'282, 1976, )
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John Malcolm Blair, The control of oil (hardcover), 1976
pp.235─237, p.416
p.235
THE MAJOR OIL COMPANIES are engaged in four successive stages of operation:
(1) the possession of reserves,
(2) the production of crude oil,
(3) the refining of crude into finished products (gasoline, fuel oil, etc.), and
(4) the sale at retail to the final customer.
In addition, they have brought under their control many of the means of transportation used by the industry ── gathering lines, pipelines, tankers, tank cars, tank trucks.
Thus, for three-quarters of a century they have supplied most of the world's oil requirements from fields which they own wells, transporting it by their own gathering lines, pipelines, and tankers (or those under charter), transforming it into gasoline, distillate fuel oil, jet fuel, petrochemical feed stock, residual oil, and other products in their own refineries, and dispensing it via their own filling stations and other outlets.
In the absence of vertical integration, each of these successive stages would be conducted by separate, independent enterprises, producing or marketing at the lowest possible cost and selling at the highest price obtainable. This structure is not just the competitive model of academic economics; it is an accurate description of the way in which business in most industries is actually carried on.
p.235
Based on the analogy of the flow of a river, the expansion toward sources of supply is generally referred to as a movement “upstream” (or “backward”), while movement toward the final product is referrd to as “downstream” (or “forward”) expansion. In the world petroleum industry, companies that have not had enough low-cost crude to supply their own refining and marketing needs have emphasized “upstream” expansion to enlarge their holding of reserves.
Companies that have held crude reserves and production capacity greater than could be accommodated through their own refining and distribution organizations have stressed “downstream” expansion.
pp.235-236
As a result of the movement in both directions, the oil industry has developed a pattern of vertical integration, both at home and abroad, that is unapproached by any other industry.
p.236
The extent to which domestic oil companies have in fact become integrated between production and refining can be measured by determining the proportion of their refinery input derived from their own crude production.
p.236
Such “self-sufficiency” ratios, and their share of domestic output, are shown in Table 10-1 for the top eight.
p.236
Only one (Mobil) does not supply more than half of its refinery needs from its own crude production. In the case of three of the companies ── Exxon, Texaco,, and Gulf ── the ratio is more than 80 percent. For these companies integration between production and refining has thus largely been achieved. For the top 8 the average, weighted by their 1969 production, is 71.7 per cent.
Comparied to industry as a whole, the extreme degree of vertical integration in petroleum is something of an anomaly.
p.236
A study of the ratio of corporate sales to gross [gross income?] corporate product by Arthur B. Laffer disclosed no increase in vertical integration among corporations generally no increase in vertical integration among corporations generally between the late 1920's and the mid-1960's: “The conclusion reached on the basis of this empirical evidence is that there has not been any discerniable increase in the degree of vertical integration in the corporate sector. If anything, there might have been a slight decline.”
p.237
The explanation for the atypical structure of petroleum lies in a complex of advantages enjoyed by integrated firms in this particular industry, of which the most important have been the benefits accorded petroleum producers under the U.S. tax laws. Percentage depletion and the right to deduct “intagible” drilling costs as business expenses made it advantageous for oil companies to make as much of their total profit as possible at the stage to which these benefits apply ── crude production. The greater the proportion of their total revenues made in crude production, the greater the advantage of the integrated firm over their nonintegrated competitored engaged only in refining or marketing.
p.237
Indeed, as Kahn and de Chazeau have shown, the integrated firms were able to enhance their profits through an increase in the price of crude, even though prices of refined products remained unchanged.2
p.237
Whether a major's operations in the later or “downstream” stages proved to be profitable was secondary to their essentiality as a means of disposing of the product on which the after-tax profit was made. Selling crude to refineries owned by other companies is at best uncertain, while the sale of gasoline to independent marketers depends upon success in what has been a highly competitive market.
p.237
The key to assured profitability was thus an [un]interrupted flow of crude through refining to the final buyer.
