Wednesday, May 21, 2008

Oil Company Profits: Fallacy and Reality

There is so much misinformation, misunderstanding and ill will surrounding the price of gasoline these days that some clarity is demanded.

The first point is that the primary reason gas costs so much is that there is more demand than supply, and the increase in demand comes from the expanding economies of China and India. OPEC could produce more oil, but it isn’t in its interest to do so.

The second point is that the U.S. has no one to blame but itself for its idiotic opposition to drilling for domestic oil, building new refineries, and failing to develop other sources of energy.

Perhaps the worst and most dishonest aspect of all of this is the condemnation being heaped on the oil companies, claiming they are making indecent profits. Hogwash! If you understand how businesses operate, you realize this is just so much foolishness. The trouble is, however, that most people do not understand how business works, and politicians trying to get elected and the media that helps them seize upon that ignorance to demagogue the issue and produce votes. Truth be told, many politicians and journalists also don’t have a clue how business works. Businesses—corporations—exist for one purpose only: to make a profit. Without a profit, a business cannot continue to operate and produce whatever it produces, food, medicine, clothing, music, energy products, etc., and it also cannot continue to provide jobs for its employees.

When talking about profits context is critical. What matters is how much money a business gets to keep for every dollar of sales it has, and that is called the profit margin. For oil companies, 90.4 cents of every dollar of sales goes to cover costs, and 9.6 cents is profit for the company’s shareholders; a 9.6 percent profit margin. As businesses go, 9.6 percent isn’t very high. To wit:

Publishing and periodicals: 34.9 percent

Application Software: 22.3 percent

Retail: 20.3 percent

Tobacco Products: 19 percent

Banks: 10.8 – 14.7 percent

Railroads: 13.9 percent

Hotel-Motel: 10.6 percent

Everyone got all excited about Exxon-Mobile’s $40 billion profit in 2007. But looking just at the amount of the profit—the number of dollars—doesn’t provide you with enough information to discuss the issue of whether that profit is “indecent.” In order to have made $40 billion (that’s $40,000,000,000) in profits, Exxon-Mobile needed revenues of more than $404.5 billion (that’s $404,500,000,000), of which $334 billion ($334,000,000,000) goes to cover costs. By the way, Exxon-Mobile paid about $30 billion ($30,000,000,000) in taxes in 2007.

Oil company profit margins haven’t increased above their modest level recently. What has increased is the cost of buying crude oil, which increases the cost of gas at the pump and also increases the number of dollars of profit. Translation: Oil companies aren’t making any more money on their investment now than in the past.

The greenies and other liberals try to make the oil companies look like the bad guys on the price of gasoline, when in fact it is primarily their fault that gas prices are as high as they are. Drilling domestic reserves and increasing refining capacity would have increased the amount of crude oil and refined petroleum products in the hands of US oil companies, and that would have kept prices lower. But heavy regulation and an outright ban on drilling for our own oil, courtesy of Congressional Democrats, have prevented that.

No comments: