Oil Company Profits

With the run up in oil prices, oil companies have seen their profits also run up. For many this is just wrong. That consumers have to pay more at the pump and oil companies see huge profits…why that is positively un-American! Never mind that there is an obvious and logical connection between profits for a firm and the price of the good said firm sells. Such a correlation is due to something nefarious and underhanded not just the working of a well established market.

Let’s run down why oil companies are experiencing such huge gains in profits. Let’s start simple. We have one oil company that is looking at drilling a well. They do some analysis and find that so long as oil per barrel is over $25 then that well is profitable. The current price is $30/barrel and the expectation is that oil will stay near that price for sometime to come. So you have this mildly profitable well. Then things change. Another country starts to experience an economic boom and they start consuming larger and larger amounts of oil. Turmoil in another part of the world causes market uncertainty as to the steady supply of oil, and people have gotten sloppy and lazy are now driving vehicles that use more gas/mile driven than before. Suddenly the price of oil surges to $50/barrel and you $5/barrel profits on that well have now jumped to $25/barrel. Note that the oil company has done nothing different. They are pumping at the same rate as before, but now for this well, the profits have jumped dramatically.

Keep in mind that the oil market is not simple. ExxonMobil does not go out drill oil, send it to its refineries, and then send the refined product, gasoline, on to its retailers. Instead, what happens is that ExxonMobil drills and pumps the oil. Some of it goes to their refiners, some of it goes to other independent refiners. Some of the oil that goes into ExxonMobil refineries might come from other sources such as Shell, BP, Texaco, etc. Part of the refined product is “branded”—that is, it has an additive added to it such as Chevron’s Techron—however, some of that gasoline is not branded and is sold to anyone who drives tanker truck up to the refinery. The gasoline that is not branded is then trucked over to the retailers and branded. So an Exxon station might have bought its recent shipment of gasoline from Texaco, but is now adding their own additive. All of this is a “good thing”. Why? Suppose you have a retailer who buys solely from the local ExxonMobil refinery, but then that refinery goes down for a planned or unplanned outage. Now what? Does the retailer just sit their with empty tanks making little or no money? No, he gets his oil from the local Chevron refinery, brands it and keeps right on selling.

And most retailers make very little profit off of gasoline. Instead they make a higher profit margin on the items in the Quick-E-Mart that is part of the station. When you are filling up and decide you need a soda and a pack of smokes, they’ve made a higher return on that sale than on the gasoline. The gasoline is what gets you at the station where some customers will buy other more profitable items.

So what would a tax on the oil companies profits accomplish? In regards to the price, I’m not sure it would do a damn thing. Companies exist to earn a profit. Take that away and the company, ideally, will look for something else to make a profit on. Now, the oil companies probably wouldn’t abandon producing oil, but they might look to invest whatever money they do have into something other than producing oil. This is bad because with less money going into producing oil, and with rising demand the supply will be constrained resulting in even higher prices. And who owns these oil companies? Millionaire and billionaires? Sure, I bet some of the shareholders are filthy rich. But I’d be willing to bet that some of the largest shareholders in oil companies are mutual funds…which means IRAs, 401ks, etc. In short, many middle class households have their retirements linked to oil companies. What would happen to those retirement funds if the government were to ride in and like a thief take their profits? My guess here is that those retirement funds will would take a hit. Billions and billions of dollars worth of a hit. A hit that would make Eron look like penny-ante robbery. Keep that in mind next time one of these dimwits running for President blabbers on about oil company profits.

And keep in mind that often times the person who whines about oil company profits is often the same one blubbering on about global warming. Talk about schizophrenic. Hello, McFly! High oil and gasoline prices are good for Global Warming. Higher prices like we are seeing now means people drive less. Less driving means lower carbon emissions. From a global warming view you actually want gasoline prices to be even higher, not lower.

I don’t see why this is so hard to grasp. It isn’t rocket science.

FILED UNDER: Campaign 2008, Economics and Business, US Politics, , , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Dave Schuler says:

    You don’t have to guess. Big financial institutions comprise ExxonMobil’s top 10 shareholders and mutual funds figure prominently among the big shareholders.

  2. Richard Gardner says:

    In the mass media, Ben Stein has op-eds last weekend on this:

    Stein: Stop Whining And Blaming Oil Cos
    http://www.cbsnews.com/stories/2008/…n4125912.shtml

    Running Out of Fuel, but Not Out of Ideas
    http://www.nytimes.com/2008/05/25/bu…a1e&ei=5087%0A

    Contrary to populist opinion, the President does not control the price of oil. And America does not rule the world. And the CIA is not all knowing/powerful.

