Prop 87: Deceptively marketed

[Editor’s note: Robert Rapier, who has wrangled with Vinod Khosla before on these pages, responds to Vinod Khosla’s column yesterday supporting Prop. 87]

When I was first asked if I would write a “No on 87″ essay, I responded that I am actually ambivalent about passage. Otherwise, I would build a strong case for a “No” vote. But some of the misleading mud from Prop 87 proponents is being hurled in my general direction. So this essay is to primarily address misinformation in a proposition the L.A. Times has characterized as “deceptively marketed.”

First, let’s get some disclaimers out of the way. I work for an oil company. However, for those of you who read past that sentence; 1). My company does not extract oil from California; 2). My company is not a contributor to the “No on 87″ campaign; 3). I do not live in California; 4). I strongly support conservation and alternative energy; and 5). I joined the oil industry to work on an alternative energy project.

My graduate school studies were on cellulosic ethanol, and I have written positive essays on biodiesel, bio-butanol, E3 Biofuels, sugarcane ethanol, CAFE standards, wind power, and conservation. However, I have also defended the oil industry against charges of price gouging, and I have argued for personal responsibility. I am also a critic of grain ethanol. I am the author of the R-Squared energy blog, and a member of the staff at The Oil Drum. Because I believe we all benefit from open debate, I have given equal time to Mr. Khosla, Prop 87 proponents, and readers who disagree with my position on Prop 87. Twice I have spoken at length with Mr. Khosla on the phone about energy policy, and I believe he would agree that I am not an oil company shill. We found much common ground. I believe we must wean ourselves from fossil fuels before Global Warming ruins the planet, and I detest blood for oil. But I have a few issues with the Prop 87 campaign.

Oil Companies are Ripping You Off

People don’t like to pay higher gasoline prices, especially when they see escalating oil company profits. But focusing on profits instead of profit margins is a silly approach. Would you invest in a mutual fund just because it made a billion dollars last year? You would be more concerned with the return, not the overall dollar amount the fund earned. The 15-20% margins of industries like pharmaceuticals, banks, the computer industry, and ethanol producers far surpass the recent 10% margins (and long-term average of 5-7%) of the oil industry. Oil companies can only dream about the margins of a Microsoft.

Now I know that Mr. Khosla won’t deny that the computer industry, where he made his fortune, or the ethanol industry, which he passionately supports, sees much higher average profit margins than does the oil industry. Are they ripping people off? (Of course the government also makes much more from oil and gas sales than do oil companies). Should Mr. Khosla be vilified because he became a billionaire in an industry with double the profit margins of the oil industry? Do you think Prop 87 mega-contributor Stephen Bing made his fortune on 5-10% profit margins?

Of course nobody would deny that the overall profit of some oil companies surpasses that of Microsoft. That’s because these companies are much larger than Microsoft. They have to be, to compete with the Saudi Aramcos of the world (that dwarf even ExxonMobil). The oil industry spends billions in capital each year. Great risks – personal and financial – are involved. Yet as a result of the “outrageous” 10% profit margins • which primarily benefit Joe and Jane Shareholder • we are “ripping people off.”

Paying Their Fair Share

I wrote at length on this issue in an essay on my blog. Proponents of Prop 87 paint a picture in which oil companies in California are not paying their fair share. They will note that Texas has an oil extraction fee, and argue that California is getting a raw deal from the oil companies. However, oil companies would love to pay the same “fair share” that they do in Texas.

There are a number of ways that states receive revenue as a result of oil and gas transactions. Extraction taxes are but one example. Corporate income taxes are another example. So, even though Texas has an extraction tax of 4.6%, versus none for California, Texas does not charge oil companies a corporate income tax. California charges oil companies an income tax rate of 8.84%, one of the highest in the nation. When times are good, states like California share in the “windfall.” If you look at the entire taxation picture, you find that California already gets a higher cut from oil companies than does Texas. Yet Prop 87 proponents argue that’s not a “fair share.”

Effect on Gas Prices

I can quote many economists and newspaper editorials that detail why Prop 87 will increase gas prices in California. Instead, I will simply tell you why myself. Oil produced in California gets refined in California. Some oil production does not become profitable until oil prices become relatively high. Some marginal producers, when faced with additional costs, simply won’t start up at the same trigger price. That means that at times oil that would have come from California producers, employing Californians, will come from elsewhere. Prop 87 will add an additional constraint on supply. Refiners will make up the difference with more expensive imports. (Contrary to the apparent belief of many Prop 87 supporters, there is not one “world market price” for oil. Oil prices vary greatly based on a number of factors).

So, gas prices won’t rise because oil companies are passing on costs imposed by Prop 87. Gas prices will rise because the supply/demand equation will have been adversely impacted. However, this is what I like about Prop 87. I support higher gas prices because that will spur conservation.

Predictions

I will go out on a limb here, and make some predictions that will be pretty easy to validate.

1. Proposition 87 will pass.
2. The gasoline price gap between California and the rest of the country will increase by at least $0.05/gallon next year as a result.
3. California oil production, already in decline, will see a much sharper decline next year as higher costs cause marginal production to shut down.
4. Longer term, the $4 billion dollars extracted by this proposition (at the expense of oil company shareholders and consumers) will result in underinvestment in California oil production, leading to more serious supply problems in the future. Ironically, these supply problems will drive up the price of gasoline, which will cause people to conserve. As a result, conservation, which could have been achieved by just increasing the gas tax by a nickel, will be the key measurable from the passage of Prop 87.

I invite your disagreement, but not rabid froth and hate mail. I get enough of that already.