Where Exxon and Friends Spend Big Profits

The industry says finding new oil is costly; companies use lots of cash to buy back their own shares.

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With the world's largest publicly traded oil company, Exxon Mobil, leading the oil industry to another record-smashing year with $40.6 billion in profits for 2007, you can be sure that people will be taking a closer look at where all that money is going.

Finding new oil or alternatives. The oil industry points out that over the years it has reinvested essentially all of its profits into the future—through capital expenditures that would lead to more oil or even renewable energy. (It may seem strange to hear that an industry could invest all of its profit in capital expenditures year after year, but remember, the companies have cash flow in addition to net income—gained, for example, when they sell assets or issue debt or stock.)

With the increase in oil prices over the past five years, it does appear that the oil industry's investments have gone up. For the top five oil companies, new investments were $91.4 billion in 2006, up 60 percent over 2001, according to an Ernst & Young analysis commissioned by the oil industry last year. But as a percentage of the staggering profits they are making, the figure fell significantly from the 1990s—when the oil industry was spending about 200 percent of net income on such investments. Since 2000, the average has been about 100 percent of income, and in 2006 it was 76 percent.

Trying to keep pace. One important backdrop to keep in mind: It's getting a lot more costly for the oil companies to add reserves through exploration and development or by purchasing tracts that have possible reserves. The Energy Information Administration's recently released analysis of the performance of the major oil companies shows that what it calls "finding costs" increased 51 percent just between 2004 and 2006.

The oil companies have to spend more money just to keep pace, and some analysts, such as the International Energy Agency, have viewed the expenditures as insufficient to keep pace with global demand. The Ernst & Young analysis broke down spending further for the five biggest oil companies. Although their largest use of cash flow—54 percent—was for "property, plant, and equipment," they spent only 4 percent of cash flow on exploration and only 2 percent on research and development. In contrast, they spent 37 percent of cash flow on stock repurchases and 20 percent on payout of dividends.

Sending it to shareholders. Exxon Mobil distributed $35.6 billion to its shareholders in 2007 through both dividends and stock purchases, up 9 percent over the previous year. Most of that was through the purchase of $31.8 billion in stock. Although the industry has long been known as a reliable source of regular dividends, that is now clearly not the preferred means by which the industry distributes its large increase in cash flow to shareholders. The EIA found that share repurchases for the companies it analyzed increased 27 percent between 2005 and 2006, while dividends fell 6 percent.

The oil industry takes some political heat for giving so much money back to shareholders when their other constituency, their customers, is suffering under the high prices that presumably would ease if the companies spent cash on producing more oil. But the oil industry points out that for the past 11 years, its stock repurchases have averaged about 21 percent of net income, while the rate for the S&P industrials was 52 percent.

Paying the tax man. Whenever politicians begin to talk about a windfall profits tax, the oil industry points out that it already does pay taxes. The EIA's analysis shows that the top 27 energy companies paid $81.5 billion in income taxes globally in 2006—a figure that has increased 82 percent since 2004 and amounts to a 37.1 percent tax rate. It's worth noting that 66 percent of those income taxes were paid to foreign governments, especially in Europe and Africa.

The oil industry also pays billions in other taxes in the United States, like excise taxes and royalties, but these are the source of much political controversy. A move came one vote shy of passage in the Senate in December to take away some of the tax incentives, many of which were passed by Congress as recently as 2005, which are supposed to encourage the oil companies to take on more expensive oil development projects in the United States. Advocates of the tax break repeal said that oil prices over $90 per barrel should be incentive enough, but the White House successfully fought back against any changes in the oil tax landscape.