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Record Oil Company Profits and High Gas Prices: A Connection?
Posted by Super G on April 26, 2006 - 10:50am
Topic: Economics/Finance
Tags: gas prices, price gouging, windfall profits tax [list all tags]
There's been some grumbling in the media about how Big Oil is gouging the public by charging record prices for gas while they reap record profits. For example, this article from The Nation says
There is no evidence of a willingness on the part of these highly profitable corporations to sacrifice in a time of national emergency.No one can dispute that oil companies are doing really well. And certainly no one can dispute that gas prices are high. But is the connection as straightforward as the article suggests? If the oil companies were less greedy, would we see lower prices as the pump?Make no mistake: These corporations should be able to absorb a hit. Over the past year and a half, the four largest oil companies—ExxonMobil, ChevronTexaco, Royal Dutch/Shell Group and BP Group PLC—have pocketed close to $100 billion in profits. During the first quarter of 2005 alone, those firms pulled in a cool $23 billion.
But instead of sharing the pain, they appear to be moving to squeeze every cent they can out of the crisis.
Find out below the fold...
Oil companies sell to refineries
Not all oil companies own refining companies. In fact, a very few actually own their refineries. They just find, drill and produce crude which they sell on the NYMEX or other markets, to refiners. A refiner can take crude from anybody—Exxon from Shell, Chevron from BP, etc.
Refineries sell to distributors
This means that an Exxon refinery can sell gasoline to a Shell distributor. The distributor chooses where to buy his products from. Naturally, Shell Oil Refining would offer a Shell Distributor a pretty discounted price, but not necessarily the lowest he might find. Thus distributors can buy from anybody and sell to anybody, regardless of their "affiliation" with a given oil company. A distributor may be an "Authorized Chevron Distributor", and thus he can sell Techron type gasoline. But that doesn't mean he is restricted to just selling Chevron products. Independent distributors (more of them than any other type) are listed in the Yellow Pages under Fuel Companies or Fuel Distributors. These are the middlemen.
Distributors sell to retailers
These independents actually buy gas from whoever they get the best deal from, then sell it to their customers. If you have ever wondered why there is an Exxon tanker filling up a Fina gas station tank, it is because the distributor is an Exxon affiliate, but the Fina station owner got a better deal from Exxon than from Fina. This happens all the time. Distributors also sell grease and transmission fluid and hydraulic fluid and motor oil to industry. You can often see distributors trucks servicing construction sites or businesses operating a fleet of vehicles.Summing up...Retailers can buy whatever they want from whoever they can get the best price! These corporations are usually very divorced from the nuts and bolts of oil companies, that focus on retailing gasoline and convenience store operation. The retail chain may be a Shell-owned convenience store, supplied by a Shell affiliated distributor, but he (distributor) may buy his oil from Murphy Oil Refining. So while the buyer thinks he is getting Shell gasoline, what he is getting is gasoline from a Shell Distributor, but produced by Murphy Oil Refining.
I have loosely used Big Oil Company names here to make a point. However, many of the big guys keep a close reign on their distributors. But that does not preclude them selling whatever they want to independent retailers, like Samir's Quicky Mart.
Thus unless a gasoline has a patented ingredient (like Techron) or other additive, it will not necessarily wind up being sold by the affiliate retailer. And we haven't even gotten to supply contracts yet, which further complicate things.
At every level of these distribution chains, people are trying to buy low and sell high. This is extremely confusing for everybody, but it is the way it works. But if you keep this in mind—oil companies sell to refiners—you can quickly see why oil companies get pissed when the finger pointing starts.So, if there is gouging, where is it happening?
My opinion is that the gouging, if any, is going on at a very local level, no higher up than the local gasoline distributors. The most opportunistic way to maximize your cash would be to buy this week's gasoline for $2.50 a gallon, and then if something (like high oil prices) allows you to, mark this shipment of $2.50 gas up to $3.00. [Keep in mind that some states regulate the maximum profit on a gallon of gas.] Normally gas markup is about a nickel a gallon or such. The convenience store makes much more on food—the gasoline is the draw to get them into the store to buy cigarettes or candy or a coke, which have much higher profit margins.Why are oil companies making record profits?The people who control the final price at the pump are the retailing companies or independent store owners. And these guys are more than happy to put it off on the oil companies, as they are very removed from them!