    Oil prices are a BUBBLE. And peak oil is a theory akin to the Marxist Dialectic.

  3. Richard Gardner says:

    Since my previous post was spam blocked,

    But oil companies are EVIL, spawn of the devil, owned by pension funds and mutual funds, contributing to old folks’ financial security.

    Let us look at XOM (Exxon Mobile) from the link above – 3 top holders are:

    Barclays Global Investors UK 4.41% – Index funds and mutual funds.

    State Street Corp 3.56% – Mostly overseeing UNION pension funds

    Vanguard Group 3.15% – Mutual Funds.

    Three groups control OVER 11% (ignoring the other 89%)

  4. Richard, you forgot the Rockefeller family members who have the crazy idea ExxonMobil would be better off not pumping as much oil.

  5. davod says:

    Steve, Dave and Richard:

    You are quite correct that the profit go to the right places. As soon as this gets pushed the divestment actions will be pushed by the warmenists and their fellow travelers in government.

    I cannot understand why the hypocrisy of the left is not pushed more.

    Schumer actually said that ANWAR was not an option because it would take ten years to come on line. Ten years after Clinton vetoed drilling in ANWAR.

    Dems complaining about the price of gas when some (I cannot immediately find them) have said that increasing the price of gas will help prevent global warming.

    I suppose the problem with these as campaign issues is that some conservatives are as much in the warmenists tank (pun) as the liberals.

  6. Beldar says:

    Good post, and worth the effort, Steve.

  7. DL says:

    It’s not about understanding that is the difficulty. It’s about post modernism’s mentality that you have a right to your own private truth and it’s just as valid as the next persons -even if it is in contradiction with everything else you believe. The left needs a scapegoat and “greed” (as in the rich)is their evil they choose to scapegoat – all the while thinking “envy” and “hatred” are virtues.

  8. yetanotherjohn says:

    Why if we let the oil companies keep these profits, they will just do something crazy like go drill for more oil. And then where will we be? But if we take all that profit, then we can be sure that they won’t drill for more oil and thus ensure that the price of gas will not stay where it is.

  9. M1EK says:

    You guys make this sound like the oil companies are operating in something like a free market. They’re not; the energy policy of this administration was to give them a bunch of tax breaks and even explicit subsidies; and do squat on anything that might actually help in the long-run. What we did was like subsidizing beer production so it’s even cheaper for alcoholics.

  10. Bithead says:

    You guys make this sound like the oil companies are operating in something like a free market. They’re not; the energy policy of this administration was to give them a bunch of tax breaks and even explicit subsidies; and do squat on anything that might actually help in the long-run.

    The only thing that’s going to solve an oil shortage, is getting more. It’s that simple. And you make it sound like we’ve not been regulating the oil companies to death. See Railroads.

  11. Bithead says:

    To add to my last, Beck says it well:

    I don’t know why people keep referring to what’s going on with energy as a “market” while it’s stepped on by government every mile of the way from the field to your tank, and from the generator to your AC outlets, ad infinitum. And it’s supposed to be evidence of markets working because people are being priced out of what’s being called a “market”… almost as if it’s a good thing or something.

    If The New York Times had run a Walter Duranty headline in 1931 that went, “Reports are that peasants appear to be consuming less wheat as a result of eating less,” what might have Americans thought of it, or of an economy manifest so? What might have been the right thing to think of it?

    My god, the lapse of ethics and politics in economics is just rotten. All over the place you’ll see people equating the applications and results of force with voluntary exchanges of values, up and down long production chains from raw materials to finished products, with arbitrary coercive interventions everywhere along the way. I don’t know why people don’t or can’t keep track of the crucial political difference between force and trade, but they just don’t. I suppose it’s because something useful to consumers is eventually squeezed out the ass-end of the thing after every government shark along the way has had its bite. “It’s not capitalism, but it’s got bits of capitalism shot through it.” (paraphrase of my mate Jid’s Brit-bit parody of a Python sketch) It kind of looks like what a market might do, and the CPU’s are running on time, after all, so all that quacking out there must mean that this is The Genuine Duck.

    ..
    It’s a lot more important to me that Americans are less able to exploit this vital material of such energy density in order to conduct the productive daily lives that they would be able to without all these cramps all over it.

    …and being called “markets”, to boot. Could we at least not be poking sharp sticks in the body?

  12. M1EK says:

    Bithead, the subsidies to oil companies far outweight the impact of the regulations. Your past incomprehension of concepts like fungibility make it difficult to credit you on anything else wrt economics, of course.

