Sunday, November 05, 2006

Proposition 87

First a disclaimer. I work for Chevron. Nothing I say here has been endorsed by Chevron, it is simply my opinion.

I believe that Proposition 87 on the California Ballot in November 2006 is overall a bad idea.

Most oil production in the United States and the world carries a "royalty." That is not unusual. California was one of the few exceptions. However, California has some of the stiffest taxation in the nation, which I suspect more than makes up for it. So this is, in essence, California enacting a new "windfall profits" tax.

Is this good or bad then? Well the structure of the tax is such that the highest payments happen when prices are high. That kind of graduation is good. there is also a limit on the total amount that will be brought in, so the tax goes away at some point. That's fine in theory. Once a tax is in place, it often gets extended or rates changed. The royalty might result in fewer barrels reduced ultimately. It depends on prices and timing. There is no chance that it will result in more oil produced.

A few problems though. First, enacting taxes on top of an already high tax burden tarnishes California's "already tarnished reputation" as a place to do business.

Second, when a company considers where it is going to work, stability, or at least perception of stability is an important consideration. California's proposition system in general reduces the stability of the economic environment.

Third, the backers of this tax make it sound as if it is a tax on gasoline. It isn't. It is a tax on crude oil production. In economics 101, you learn that taxes are borne by both companies and consumers, in some varying ratio, depending on the elasticities of supply and demand. This will have the same impact. Simply passing a law that prohibits market forces from working never works. I have heard people say that the royalty will not affect prices. This might be true in times of very high price and margins like today. But here's how it works. As prices come down, (and they will come down), the price of oil will be set by whoever has the highest marginal cost of a barrel. Anyone whose barrels cost more to produce than the price will shut down production. Cost here includes everything it takes to get a barrel out of the ground and to a refinery. As prices slide, one of two things will happen, either, the companies producing in California will shut down because their costs exceed the price, or our oil becomes the price setter. Either way, consumers pay the price.

Another issue, is that this tax mainly hurts companies with production in California. Chevron having the highest production in the state. This is sad, more than anything. Chevron is actually a really good company in the scheme of things. The company has taken a lot of heat over the years for staying in California, when the clear trend is for oil companies ot go to Texas. So this measure is kind of pro-Shell, pro-BP, pro-ExxonMobil (all of which are much bigger than Chevron).

The final issue I have with it is the direction of where the funds go. There seems little oversight or governance. It is a huge obligation for what might be basic research in alternative energy. As a California resident, I want those funds to go towards reducing my tax burden, not to finance some pie in the sky boondoggle.

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