I know—as clear as mud. But it is the "free economy" at work...
Because the wells they are producing from today were drilled in past years, where they used $15-25 per barrel as their estimated selling price for the oil. Thus when the market got tight, they have cheap oil going at a higher price. Why? Simple—demand is high.So, it is not the case that oil companies are incurring high exploration costs and passing these costs onto the consumer?Now this higher priced oil is filtering back to them in the form of higher priced goods, so the profits decline slowly over time as higher priced energy enters the economic mill. But right now, they are making a lot of money.
No. Oil companies are not setting the retail price except via the NYMEX, where they sell to refiners.So, let's say, very hypothetically, that Exxon Mobil wanted to make a gesture of good faith. Could they sell the crude for cheaper in hopes of lower prices at the pump, or does the nature of the futures market and all of the middlemen make that impossible?When the traders run the price up, oil companies naturally win. But the crude price is set by market demand i.e., what will they pay today?
It would not work for exactly the reasons you think.But...
ExxonMobil, owning their own up and down stream divisions, could sell at a loss or reduced profit on the retail end, provided they compensated their convenience store owners for their lost gasoline revenues (these stores are franchises). But that would make whatever cut they did offer twice as financially painful—they would take the announced cut and associated reduction in profit, and then have to pay the store owners their traditional profit to keep them happy.
So you are not asking them to just fall on their own sword, but to get back up and hurl their bloodied body on it again...ouch!
So—if ExxonMobil did do this, it would be a huge gesture! But only those in the same business would understand the magnitude of what they had done. And whoever did it would shortly be replaced by the Board of Directors as the principal shareholders all called for his head on a pike! Remember, outside of the energy sector, the stock market is a total losing proposition.
On the other hand, I don't see why it would do Mr. Raymond himself any harm to give away $200-300 million of it. What sort of material deprivations, exactly, would he incur by doing this?
While your compassion is admirable, I would prefer to live in a place where everybody can decide how much all the fatcats get taxed, rather than dragging the scapegoat-of-the-day-CEO through the mud.
This campaign against Lee Raymond is being orchestrated by two rather strange bedfellows, Bill O'Reilly and Charles Schumer. Raymond has been retired since January for God's sake. Nobody knew his name before last week. But now his $400 million is the solution to our energy problems? Ridiculous.
I myself think there is something truly shameful and disgusting about the way ALL of the very rich hoard wealth, and use it to appropriate a morally unseemly share of the planet's finite resources to themselves, and away from billions of others that need it. It may not be obvious that this is shameful and disgusting in a society as saturated with wealth-worshipping free market ideology as American society is, but for that very reason, what I just said sometimes just needs to be said. To a lesser extent, I think what I said is true also of all lesser degrees of affluence also.
There was an illuminating article just recently about what the very rich actually DO with their wealth: http://www.wsws.org/articles/2006/apr2006/rich-a19.shtml
When a company dominates a national industry for decades, and the population and GNP grow over that time, they get to see very big numbers on their balance sheets. There are more people, making more money, and (with current prices) Exxon is pulling down a higher portion of family income.
The numbers are driving a greater concentration of wealth and power for Exxon, and the way they are using that wealth and power is ... simply evil.
I think it is an unanticipated consequence of the stock market boom/bubble, and the well known connection between available shares and an aging baby boom population. Money flows into the stock market, supporting the bubble, and giving companies huge capitalizations. Management compensation, as a fraction of capitalization, is nothing ... while at the same time it is huge from a 'real world' perspective.
I was actually in a small company, and saw a couple guys turn into billionares on the day of public offering. It was actually freakier that a couple guys who knew me, who would say hi to me (a working engineer) in the elevator, were suddenly billionares.
Why did they get that rich? Well, they were certainly smart and hard workers ... but not even they expected that much. It was the dot com boom, and the market just threw money at them/us.
It's a strange world.
There are probably 100 million Exxon customers in the U.S., so that would come to 20 cents per customer per year, or about a penny and a half per month.
But why only the U.S. customers ? Exxon probably has a billion customers worldwide for its various products. So that would make 2 cents per year per customer.
And what if his pay were distributed among all of the poor in the world ? How many poor are there ... perhaps 4 billion ? They would each get a half-penny per year.
