Please no HURF DURF Big Oil
April 1, 2008 5:41 PM Subscribe
Why are oil companies making so much money?
Why have oil companies been doing so well recently? Certainly the price of oil/gas has been going up, but isn't this do to limited supply, increased costs/availability of refining and increased prices of crude?
Each of these factors seem like they should be a bad thing for oil companies. Certainly, these costs are being passed on to the consumer, but how does this translated into record profits? For example, farmers do not benefit when seed prices go up. I'm interesting in the economics of the answer, not diatribes on corporate greed.
If it is just as simple as raising prices faster than their costs, why haven't they done this before? Wouldn't it hurt their business to gouge prices excessively when costs are already up from other factors? Or are supply and demand economics completely out the window here? Are there any numbers to suggest how much of the increase in oil prices are due to actual scarcity and how much is due to artificial price increases?
Why have oil companies been doing so well recently? Certainly the price of oil/gas has been going up, but isn't this do to limited supply, increased costs/availability of refining and increased prices of crude?
Each of these factors seem like they should be a bad thing for oil companies. Certainly, these costs are being passed on to the consumer, but how does this translated into record profits? For example, farmers do not benefit when seed prices go up. I'm interesting in the economics of the answer, not diatribes on corporate greed.
If it is just as simple as raising prices faster than their costs, why haven't they done this before? Wouldn't it hurt their business to gouge prices excessively when costs are already up from other factors? Or are supply and demand economics completely out the window here? Are there any numbers to suggest how much of the increase in oil prices are due to actual scarcity and how much is due to artificial price increases?
Oil Industry Consolidation is part of the answer. In a free market, prices are ostensibly kept down by competition. When the competition is a majority stockholder in your own corporation and vice versa, the price constraints will change.
posted by kuujjuarapik at 5:57 PM on April 1, 2008
posted by kuujjuarapik at 5:57 PM on April 1, 2008
Part of the explanation is that demand has increased recently, but there aren't many new, cheap supplies. Thus there is no (immediate) flood of new supply to offset the demand, and the price rises, raising profits. In the recent past there had been a fair amount of excess production capacity, so increases in demand could be met with an increase in supply, rather than an increase in price.
posted by thrako at 6:12 PM on April 1, 2008
posted by thrako at 6:12 PM on April 1, 2008
Best answer: Their profit margins aren't really all that out of line with other companies, but they do a huge amount of volume.
Price rises have been due to increased demand, not due to decreased supply.
posted by Class Goat at 6:18 PM on April 1, 2008
Price rises have been due to increased demand, not due to decreased supply.
posted by Class Goat at 6:18 PM on April 1, 2008
Relevant to the question:
"Big Oil Executives Deflect Blame for Skyrocketing Fuel Costs"posted by ericb at 6:28 PM on April 1, 2008
"Fuel is Loss Leader for Many Gas Stations; They Make Money in Convenience Stores"
Best answer: Part of the explanation is that demand has increased recently...
Price rises have been due to increased demand...
China, India to drive demand for oil through 2030.
Warning on Impact of China and India Oil Demand.
Price rises have been due to increased demand...
China, India to drive demand for oil through 2030.
Warning on Impact of China and India Oil Demand.
"Bolstered by speedy economic development and industrialization, energy demand from Asia has been one of the main contributors to higher oil prices. Over the last two years, China and India accounted for about 70 percent of the increase in energy demand and the world’s energy needs would increase 55 percent by 2030. Another reason for higher prices is investments not made by oil producers, including the Organization of the Petroleum Exporting Countries, the [International Energy Agency said."posted by ericb at 6:31 PM on April 1, 2008
Best answer: N-thing that oil companies aren't all that profitable, relatively. Net profit margins of 10% aren't very impressive considering the technology and investment needed to stay in business.
There's also a simple accounting reason -- they use Last-In-First-Out (LIFO) inventory tracking for costs which are increasing. So they are selling you gasoline at the $100/barrel oil prices from a barrel which cost them $80/barrel or so. That's great on paper for them. Problem is, is that they have to turn around and buy the next barrel at $100. If oil prices start dropping, this accounting process will result in some nasty losses. Note that if they used the first-in-first-out method, a lot of the "windfalls" of late would disappear.
Also note that oil companies were doing horribly for years. Plot out some oil company stock prices (e.g. XOM) back out as far as you can. Most oil companies did horribly in the 70s -- XOM losing 60% of its value.