  13. Bithead says:

    the subsidies to oil companies far outweight the impact of the regulations

    You’ve just expained to us in graphic terms how badly you under-estimate the damage done by the regulations, as do most who think governmental regulation of everything is the way to go. Remember, railroads, too, were subsidised… and that regulation proved no less fatal to them.

  14. M1EK says:

    Spare me the lectures from a guy who has no clue about a basic economic concept like fungibility.

  15. Steve Plunk says:

    M1EK is right, it is not a free market. It is manipulated by OPEC. The oil companies do not control the world price of crude but foreign governments do.

    I hear a lot about subsidies to the oil companies but when examined closely those so called subsidies are not as advertised. We must also remember the government mandates that are forced upon refiners that offset those “subsidies”.

    If we want to blame someone for high energy prices it is clearly government. Ours, theirs, every government shares culpability for the problem.

  16. Steve Plunk says:

    I noticed commodities trading regulators have announced an investigation into price manipulation by hedge funds and large investors. It seems to be common knowledge these parties are driving up oil prices yet no one is doing anything to counter them. Maybe this investigation will be the needle to pop the bubble.

  17. Bithead says:

    M1EK is right, it is not a free market. It is manipulated by OPEC

    In a race to determine which is of larger damage,between OPEC and our own goverment, government wins, hands down. Example; Our own government played into OPEC hands, when they shut off most of the domestic fields where known oil deposits are.

  18. Bithead says:

    I noticed commodities trading regulators have announced an investigation into price manipulation by hedge funds and large investors. It seems to be common knowledge these parties are driving up oil prices yet no one is doing anything to counter them. Maybe this investigation will be the needle to pop the bubble.

    Indeed. Wasn’t that the ploy Soros told us he’d use?

  19. Bithead says:

    Spare me the lectures from a guy who has no clue about a basic economic concept like fungibility

    You’ve made yor point… It’s a world market. I agree, and my statements operate within that realm.

    Now explain to us how adding to that world market with the respurces WE can control doesn’t work to our own advantage.

  20. Michael says:

    The only thing that’s going to solve an oil shortage, is getting more. It’s that simple. And you make it sound like we’ve not been regulating the oil companies to death. See Railroads.

    I know you’re all about supply-side economics, Bit, but demand is still a factor. Reducing demand would do as much to solve an oil shortage as increasing supply would.

  21. Michael says:

    the subsidies to oil companies far outweight the impact of the regulations.

    Numbers please.

  22. Bithead says:

    I know you’re all about supply-side economics, Bit, but demand is still a factor. Reducing demand would do as much to solve an oil shortage as increasing supply would.

    If demand were the issue, prices would already be down. World demand has been off for months, now.

  23. Bithead says:

    Michael, I’ve already provdied you the disaster list, remember?

  24. Michael says:

    If demand were the issue, prices would already be down. World demand has been off for months, now.

    Demand is still a factor, if it weren’t the “bubble” you keep advocating would never burst, which you keep advocating it will.

    Michael, I’ve already provdied you the disaster list, remember?

    I was actually requesting them from M1EK (more for the subsidy numbers), since he is the one that made the claim I was responding to, though I don’t believe either of you have posted actual numbers yet, not in this thread at least.

  25. spencer says:

    You failed to complete your analysis. The economic role of profits is to steer investments– profits are the steering wheel of a capitalists system. High profits in an industry signals that we need more of the output of that industry. It works two ways. One, the industry invests its high profits in building more capacity. This is the way it is suppose to work because they supposedly know more about the industry then anyone else. Two, other sources of capital are attracted to invest in the industry by the high profits and they also add to capacity. So soon, there is much more capacity and the high profits vanish because of competition.

    But it is not happening that way this time. In the 1970s the oil companies spent every penny they could get on new exploration and drilling. By the time the 1982 recession hit demand that new capacity was coming on line and for a decade we had a surplus of oil driving prices down and they stayed down for nearly another decade. Moreover, this happened despite price regulations and the windfall profits tax.

    But this cycle even without price controls or windfall profits taxes the major oil companies are hardly expanding their exploration and drilling budgets.Drilling activity is half of the peaks its reached in the 1970s and even less of what a regression of real oil prices against drilling implies it should be. Rather the major oil companies are returning an unusually large share of their record profits to their shareholders with the message to find a better use for the capital then oil drilling and exploration.

    So in essence your story of the economics of high oil prices and the way the system works is only telling half of the story. Why don’t you tell the rest of the story?

  26. M1EK says:

    Now explain to us how adding to that world market with the respurces WE can control doesn’t work to our own advantage.

    We would only lower worldwide prices a tiny amount – we’d be sacrificing our future profits for a small amount of benefit shared across the entire world.

    You still, clearly, don’t understand what fungible _means_ in this case. We can’t lower our own prices by $10 and everybody else’s by $0; it’ll end up being $1 lower for the whole world – at which point we need to have an honest discussion about whether the $1 (for us) is worth it.

    And, folks, OPEC isn’t why prices are high now _either_. The world is pumping as much now as it probably ever will – and the markets are finally catching up as they learn not to trust the lying Saudis.

  27. Bithead says:

    We would only lower worldwide prices a tiny amount – we’d be sacrificing our future profits for a small amount of benefit shared across the entire world.

    Actually, that’s not been the history of the thing. One need only look as far back as Prudhoe Bay… when we decided to put that online, OPEC lowered it’s prices by rather a lot, in an attempt to keep Alaskan oil in the ground.

    What makes you think this time wouldd be any different?

    We can’t lower our own prices by $10 and everybody else’s by $0

    Well, that’s why I’ve been confused about your constant harping on this. At what point have I EVER said that the price drops wouldn’t be world wide?

    The world is pumping as much now as it probably ever will

    We’ve been hearing this chant for 100 years. YOu’ll forgive me if I don’t take it at face value.

  28. Steve Plunk says:

    Spencer, I wonder if drilling activity would be higher if ANWR and the off shore fields were opened up. Since governments have control over where drilling can take place it again seems to a case of artificial supply constraints by not allowing the market to work. There is also money being spent by oil companies on alternatives to traditional energy sources.

    The high cost entry into the oil business means we cannot see quick advances by outside companies to take advantage of good returns on investment. These things move slowly but they will move. We are paying now for poor decisions made many years ago.

  29. Bithead says:

    But this cycle even without price controls or windfall profits taxes the major oil companies are hardly expanding their exploration and drilling budgets

    Then again, they’re not being ALLOWED to.

    Since governments have control over where drilling can take place it again seems to a case of artificial supply constraints by not allowing the market to work. There is also money being spent by oil companies on alternatives to traditional energy sources.

    Correct, and exactly my point.

    We are paying now for poor decisions made many years ago

    Perhaps more correctly, we’re paying the high price of governmental involvement.

  30. spencer says:

    Never confused by the facts are you Bithead?

    Is that why you are always making up your own?

  31. M1EK says:

    Bithead, OPEC charges what the market will bear. In the past, they “lowered their prices” by deciding to pump a lot more oil.

    Listen to this very carefully:

    This lowered the price for everyone. This is what fungibility means.

    Now, why won’t it work now?

    Listen to this very carefully:

    This time, there is very strong evidence that they cannot just decide to pump more oil.

    Get it?

  32. Bithead says:

    Bithead, OPEC charges what the market will bear. In the past, they “lowered their prices” by deciding to pump a lot more oil.

    Listen to this very carefully:

    This lowered the price for everyone. This is what fungibility means.

    Of course! Listen to ME carefully and asnwer the question you’ve already ignored….
    When have I ever said otherwise?

    And in any event, why would I consider prices for everyone else remaing higher, a good thing?

    And the market will bear quite a bit just now, because the competition has left the field for ‘environmental’ and ‘NIMBY” reasons. I’m telling you that the same thing will happen just now.

    Is that why you are always making up your own?

    You have specifics? (… he asked knowing otherwise)

  33. Bithead says:

    This time, there is very strong evidence that they cannot just decide to pump more oil.

    No sale. Is this the same strong evidence that told us we’d run out of oil over 100 years ago?

  34. Steve Verdon says:

    Spence,

    You’ve already answered you question. Since the oil companies built up lots of capacity only to have the rug yanked out from under them, they are now playing a waiting game to see if this recent run up in prices is going to last or if it is a bubble that is going to pop. It isn’t that hard to understand really.

    I’m thinking bubble here, as is James Hamilton.

  35. M1EK says:

    JDH isn’t thinking bubble in the way you are, Steve. He’s noticeably skeptical of the Saudis as well.

  36. Bithead says:

    Yeah, well, let me guess, here. Be bases that train of thought on ‘peak oil’, huh?

  37. Steve Verdon says:

    JDH isn’t thinking bubble in the way you are, Steve. He’s noticeably skeptical of the Saudis as well.

    Where did I say anything about the Saudi’s at all? And I’ve read Hamilton’s articles on this and agree with them largely across to board. Thus, to say he and I have rather different ideas suggests you need to return to mind reading school.