There are about 6 billion outstanding shares, so each of those shares would get three tenths of a penny per year, or a roughly 0.005% annual dividend. Before taxes.
The question should really go to shareholders though. It could be that 400 million to a environmental program or etc. would stand them in better stead 10 years from now ... when people figure out Exxon's social responsibility has really been.
And I personally think Lee should be able to have a pretty happy retirement on 30 or 40 million. If he can't he has other problems.
Much of Lee's $400 million is actually in stocks and stock options -- meaning that he has wealth, but not cash, and the company has given up shares of its stock (shares that were already outstanding), or options on shares, but not in the same way as $400 million in cash would have.
I don't know enough about the accounting behind it all, but they didn't give 1/1000 of the market cap away -- the market cap remained the same (unless investors decided they didn't like the $400 million, and, thus, started selling/not buying, driving the price and, thus market cap down), their profits barely took a hit, and they retained value in the company.
And the company is perfectly within its rights to provide absolutely ridiculous amounts of compensation to people. And, if I was offered $400 million, I'd take it.
As for taxes on the wealthiest, I concur -- taxes at the high end need to be raised. With the one caveat that the taxes need to be consumption-based, not wealth-increase based. If Lee keeps all his $400 million in stocks, etc., or gives it all to charity (while driving an '83 Honda Civic and living in a trailer), then I don't want him taxed -- let him build businesses, support charities, etc. If, on the other hand, he throws a $15 million birthday party for his dog (as far as I know he hasn't, but it's a hypothetical), then that whole $15 million gets taxed -- and I really don't give a hoot in a holler about whether it was made as salary or as capital gains.
$400 million doesn't bother me (don't invest in ExxonMobil, don't buy their gas). Reducing incentives to invest and save bothers me.
http://www.newsmax.com/archives/articles/2005/11/9/154053.shtml
Let's see how Lee distributes that 400 million to charities, but at this point it doesn't look like he's going to shape up as my paragon of virtue.
There will be calls for windfall profit taxes, but they tend to drag on after the windfall has blown through. If I were the COB of XOM, I'd be seriously thinking about cutting off the call for taxes by making a jaw-dropping donation to Katrina relief/NOLA rebuilding, like a billion dollars or so. They need NOLA rebuilt so they can have plenty of staff for their Louisiana infrastructure, and they get a tax deduction instead of tax increases that don't go away.
Does anybody think that, if shareholders were polled, there would be a consensus to donate, say, 10% of profits to some worthy cause? And, if so, do you think a majority of these could agree on what is worthy? Why not simply ask the shareholders themselves to donate? Some of these think they already have, through the taxes the oil company already paid plus the taxes the shareholder him or herself is about to pay - it might be worth noting that, without any new tax, the sum of taxation - federal plus state plus royalties, is clearly more than 50% of total net revenues.
Oh, wait -- we have those. They're called Gazprom, Transneft, Rosneft, etc.
Governments act in the interests of their constituencies, based on the entire array of government services. Therefore, they become instruments not only of "social good" but also of foreign policy, economic policy, etc. And when was the last time you saw a non-rigged election where more than, say, 70% of the people agreed on the direction of a company?
Thought experiment: Put the oil countries (the American ones, at least -- so take out Fina, Shell, BP, etc.) under the control of the Bush Administration (has to be executive branch; legislative branch was designed not to produce rapid consensus). They now materially support (not sell to, support) the Iraq War, the response to Katrina, ANWR, etc. Happy? I'm sure not.
That's why taxes are the way to go. Companies keep doing the company things, governments do the governmental things, and the two understand the relationships (yes, yes, to a point, to a point). Government can regulate, but not completely control. And, if there's a party in power that you don't agree with, you can still be pretty sure that you're not going to see the "Republican Discount Day" at ExxonMobil.
The current system may not always produce what I want, but that's better than the alternative.
We'll just have to reduce our dependence on their products. That'll get their attention.
http://www.resourceinvestor.com/pebble.asp?relid=12519
With exceptional profits sometimes come expectional losses.
The scandal here (still in April 2006) is that we gave those Energy Bill handouts, and now are surprised at the money they have.
See the most recent post Hurricanes and Global Warming - Is There a Connection?. And also, melting permafrost in Western Siberia is indeed an irreversible (but little appreciated) change.
