High prices for crude oil in 2004 and into 2005 have reduced consumers' purchasing power and raised costs for businesses while providing billions of dollars to the oil industry and oil exporting countries. The industry's increased revenues have led to record profit levels. As the 109th Congress engages in oversight of recent broad energy legislation which aims to increase the domestic supply of crude oil to mitigate oil price increases in the longer term, another key factor in determining increased supply is how oil companies decide to allocate their profits between shareholder returns and investment in oil production. This report is written in response to a number of requests from Congress concerning profits in the oil industry. This report provides background information concerning the level of oil industry profits, the sources of those profits, and a discussion of the potential uses of profits.

Risk management is important in the energy industries because of the volatility of oil and natural gas prices. Price volatility can reduce the profit of business strategies and hurt consumers. The use of financial derivatives, both traded and overthe-counter, has developed as a low cost method of hedging price risk. However, the use of derivatives has also been linked to major financial scandals and bankruptcies. Risk management strategies can be undertaken without the use of derivatives.

Due to the growth in natural gas production, primarily from shale gas, the United States is benefitting from some of the lowest prices for natural gas in the world and faces the question of how to best use this resource. Different segments of the U.S. economy have different perspectives on the role natural gas can play. Suppliers, which have become the victims of their own production success, are facing low prices that are forecast to remain low. Some companies that have traditionally produced only natural gas have even turned their attention to oil in order to improve their financial situation. Smaller companies are having a difficult time continuing operations and larger companies, including international companies, have bought into many shale gas assets. Prices have remained low even as consumption has increased, in part, because producers have raised production to meet the demand and because companies have improved efficiency and extraction techniques. Some companies, many with large production operations, have applied for permits to export natural gas. This has raised concerns from consumers of natural gas that domestic prices will rise. The debate regarding exports is ongoing. Industries that consume natural gas have seen input costs drop, and some have heralded low natural gas prices as the impetus for a manufacturing revolution in the United States. Some companies have begun to make major investments to take advantage of the low natural gas prices, particularly in petrochemicals. Other companies are waiting to see if prices will remain low long enough to warrant major investments in new facilities. Meanwhile, the electric power sector has already seen a transition from coal-fired generation to natural gas. Low natural gas prices are also putting pressure on renewable sources of power generation. However, increases in demand will put upward pressure on natural gas prices. The transportation sector, the one part of the economy vulnerable to foreign energy supplies, is beginning to explore ways to use more natural gas. Transportation makes up less than 1% of U.S. natural gas consumption and would require billions of dollars in investment to increase that share significantly. All of the change that has taken place so far has occurred despite environmental concerns and regulatory developments at the state and federal level that might curtail production. Natural gas is a fossil fuel that produces various pollutants, some more than other fossil fuels and some less. Methane, the major component of natural gas, is also a potent greenhouse gas when released without burning. Other environmental concerns focus on water use and disposal in hydraulic fracturing to extract natural gas from shale formations. Over the next five years, many of the issues being debated now may be decided. The industry and market are adapting to the newly found supplies and the concerns associated with them, as well as integrating more natural gas into the economy. There are many evolving issues some of which Congress can influence directly because of statutes and some indirectly. On the demand side, legislation has been introduced regarding exports of liquefied natural gas and alternative fuels for vehicles. There has been other legislation related to environmental regulations of natural gas.