Sunday, August 06, 2006

Evil Oil Companies?

Like the price of other products, the price of gasoline is determined by common factors such as the cost of goods and the costs of sales, and enough of a profit over and above those costs to make it worthwhile to be in the gasoline production/sales business.

Any time one of those broad categories of costs goes up, the price must rise commensurately in order to provide a steady level of profit. So, as the price of crude oil rises, the cost of refining the oil into fuels goes up, and the cost of gasoline and diesel goes up, too. As the cost of gasoline and diesel rises, the cost of delivering gasoline from the distribution point also goes up, because the tankers that carry the gasoline have higher fuel prices, too.

Every business has to make a profit. Breaking even does not enable a business to pay its owners for their investment. If you can make more money by putting your money in a savings account than you can by investing it in a business, why invest in a business? And, obviously, if the business loses money it won’t be around long.

How much profit should a business make? There is no right answer to that question. Some businesses make a larger percentage of profit than others. For example, McDonalds made 13.8 percent and Coca-Cola made 21.2 percent in a recent quarter, and Google made 24.2 percent. Merck, Bank of America, Microsoft and the Citigroup all made much, much more. And two of the nation's largest newspaper chains grumble when they don't make over 15 percent on sales.

In case you don’t understand what profit margin is, it measures how much out of every dollar of sales a company actually keeps in earnings. In the case of McDonalds, which made 13.8 percent, it means that for every dollar of sales, the company had 13.8 cents more than it cost it to produce and sell its products.

Oil companies typically make about 8 – 10 cents of profit for every dollar of sales, so for every gallon of gasoline that sells for $3.00 the oil company makes between 24 and 30 cents. Where does the rest of the money go? To production and sales costs, to taxes (The federal tax is 18.4 cents per gallon, while state and local taxes vary from 8 cents in Alaska to nearly 50 cents per gallon in New York) and a little bit to the dealer.

So why are people so upset over oil company profits? Many other industries make a larger margin of profit than oil companies do, and the amount of profit isn’t excessive when compared to banks and newspapers. It’s because of the amount of dollars involved. When it is reported that an oil company made, say, $7,000,000,000 in profits in one quarter with an 8 percent profit margin, it means that its total sales were $87,500,000,000. If its profits rise to $11 billion because crude oil prices and refining costs go up causing the price of a gallon of gasoline to rise, its sales would have also risen to $137,500,000,000. The company isn’t making a bigger margin of profit per gallon, but because the price of gasoline in higher, its dollars of profit go up. And so do its costs, from $80,500,000,000 to $ 126,500,000,000.

Oil companies are not making “obscene profits” and they are not gouging the consumer; they are making the same margin of profit as always. The culprit is “market forces.”

To ask oil companies to forego some of the dollars of profit they are making to make life easier on consumers is a really, really, really stupid suggestion. It would punish the oil companies and their investors for something over which they have no control, and it would ask of them something that has not been asked of other industries that make far higher profit margins than oil companies do, which is really, really, really stupid.

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