Capital is also a limited resource. I worry that if we throw too much capital into arctic oil and tar sands to slow the post-peak decline, we won't have enough capital to still make the transition to whatever comes next. Whether you believe in Bush's cellulosic ethanol or Lovins' hyperefficiency or the Engineer-Poet's wind and zinc fuel cycle, there's a lot of capital that has to be spent (especially if you believe it will take all of those). It certainly seems possible that misallocation early on could preclude us from reaching a reasonable end state...
http://en.wikipedia.org/wiki/Global_dimming
db
My fear is that after Katrina, that even deep sea GOM is going to be considered risky investment.
When I ask my boss why oil companies are so conservative, he says it's because of what happened in the mid-1980's. That's when they had invested in non-crude alternatives, when price of oil crashed and they lost significatnt amounts of money.
So in that sense, NATION magazine is right. The oil companies can do us all a favor by taking risk (if assuming $40 oil is risky!) and investing in non-crude fuels now! Note this is not charity, since they are bound to make money, though perhaps at 20% ROI instead of 40%!
It is now more like $35 /bbl for planning purposes.
Dont forget, 17 out of the last 20 years have been very sluggish years and were hallmarked by industry layoffs and low investments.
It is what they will do with the money that will be important. Me? I would start up the Exxon Nuclear Power Division. Now give me my $ 400 million...
What happened in the mid-1980's?
OPEC opened the manifolds and flooded the world with cheap oil. This was a deliberate act of economic warfare intended to destroy any diversification into alternate energy or renewables, and to cut the legs out from under any non-OPEC producers.
Was OPEC successful? I know two colleagues who committed suicide after they discovered thier skills, hard work, and dedication meant nothing outside of the oil industry. You need to understand the scale of what occured. If GM fails the employees can go to another auto firm, or to similar employement in another sector. The oil industry has a great many specialized skills that do not transfer. Even when they do transfer the scale of industry undertakings is such that outsiders have trouble coming to grips with it. I know a former Training Co-ordinator who fought for a similar position outside the industry only to find the interview coming to a quick close after he described the extent of his responsibilities. His annual training budget was more than the annual gross earnings of the firms to which he was applying. Of course he was a "co-ordinator" and not a "manager." But this was in a firm where to hold the title of "manager" you had to have independent sole discretion signing authority for $500,000. And you didn't have to sign a damn thing; once you give your verbal committment the deal was done.
Was there any outcry over this destruction of a key industrial activity? Anybody raise a cry over all the rigs that got stacked and scrapped? Any concern with all the famalies that were impacted, torn apart? Heck no. Gas was cheap, life was good, and who cares if your neighbour takes his own life.
When your being is scarred in this fashion it will take some time before your intellect can convince you that it will not happen again. If you think the current generation of industry leaders too conservative and you want to understand the reason for that convservatism, then you have to understand the emotional and deeply personal impact of the 1980s.
I thought the high price of oil would represent a sufficient incentive to get oil companies to invest in new new exploration and research into exploiting very deep water and polar oil. I don't see why they need the current level of profit in order to do so (although I admit it can't hurt).
Also, I'm curious. What are the majors ACTUALLY doing with their record profits? My understanding is that these profits are not, for the most part, going into R&D and exploration budgets, but are being transferred to shareholders in the form of dividends and stock buybacks. But I heard this through the grapevine, so I'm wondering if anyone has the information to confirm it one way or the other.
Assuming for the moment that they are using the money to enrich their stockholders, then I don't see any problem with a windfall profits tax. That way the gov't could use the money to fund research into renewables or other alternatives.
Of course, that assumes the gov't will use the money wisely instead of purchasing some new cruise missles to fire at Iran.
Almost 70 wildcats have been drillen by various firms in the Barents Sea so far, and only one has found a marginally commercial amount of oil, contrary to expectations (some natl gas has been found).
I think the lack of drilling (for example in the purported oil-rich offshore Greenland per USGS) is a result of great uncertainty over new prospects and the enormous cost each represents in these challenging and remote areas. Consider that no drilling is done without very expensive preparation using the most advanced seismic tech available, and even so results are far from guaranteed.
The key variables in the model are estimated as follows:
- Wildcat Ratio: It takes a number of wells to identify and prove a prospect. Assume that 10 dusters are required for each gusher. Note that this does not refer to step out wells within an existing field. Modern technology may have improved this ratio somewhat.