p.237
To the extent that control over any of the downstream stages rested in th hands of others, the flow might be interrupted, thus curtailing the production of crude and the consequent all-important after-tax profits.
p.237
Even without the tax incentives, companies would be motivated toward “backward” or “upstream” expansion by the simple quest for an assured source of supply. It is a natural business motivation to avoid dependence on companies which in the sale of final products are one's competitors. The strength of that motivation is of course enhanced if the supplies involved, as in the Middle East, are spectacularly low in cost.
p.416
1. Arthur B. Laffer, “Vertical Integration by Corporations, 1929─1965”, Review of economics and statistics, February 1969, pp. 91─93.
2. See Alfred E. Kahn and Melvin de Chazeau, Integration and Competition in the Petroleum Industry, Yale university press, New Haven, Conn., pp. 211─222.
(The Control of Oil., John Malcolm Blair 1914─, 1. petroleum industry and trade., 2. petroleum industry and trade──United States., 3. energy policy──United States., HD9560.6.B55, 338.2'7'282, 1976, )
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John Malcolm Blair, The control of oil (hardcover), 1976
p.187
Over a long period of years, nothing has contributed more to the evolving structure of the oil industry than the preferential tax advantages bestowed on it by the Congress. Their importance is apparent from the fact that, in the face of a corporate tax rate of 48 percent, the federal income taxes paid in 1974 by the 19 largest oil companies amounted to only 7.6 percent of their income before taxes.1
Recognizeable only to those trained in the arcane art of translating the almost indecipherable prose of tax statutes, the proliferation of preferential provisions is a tribute to the ingenuity and thoroughness with which the industry's tax lawyers (and their Congressional allies) have gone about their work.
Of the preferential provisions, three have been by far the most important ── percentage depletion, the expensing of intangible drilling costs, and the foreign tax credit.
p.187
In the past, criticism of these tax preferences has focused largely on the loss of revenue and the lack of equity. Concerning the former, the staffs of the Treasury department and the Joint committeee on internal revenue taxation placed the combined tax loss in 1972 from percentage depletion and the expensing of exploration and development costs at $2.35 billion.2
With respect to equity, the point has repeatedly been made that the tax preferences have had the effect of shifting to individual taxpayers, as well as to other industries, a sizeable tax burden that the oil companies would otherwise have to pay.
For example, the three “defense-related” industries ── petroleum, motor vehicles, and aircraft and missiles ── had in 1965-1966 total asset of $96,778 million and paid U.S. income taxes of $3,185 million.
Of these totals, petroleum companies held 59.7 percent of the assets but paid only 9.3 percent of the taxes. In contrast, motor vehicle companies accounted for 31.7 percent of the assets but paid 79.2 percent of the taxes. And companies in the aircraft and missiles industry held 8.6 percent of the assets but paid 11.5 percent of the taxes.3
“”
pp.187─188
Less well recognized than the revenue and equity criticisms is the fact that the particular forms of tax favoritism employed by the oil industry have been such as to give a powerful discriminatory advantage to integrated companies over the nonintegrated refiners and marketers.
This results from the fact that that two of the three principal tax advantages ── percentage depletion and expensing of exploration costs ── are available only to firms engaged in crude production, and the foreign tax credit is likely to be more valuable to them.
p.188
Thus, in the years following World war II the tax privileges led to a vast expansion in well-drilling activity.
pp.188─189
This complex of tax preferences and supply controls artificially raised nd maintained prices, increased the after-tax profitability of oil production, shifted to other taxpayers the burden that would have been borne by the oil industry, and resulted in a vast waste of economic resources. It also had the effect, little noted at the time, of hastening the day when the United States would run out of oil.
(The Control of Oil., John Malcolm Blair 1914─, 1. petroleum industry and trade., 2. petroleum industry and trade──United States., 3. energy policy──United States., HD9560.6.B55, 338.2'7'282, 1976, )
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