Exxon’s Earnings: No Apology Necessary

This article appeared in Investor’s Business Daily, February 2, 2006.

Exxon Mobil announced this week that it earned $10.3 billion in the fourth quarter of 2005, up 23% from the same quarter in 2004. The company’s earnings for the year totaled $36.1 billion, the most profitable year (in nominal terms, anyway) for any company in U.S. history.

Tar was gathered, feathers distributed, and the political mob undertook its predictable march.

Perspective, however, is everything. If we simply divide Exxon Mobil’s net income by sales, we discover that the company reported a 10.7% profit margin in the quarter. That’s probably a bit above the U.S. industrial average, but it is hardly remarkable.

For instance, the nation’s moist prominent critic of “oil profiteering” — Fox News personality Bill O’Reilly — works for a company (News Corp.) that reported a 10.2% profit in the fourth quarter.

If you’re after big earners, check out Yahoo (a 45.5% profit margin), Citigroup (33.4%), Intel (24%) or Apple (22.7%).

Returns on invested capital over a longer time frame are even more telling. Analysts at Goldman Sachs found that returns on investment capital in the oil and gas sector from 1970 – 2003 were less than the U.S. industrial average over that same period. The oil industry would have to earn record profits for some time before it would produce above‐​average returns for its long‐​term investors.

Political threats to impose windfall profit taxes are counterproductive for two reasons. First, they threaten to institutionalize a form of one‐​way capitalism in which investors are allowed meager profits, but more robust earnings are punished.

Who would want to park their money in an industry like that? If investors were discouraged from putting their money into the oil sector, where would the capital come from to put more oil and gas into a resource‐​starved market?

Second, the U.S. already has a corporate income tax in place to harvest a share of those windfall profits regardless of which sector produces them. Any policy that subjects income from particular industrial sectors to more onerous taxation because they are the villain de jure is bad public policy. In essence, it gets the government in the business of allocating capital to different sectors of the economy and sets up incentives for rent‐​seeking be‐ Whether Exxon Mobil is making good or bad decisions with its operating capital is not the government’s business. Behavior on the part of corporations and their political patrons.

How Exxon Mobil’s profit was earned and how that money will be used is also at issue. Some critics allege that the company’s market power — augmented by mergers and acquisitions within the oil sector — gives Exxon Mobil (or some shadowy group of corporate conspirators led by Exxon Mobil) the power to set whatever price it wishes.


World crude oil prices — and thus retail gasoline prices — are established in commodity spot markets. Exxon Mobil executives do not plot in back rooms to decide what to charge at the pump. Instead, Exxon Mobil’s contracts with its own stations tie wholesale fuel prices to prices in the nearest spot market plus transportation costs.

Others attack the company’s decisions about how best to employ this surge of revenue.

House Speaker Dennis Hastert and many House Republicans complain that the industry is not investing enough in domestic oil refining capacity.

Consumer activists complain that too little is going into oil exploration and development.

Others complain that not enough is being “given back” to the poor in the form of free or low‐​cost energy assistance programs.

The entire conversation is misguided. Whether Exxon Mobil is making good or bad decisions with its operating capital is not the government’s business.

Even if it were, politicians are not in a position to intelligently discuss the matter.

In a free‐​market economy, capital is best allocated by market actors disciplined by profit and loss, not by vote‐​maximizing politicians who are unlikely to know what they are doing.

Exxon Mobil has nothing to apologize for regarding recent earnings statements.

If consumers were better served by lower corporate earnings, we’d all be visiting Zimbabwe for economic advice.