The ones that are really benefitting from high oil prices are the ones who the oil companies pay -- the sovereign countries.
posted by FuManchu at 7:06 PM on April 1, 2008
There's also a simple accounting reason -- they use Last-In-First-Out (LIFO) inventory tracking for costs which are increasing. So they are selling you gasoline at the $100/barrel oil prices from a barrel which cost them $80/barrel or so. That's great on paper for them. Problem is, is that they have to turn around and buy the next barrel at $100. If oil prices start dropping, this accounting process will result in some nasty losses. Note that if they used the first-in-first-out method, a lot of the "windfalls" of late would disappear.
Also note that oil companies were doing horribly for years. Plot out some oil company stock prices (e.g. XOM) back out as far as you can. Most oil companies did horribly in the 70s -- XOM losing 60% of its value.
The ones that are really benefitting from high oil prices are the ones who the oil companies pay -- the sovereign countries.
posted by FuManchu at 7:06 PM on April 1, 2008
And those profits go to the stock holders. Who many of us are via our retirement accounts.
posted by gjc at 7:22 PM on April 1, 2008
posted by gjc at 7:22 PM on April 1, 2008
I'm interesting in the economics of the answer, not diatribes on corporate greed.
The simple economics is that it is easier to raise prices and increase margins past what you got away with before, when:
1. There is implied scarcity (whether real or not, scarcity raises prices)
2. You can have the MSM blame state and federal tax laws for high gasoline prices on your behalf
3. You can have the local government approve your conglomeration with the second largest oil company, which:
a. Drastically reduces competition with the remaining producers
b. Greatly decreases cost of production by volume
Basically, when you're an oligopoly, you own one of the three branches of government, and times are tough, you can gouge the public more easily than when there is competition.
posted by Blazecock Pileon at 7:28 PM on April 1, 2008
The simple economics is that it is easier to raise prices and increase margins past what you got away with before, when:
1. There is implied scarcity (whether real or not, scarcity raises prices)
2. You can have the MSM blame state and federal tax laws for high gasoline prices on your behalf
3. You can have the local government approve your conglomeration with the second largest oil company, which:
a. Drastically reduces competition with the remaining producers
b. Greatly decreases cost of production by volume
Basically, when you're an oligopoly, you own one of the three branches of government, and times are tough, you can gouge the public more easily than when there is competition.
posted by Blazecock Pileon at 7:28 PM on April 1, 2008
Blazecock's point #2 both assumes conspiracy and ignores those 10% margins, which were historically 4%. If the oil companies all decided that they would go without profits, the price would drop by, wait for it, $0.04 - $0.10 per gallon.
posted by FuManchu at 7:42 PM on April 1, 2008
posted by FuManchu at 7:42 PM on April 1, 2008
Oooh, bad editing skills, that was supposed to be 4%-10% per gallon. On $3.50/gallon, that's $0.14 - $0.35/gallon in savings. Compared with a US average of $0.47/gallon.
posted by FuManchu at 7:46 PM on April 1, 2008
posted by FuManchu at 7:46 PM on April 1, 2008
Best answer: The ever-helpful How Stuff Works scores again.
posted by megatherium at 7:55 PM on April 1, 2008
posted by megatherium at 7:55 PM on April 1, 2008
They sell enormous quantities of a substance that all of us need and are willing to pay for. Why wouldn't they make money?
posted by decathecting at 8:35 PM on April 1, 2008
posted by decathecting at 8:35 PM on April 1, 2008
Compared with a US average of $0.47/gallon.
Except it's not really $0.47/gallon, it's $0.19/gallon federal tax.
Once you factor in the tax breaks petrochemical companies have received the last two decades from the federal government, and in particular the $15 billion dollar tax break they received two years ago as a welfare gift from American taxpayers, that federal gasoline tax revenue quite literally vaporizes into thin air.
What remainder you have as state tax revenue depends entirely on what state you happen to live in. So if you live in certain states, you're not paying much or any gasoline tax, really. In fact, you're generating as much profit for the oil companies as a buyer in any other state.
The reality is that state and federal taxes do not really have much or any of a negative impact on energy company profits, once the accounting is done.
posted by Blazecock Pileon at 10:25 PM on April 1, 2008
Except it's not really $0.47/gallon, it's $0.19/gallon federal tax.
Once you factor in the tax breaks petrochemical companies have received the last two decades from the federal government, and in particular the $15 billion dollar tax break they received two years ago as a welfare gift from American taxpayers, that federal gasoline tax revenue quite literally vaporizes into thin air.
What remainder you have as state tax revenue depends entirely on what state you happen to live in. So if you live in certain states, you're not paying much or any gasoline tax, really. In fact, you're generating as much profit for the oil companies as a buyer in any other state.
