The enemy within?

WITH the Gulf War over, another war--this one waged against America's oil companies-seems about to start. Emergency price-gouging legislation has been enacted in Connecticut and Massachusetts; forty other states have initiated special investigations or public hearings. The "Excess Oil Profits Tax Act of 1991," introduced by Senators Metzenbaum (D., Ohio), Lieberman (D., Conn.), and Cohen (R., Me.), would impose a 40 per cent tax on the "excess profits" of the larger oil companies.

The suspicion that oil companies can manipulate the price of oil was reinforced when gasoline prices began rising immediately after the August invasion, long before the higher-priced crude actually reached service-station tanks. By the end of October prices had risen 28 per cent; the net decline in world oil supplies was less than 2 per cent. The historical relationship between crude-oil supply and gasoline prices suggested that a rise of only 13 per cent, less than half the actual rise, was justified.

The perception of gouging" was unavoidable--and wrong. The free-market price for oil properly reflects both the current supply and the probability of future supply disruptions. The market seems to have worked perfectly this time: once the air war started and it was clear that the Saudi oil fields were safe from Iraqi attack, prices fell sharply.

If oil companies do orchestrate prices, they are singularly inept at it. A recent study by the St. Louis.-based Center for the Study of American Business shows that the real price of gasoline (in constant 1990 dollars) was $1.26 per gallon in 1960, or about 12 cents more than the level of this February. Over the long haul gasoline prices have not kept pace with market-basket inflation, yet no one accuses the food or newspaper or automobile industry of price "gouging."

Many believe that profits are a better indicator of market power than prices. The petroleum industry did, in fact, make money from the recent oilprice rise: the profits of the major oil companies rose a whopping 77 per cent in the fourth quarter of last year compared to the same period of 1989, according to the Department of Energy.

As with prices, however, there is less here than meets the eye. Net income for all of 1990 was up only 9 per cent from 1989's figure, which was depressed below that of 1988. Competition among refiners, marketers, and distributors prevented gasoline prices from rising as much as crude-oil prices, and as a result this end of the industry generated about 30 per cent less profit in the last quarter of 1990 than in the same period of 1989.

More importantly, when profits are measured against the investment made to earn those profits, oil companies are seen to be doing less well than other industries. In 1990, for example, the rate of return on stockholders' equity for the major oil companies (12.8 per cent) was less than the return for large non-oil manufacturing companies (13.9 per cent). In fact, the rate of return on oil-industry sales, assets, and equity has been below the average for U.S. industry in each of the past six years.

An excess-profits tax is seen by many as a better solution than energy price controls. Its economic effects would be equally disastrous, however. As currently envisioned the tax would be levied on the difference between the current year's net income and the company's average net income over the previous five years. Any rise in oil prices, even if below the rate of inflation, would produce "excess profits." Indeed, if the industry were merely to push its profit rate up to the average for U. S. industry, it would incur a massive excess-profits tax hability. At a time when oil-import dependence is a major concern his tax would penalize those firms which invest heavily and successfully in domestic operations.

-- ED RUBENSTEIN