Big Oil Tax Battle: Energy Stock Impact

NEW YORK ( TheStreet) -- The bosses of Big Oil were called before the Senate Thursday morning in an attempt to defend the tax breaks that the government would like to take away from them.

Amid the grandstanding by politicians and the boilerplate rhetoric about U.S. competitiveness from oil-industry CEOs, a simple question arose: Is this an issue that energy investors need to monitor closely?

Certainly there are big stakes for Big Oil in the big tax debate, from the rush to invest in U.S. shale plays, to the use of profits to pay investor dividends and buy back shares, thereby boosting earnings.

For the senators on the Finance Committee, there were political point-scoring opportunities aplenty. They made pains to point out that even as oil companies book hefty profits, with the price of crude racing above $100 a barrel (at least until recently), the federal deficit grows ever more massive.

Yet in introducing the "Close Big Oil Tax Loopholes Act" N.J. Senator Robert Menendez wrote in an attack mode that took aim directly at issues dear to the hearts of investors: "According to a recent report from Citizens for Tax Justice, Big Oil companies spent most of their profits in the purchase of their own stocks and boosting its dividends between 2005-2010. In 2010, four of the largest 'Big Five' oil companies (excluding BP due to the oil spill) allocated only 18% of their post tax profits on exploration and 60 percent on dividends and stock repurchases."

Congress sees an additional $21 billion in tax revenue over ten years if the proposed legislation is passed. Big Oil argues that the tax revenue gained will be offset by the tax revenue lost when it pulls out of drilling programs in the U.S., state-by-state. Big Oil executives also made the case that the way to raise tax revenue from the oil and gas industry is to open up more land to drilling, which also increases U.S. energy independence.

On the dividend issue specifically, during the Thursday testimony Republicans turned this debate around, asking the Big Oil executives what the repercussions for Big Oil dividends would be if the tax changes were made and what the impact would be on U.S. pensioners whose pension assets are invested in state-run plans that rely in part on dividend streams from companies like the Big Oil stocks.

When BP had to suspend its dividend during the oil spill, institutional investors -- primarily representing British pension assets-- sold out of BP shares in droves.

The shares of all the five Big Oil companies declined on Thursday, though so did energy stocks and the equities market, and by the afternoon, the losses were minor.

Among the Big Oil big five called to the Senate, ConocoPhillips ( CVX) shares were down the most of any of the Big Oil companies, at a 1% decline in the afternoon. On Wednesday, ConocoPhillips released a statement calling the tax plan "un-American," and its CEO James Mulva took a beating for the comment in the Senate testimony.

Royal Dutch Shell ( RDS.A) and BP ( BP) shares declined by less than 1%.

ExxonMobil ( XOM) shares and Chevron ( CVX) shares were flat in trading on Thursday afternoon.

Phil Weiss, an energy analyst at Argus Research who used to work in the tax accounting business, said any time that politicians are talking about making corporate tax changes, it's best to wait until the legislation is signed on the dotted line before seriously weighing the financial impact on stocks. "Whatever happens, even in final legislation, can be very different, or not happen at all," the analyst said.

The changes being contemplated in Washington D.C. go beyond the Senate bill introduced on Wednesday by Robert Menendez (D-N.J), called the "Close Big Oil Tax Loopholes Act." President Obama has called for an end to all oil & gas industry tax breaks, and Argus Research's Weiss and other analysts say that it's the smaller independent & exploration companies that would feel the brunt of the pain if the broader legislative effort is achieved. This may be one reason why the Senate is just focusing on the Big Oil big five in its act of selectively applied tax changes. At least the oil and gas industry can't say the small guy will be crippled.

"It matters more to the little guy, but the big guy can't give up because it is going to increase costs. The problem is that it ultimately increases costs and ultimately those costs flow through to bottom line," Weiss said. "Even if the percentage is the same, it's more relevant for smaller companies because it is same size piece of a smaller pie," Weiss added.

Allen Good, Morningstar energy analyst, said it was no surprise to him that the government is going after Big Oil, and it happens every time that the price of oil rises rapidly. Yet he noted that Republican control of the House and many Democrats from the oil state of Louisiana make the political math complicated. Additionally, the effort to eliminate the tax breaks for Big Oil coincides with President Obama's ambitious plan to reduce reliance on foreign oil by one-third, and from that perspective, "this doesn't square," the Morningstar analyst said.

To drive this rhetorical salvo home, a Republican senator rolled the videotape on footage of President Obama saying in a recent speech that as Brazil finds more and more offshore oil, the U.S. wants to step up and be Brazil's big buyer.

"The major integrated oil and gas companies may not be affected much, but they can rethink what they do domestically if the tax picture changes," Morningstar's Good said, and this was a point made by the Big Oil executives on Thursday morning repeatedly. The Morningstar analyst said, "Look at what's going on with all the big oil companies buying into the U.S. shale plays. They are still banking on that but this can change the cost dynamic. In future years Big Oil is more exposed to these domestic taxes given their investment in shale, so they are not overlooking the issue one bit," Good said.

While the focus on the Big Oil big five wouldn't hit the bottom lines of the smaller exploration and production companies, Morningstar's Good noted that the independents are "built to sell," and that a change in the cost dynamic of these operations with the elimination of tax breaks isn't immaterial in terms of their strategic plans.

The situation has also changed since the last time Big Oil was dragged in to defend its corporate tax treatment, noted Argus Research's Weiss. "It's come up repeatedly but never happened because of the fiscal position, and now with Congress needing to find ways to raise funds, picking on those with the deepest pockets feels like it has higher risk to me," the analyst said.

"If we are going to get serious about addressing our national debt, we can no longer afford to keep giving away taxpayers' money to the most profitable companies in the world. There are going to be some tough decisions when it comes to cutting back, but I hope we can agree that our government writing checks to oil and gas companies with tax dollars should be on the chopping block," Senator Claire McCaskill (D-Mo.) stated in a release introducing the legislation on Wednesday.

Indeed, at one point Democratic Senator Charles Schumer of New York demanded that Big Oil executives answer the tenuous-at-best "logical" question: "Should you get tax breaks or students receive financial aid....? Because that's the choice we have to make."

During the Senate hearing, Ron Wyden (D-OR) played videotape from a similar hearing in 2005 when oil had risen to $55 a barrel, and the Big Oil executives were asked if they needed government incentives. Every single Big Oil executive said 'no,' a statement that Senator Wyden made the Big Oil executives repeat on Thursday.

ConocoPhillips CEO James Mulva suffered the most abuse for his company's Wednesday press release calling the tax proposals "un-American," but it was Senator Jay Rockefeller of West Virginia who best reflected both sides of the debate. Rockefeller first threw a softball compliment to ExxonMobil CEO Rex Tillerson for working with the Boy Scouts in West Virgina, but went on to say that Big Oil was anything but Boy Scout-like in its behavior.

Senator Rockefeller compared the Big Oil big five to Saudi Arabia, in being defensive and out of touch with Americans. "You are really out of touch and deeply and profoundly committed to sharing nothing," Rockefeller said. Not that Rockefeller expressed the greatest hope for the legislation passing as is, either.

"My guess is you will be able to protect yourselves, through lobbyists and friendships and refineries placed in key states. You assume you will prevail," the Senator said to Big Oil during his pointed criticism of the companies.

Chevron CEO James Watson had said earlier during the hearing, "I'm proud of our profits."

Indeed, anything less would be "un-American."

-- Written by Eric Rosenbaum from New York.

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