What's Yours is Mine

ExxonMobil earns billions of dollars. The U.S. Congress
spends billions of dollars. These two simple truths seem to
be inspiring Senator Clinton’s attempt to divert a few
billion dollars from where they are earned to where they
are (already) spent.

We have no idea whether Clinton’s effort to levy a windfall
profits tax will succeed, but we are intrigued by the fact
that oil-company cash is in the crosshairs of the Senator’s
tax-happy sights. Now that politicians like Ms. Clinton
have signaled their intention to appropriate the “excess”
profits of oil companies, we would expect the oil companies
to begin devising ways to produce smaller, or non-existent,
“excess” profits. In other words, we would expect the oil
companies to quickly adopt a use-it-or-lose-it attitude.
Making profits disappear is much easier than making them
appear in the first place. And one good way to accomplish
this objective is to re-invest it, especially in smaller
oil companies with attractive exploration properties, but
modest-to-no earnings. Therefore, to the extent that
Exxon’s cash becomes a target of Congressional revenue-
hunters, mid-tier oil companies might become acquisition
targets of companies like Exxon.

A stock-for-stock transaction, for example, would serve
very nicely to dilute Exxon’s earnings, especially if Exxon
used its lowly valued stock to acquire the richly valued
stock of another oil company.

(A couple of potential acquisition targets come immediately
to mind, but we have decided not to divulge them
immediately. Instead, we’d like to have some fun with you,
our Rude Awakening readers, by asking you to identify mid-
sized oil companies that YOU believe would be attractive
acquisition targets for a larger oil company. Please email
your suggested stock ideas to Joel
[aussiejoel@the-rude-awakening.com].

The suggested stock must have a market capitalization
greater than $500 million. No small caps, please. And
obviously, no inside information, please. We will examine
the submissions that we receive over the next 24 hours and
will provide a sampling of the best ideas in the Friday
issue of the Rude Awakening.)

Beating up on an oil company is one of the oldest, and
least creative, of all political games. That’s because no
one ever feels sorry for an oil company. In fact, most
folks hold oil companies in such low esteem that a member
of Congress seems respectable by comparison.

According to the popular folklore, oil companies earn
billions of dollars for making lots of great, big messes.
And like most folklore, this particular one contains a few
grains of truth. But it’s also true that oil companies
provide an essential product, without which life would be
much less pleasant.

Even so, many oil-company foes, like Senator Clinton, chose
to ignore or minimize such inconvenient facts. The folks
who revile the oil companies, and encourage the rest of us
to do likewise, prefer to ignore the irony that the very
same companies they revile are the ones that warm their
houses, power their cars and illuminate their ivory towers.
We don’t feel sorry for the oil companies. But neither do
we believe that governments should retroactively punish
capitalist enterprises for succeeding too well.

Furthermore, it might surprise Senator Clinton – as well as
many Rude Awakening readers – to discover that oil company
profits are much less “obscene” than those of the nation’s
largest finance companies.

As the chart above illustrates, the combined cumulative
earnings of Citigroup and Bank of America from 1995 through
the third quarter of this year totaled an astounding $223
billion, a sum which happens to be $14 billion HIGHER than
the combined cumulative earnings of ExxonMobil and Chevron
over the same timeframe. In each and every one of those ten
years, the two big finance companies earned more money than
the two big oil companies. Never once did Exxon and Chevron
manage to produce an “obscene” profit that exceeded that of
Citibank and Bank of America…NEVER ONCE.

Is the comparison fair? You bet. The combined enterprise
value of the two oil companies is nearly identical to the
combined enterprise value of the two banking behemoths. So
why tax the oil companies’ “windfall” profits and not those
of the finance companies?

Only Senator Clinton knows for sure. If Ms. Clinton had
truly wished to recoup “windfall” profits, she could have
started the process with Citigroup, which just happens to
enjoy a large, comfy presence in her home state of New
York. One could argue that Citigroup has enjoyed a decade-
long windfall, thanks to the very low interest rates – and
steep yield curve – provided by Alan Greenspan’s Federal
Reserve.

To be clear, we don’t think either sector produces obscene
profits worthy of supplemental taxation. But if forced to
choose between the two, finance-company profits seem much
more obscene than those of the oil companies.

Sure, the oil companies make an occasional mess of things
while trying to provide an essential product. But
extracting a dollar of “windfall” profits from oil
exploration seems much more commendable than extracting
profits from yield-curve exploitation.

To produce a barrel of fossil fuel, the oil-extracting
capitalist requires: Several billion years geological prep-
work. Assuming this essential work has occurred, the
hopeful oil-extracting capitalists, as a group, must spend
billions of dollars to find oil reserves, then spend a few
more billions to pull the stuff out of the ground, then
spend billions to build pipelines to transport it to
refineries, then billions more to convert the crude into
refined products and transport these products to the end
user.

All of these activities take place within an environment of
extreme price volatility. In other words, the companies
that conduct these massive efforts can never really be sure
what prices they will receive for the products they
produce.

By contrast, to create financial profits, the hopeful
financial services capitalist requires little more than an
accommodating Federal Reserve Chairman. Assuming such a
chairman presides over the Fed, the financial services
capitalist need spend only a few billion dollars to create
an infrastructure that can borrow lots of money at
subsidized short-term rates and lend it out at higher
rates, often much higher rates. Then, to increase profits
to truly obscene proportions, the finance companies must
borrow even more money at subsidized short-term rates and
provide mortgages and credit cards to folks who cannot
really afford them. And the best part is; the least capable
borrowers provide the biggest profits.

While awaiting the inevitable cycle of defaults on these
“sub-prime” loans, the finance companies like Citibank and
B of A charge as much as 25% interest on credit card
balances. Therefore, as corporate activities go, providing
a vital energy source to the nation’s economy seems much
less “obscene” than extending usurious credit lines to
people who cannot afford them.

But we are not in the business of evaluating corporate
morality, only corporate opportunity. And now that oil-
company profits are coming under attack, investment
opportunities may be emerging among mid-tier oil companies.
If the major oil companies must chose between investing
their cash or losing it to taxation, we should expect
merger and acquisition activity within the energy sector to
ramp up quickly.

Be sure to check in Friday for some specific ideas!

Cheers,

Eric Fry

And the Markets…