The reality is that state and federal taxes do not really have much or any of a negative impact on energy company profits, once the accounting is done.
posted by Blazecock Pileon at 10:25 PM on April 1, 2008
Blazecock, the existence of those subsidies with the low margins just further proves what a difficult and competitive business it is. Without those tax breaks the margins would be even lower. Oligopolies have very high margins (e.g. Coca-Cola and Cisco which have net margins of 20%). Exxon would not have accepted margins below 5% throughout the '90s if they had any kind of pricing power.
posted by FuManchu at 1:56 AM on April 2, 2008
posted by FuManchu at 1:56 AM on April 2, 2008
It's hard to use volume and margin/volume in this case. They don't produce fuels as one discrete widget at a time.
One way they justify their profits is to show that their percentages are still in order. For example, not real numbers and over simplified: they show that in the past, 10% of a gallon of gas was refining costs. Then they get before congress and say "look, we are actually making less money! We've reduced our costs to 9%!" Except that many of their costs aren't based on the price of fuel, or at least not linearly. Joe the machine operator's salary doesn't triple when the price of oil triples.
The problem with refining is that there are very few refineries and it's very hard (if not impossible) to build a new one (in the US) these days. So when they say "it's the free market", they aren't right. It's a market, but it's not free if someone else can't come in too. Then they say "there's no shortage of refining capacity! We don't need more refineries." Two problems with that- one, they are right. There are not all at 100%. But they are as close to it as they can get. One hurricane, explosion or "scheduled maintenance" increases the price (and their profit at the other still working units). And then they don't bring the repaired facility online until its in their best interest. Two, they might be right that there is excess capacity. But who are they to say some other new refiner shouldn't try their hand at joining the marketplace?
It's like what happened in California during the electricity thing. If you are skimming a percentage off of the end price, it's really, really in your best interest to reduce the availibility of the supply.
The price for crude oil is a bit more of a free marketplace, actually. There are plenty of countries with oil, and with unused production. But what they do is economically titrate (forget the economics word for it) to extract the best price. Why turn on all the spigots if that's going to reduce the price? There are wells out there that were turned off in the 80s and 90s when the price of crude oil dropped. As long as people are still buying, why incurr the costs of bringing new production online when all it's going to do is reduce the price you are already getting?
It may not be classic price fixing or collusion, but it's darn close.
posted by gjc at 8:52 AM on April 2, 2008
One way they justify their profits is to show that their percentages are still in order. For example, not real numbers and over simplified: they show that in the past, 10% of a gallon of gas was refining costs. Then they get before congress and say "look, we are actually making less money! We've reduced our costs to 9%!" Except that many of their costs aren't based on the price of fuel, or at least not linearly. Joe the machine operator's salary doesn't triple when the price of oil triples.
The problem with refining is that there are very few refineries and it's very hard (if not impossible) to build a new one (in the US) these days. So when they say "it's the free market", they aren't right. It's a market, but it's not free if someone else can't come in too. Then they say "there's no shortage of refining capacity! We don't need more refineries." Two problems with that- one, they are right. There are not all at 100%. But they are as close to it as they can get. One hurricane, explosion or "scheduled maintenance" increases the price (and their profit at the other still working units). And then they don't bring the repaired facility online until its in their best interest. Two, they might be right that there is excess capacity. But who are they to say some other new refiner shouldn't try their hand at joining the marketplace?
It's like what happened in California during the electricity thing. If you are skimming a percentage off of the end price, it's really, really in your best interest to reduce the availibility of the supply.
The price for crude oil is a bit more of a free marketplace, actually. There are plenty of countries with oil, and with unused production. But what they do is economically titrate (forget the economics word for it) to extract the best price. Why turn on all the spigots if that's going to reduce the price? There are wells out there that were turned off in the 80s and 90s when the price of crude oil dropped. As long as people are still buying, why incurr the costs of bringing new production online when all it's going to do is reduce the price you are already getting?
It may not be classic price fixing or collusion, but it's darn close.
posted by gjc at 8:52 AM on April 2, 2008
This thread is closed to new comments.
Somewhat longer answer to this question: Wouldn't it hurt their business to gouge prices excessively when costs are already up from other factors?
Only if a significant number of consumers had a reasonable alternative. The vast majority of their market doesn't, therefore they can gouge all they want.
It's a total pain in the ass, but it could be worse. Sadly, I fear it'll get to that point.
posted by Ufez Jones at 5:55 PM on April 1, 2008