Sunday, May 07, 2006

Oil Company Profits Indecent?

The issue of high gasoline prices has been suffused with a great deal of irrelevant information and emotionalism.

The truth is that gasoline prices are high not because Big Oil is making indecent profits, or because the oil companies are in collusion with one another, or any of the other emotional class-based arguments now circulating. The main reason for high prices at the pump is a far less exciting and far more practical one: supply and demand.

Supplies of petroleum must be found and obtained. There is only so much of that activity going on in the world; hence there is a finite supply of crude oil to begin with. Then, the oil must be refined into gasoline and other petroleum products, and again there is only so much of that going on in the world.

United States companies drill for crude oil and refine oil, however, both new drilling and new refinery construction have been almost non-existent for the last 20 years due to environmental concerns, and damage to U.S. facilities by Hurricane Katrina has further reduced domestic capacity. Thus, the amount of oil and gasoline that American oil companies have under their control is only a fraction of what is needed to meet domestic demand, and the additional oil must be purchased on the world market where availability and price are controlled by other nations. The tremendous increase in demand from China has put greater demands on world oil and gasoline supplies. As the demand for crude oil and gasoline grows, so does what it costs domestic oil companies to purchase them, and as costs rise, so do prices.

Oil companies have been demonized for making “obscene” profits, but this perspective depends upon a failure to know or understand the basic economics of business. Critics of Big Oil look at the dollar amount of the profits without the critical perspective of profit margin, or what part of every dollar of sales is profit. Several U. S industries routinely make profit margins of 12 to 18 percent; oil companies make about 10 percent. Even in this time of so-called “obscene” profits, oil companies are still making a profit of about 10 percent. In other words, for every dollar of sales, 10 cents is profit; the rest is the cost of production, distribution and other business aspects. As the cost of production goes up, so does the price and so does the dollar amount of profit. But the margin of profit stays the same. As the price of gasoline has doubled so has the dollar amount of profit, so that when you compare profits from the time when gasoline sold for $1.50 a gallon to now when the price is around $3.00, profits are much higher now, but the margin has not grown.

ExxonMobil's actual profits amounted to $8.4 billion in the first quarter of 2006. That’s a lot of money, true enough, but it is $1 billion less than CBS News had predicted and it is a 22 percent decline from the $10.7 billion achieved in the fourth quarter of 2005. And it isn’t “obscene,” as the media and oil company critics would have you believe.

Looking at another side of this issue, in 2005, ExxonMobil reported paying just under $99 billion in taxes: $23.3 billion in income taxes, $30.7 billion in excise taxes, and $44.6 billion in "other taxes." At the pump, you pay somewhere between 40 cents per gallon and 60 cents per gallon in taxes to the federal and state governments.

Yes, the profit numbers are big numbers. But so are the cost numbers and the total sales numbers. ExxonMobil’s $36 billion of profits sounds huge. But when that is considered relative to total sales of $359 billion, it suddenly doesn’t seem so big. Profits equal one dime per dollar of sales, and as U.S industries go, that isn’t a big profit margin.

Other industries and their profit margins: Pharmaceuticals 19; Banking 18; Financial 13; Software and Services 10; Insurance 11.

Technorati Tags: , , , ,


Conan said...

Crom! This is a good site,lots of good writing, much more than my humble blog. I just like to poke a stick in the eye if Islam etc.

Brad Barfield said...

Damn, it's just too heavy for me today...

Spindrift said...
This comment has been removed by a blog administrator.
Anonymous said...

Hi! Just want to say what a nice site. Bye, see you soon.