- Cost per Wildcat. This value may show wide variation. For deepwater offshore the cost is around $50 million per well. For shallow water offshore and difficult mountain terrain the cost may be $25 million per well. The least cost may be as little as $2.5 Million.
- Prospect Size. The Royals have all been found. Most of the nobles have also been found. This means that what we have left to find is smaller pools of 300 to 500 million bbls.
Now let us build an exploration table.Period 1
Wildcat Ratio: 10 to 1
Cost per Wildcat: $2.5 Million
Prospect Size: 1,000,000,000
Discovery Cost per BBL: 10 x 2.5 = 25,000,000 /1,000,000,000 = 0.025
Period 2
Wildcat Ratio: 10 to 1
Cost per Wildcat: $25 Million
Prospect Size: 5,000,000
Discovery Cost per BBL: 250,000,000 / 5,000,000 = 50
Period 3
Wildcat Ratio: 10 to 1
Cost per Wildcat: $50 Million
Prospect Size: 1,000,000
Discovery Cost per BBL: 500,000,000 / 1,000,000 = 500
Plug in your own numbers. XOM drilled Mukluk. This was a billion dollar duster back when a billion dollars was real money. XOM could have saved themselves a big pile of money if they had just taken 3/4 of a billion greenbacks, dumped them in the parking lot and burned them. Drilling the actual well cost them an extra 250 million they could have saved by just having a big bonfire.
That's just the way it's got to be, if we want price to be our regulator on world consumption.
Now, I guess we could blue-sky a global allocation/rationing system, but I don't see that being politically possible for decades.
In the meantime we do have the ability to choose, a bit, who gets to make the profit on that inexpensively produced oil sold at high market prices. We can let the oil companies here and abroad have it (under the assumption that everyone's pension fund owns oil stocks so it's all good), or we can decide that society (through government and taxes) should grab a bit.
You can grab a bit in import duties, gas taxes, or windfall profit taxes - but once you decide to do it those are just details.
(I think the Europeans, and others, who have "prepared" with existing high gasoline taxes chose the right path. It's left to us to catch up in America, one way or the other.)
Having said that, if we believe in peak oil, then at some point all these profits become pure windfalls, because all the profit in the world will not induce E&P spending if companies feel that no oil is to be found at costs below those that would lead to demand destruction if they were passed on to consumers. Of course I don't pretend to know when that point is. Simmons extensively discusses this point in "Twilight in the Desert."
The larger point is that having long since left the stage where we take care of each other in villages, the need to care for each other, for the weak to take care of the strong to preserve community is still there. Under the ruling Republican philosophy, community only extends to to those who can pay for all their own needs, the rest are excluded. We give lip service to this need for community but it really does not matter except perhaps as an afterthought. IN NOLA we may be finding out where the limits of this philosphy are.
As long as we depend so heavily on the profit motive (and for the moment, gioven the failure of socialism, we seem to have no obvious alternative) there are bound to be heavy costs to society which economists will fail to measure. We are seeing what the ruthlessly competitive society of Economic Men and Women looks like and we have not yet figured out how to live with the consequences.
- Kehlog Albran, The Profit
In all seriousness, the possibility of "windfall" profits is one reason people invest in ventures. If you tax them away, you won't get as much investment and you'll have even less supply than the problematically-low levels we've got.
Let the oil companies make money now. All that money going to them is the one thing that's going to get free actors to conserve, switch to other supplies, and do the other things required to bring oil consumption down.
.. and Pay off more PR companies, Scientists and 'Biostitutes' to misguide the public away from solutions that are really good for the public, like LA's Public Transportation, or knowing about Global Climate Change. SS said that the deep-sea finds and use of other 'big-project' fields will soften the blow of PO, but that's only if it's not handled the way it is now, ie, Business as Usual.. Consume-mass-Quantities, the Market and Science will assure smooth sailing.. to The Island!
EXXON's Mission; To Serve Man
.. with fava beans and chianti.
Couldn't agree more.
Should GOOG be subject to a 'windfall' profits tax? After all, they are making nearly pure profit from their ad biz. Investors who got into this stock are taking a big risks in hopes of making those 'windfall' profits.
Additionally, during the lean years, did oil cos get a special windfall loss tax credit? Nope.