What do you think the R&D costs are based on those reports? The line is blank, but there certainly are some. I used to live near the Mobil R&D center, which was quite big.
However their SG&A costs are tiny compared to revenue. But that isn’t R&D. Even if all the Other was R&D (unlikely) that is still a smaller percentage than high tech companies.
Would R&D costs scale with oil prices? I don’t see it. That means profitability increases at a higher rate than base prices, just as one would expect giving increasing prices and roughly constant margins.
It wouldn’t if there was significance price resistance, but that doesn’t seem to be the case, at least in the short term.
It is extremely common to mitigate the risk of downside price movement through hedging.
It is correct that there is high operating leverage in exploration and production, so for your average company, you are correct to state that higher prices should result in more profit. You are exaggerating the effects, though. Expenses have risen drasticly in recent years. Everything from land costs, to insurance, to rig rates, to fuel costs, and employees costs have risen. I could come up with a list of dozens and dozens of companies that have not seen any increase in profit margin in the past couple years.
Regarding your second thought, it is common for volumes to increase due to higher prices. For example, rising prices may cause a producer to produce from a different zone that would ordinarily be uneconomic. Rising prices can extend the life of wells. Additionally, you may produce in new areas using more expensive technology when prices rise. Some of the unconventional gas reserves in the U.S. are the perfect example of this. The shale plays (Barnett, Fayetteville, New Albany, etc) are groing in importance because rising natural gas prices (and improved technology) have made it economic to produce. The rising prices haven’t necessarily increased profit margins so much as made it economic to go after more expensive reserves.
Just like many other financial ratios and statistics, comparing profit margins from one industry to another is meaningless in many cases. Even in the same industry it sometimes doesn’t provide much. Since we’re talking about the oil and gas industry, I’ll make a comparison. You might have a producer who does nothing but produce small, low risk, 100% success rate type barnett shale wells. He’s never going to hit a big well and he’s never going to have a dry hole. His goal is to have a large land position and a manufacturing type program. Drill a lot of wells, keep expenses down, and make money by volume. On the other hand you could have an offshore Gulf of Mexico producer who might do well to have a 70% success rate. The costs per well are enormous. A single well can also be a company maker if highly successful. Since they are taking greater risks, you would hope that they can have a higher profit margin on average.
But that’s taking the possibility of a decrease in price into account, isn’t it?
But many of these, except for fuel costs, would have gone up no matter what the change in oil prices was. Going from a potential loss to a profit counts also. Many people would find it ironic for a gas company to complain about rising fuel costs.
I was actually talking about demand, and I think I mentioned that rising prices would cause more production. Without a cartel involved, rising prices should in general cause more production, which would increase inventories, which would drive prices down. While it is improper to blame oil companies for rising prices, which are driven by suppliers, they certainly benefit from them.
If the purpose of a windfall profits tax was punitive, I’d be against it. If it was used to fund the appropriate research, and perhaps to ease the impact of higher prices on those who could least afford them, I’d be for it. However it doesn’t immediately encourage conservation, so I’d be more in favor of a higher federal gas tax whose revenues would be used for research.
It is possible to conserve - as I mentioned, California has decreased oil consumption with a rising population no doubt due to high gas prices.
Yes, my point was that you can make an acquisition at today’s prices and mitigate the risk that prices fall through commodity hedging. You can not easily mitigate the risk that the government will change tax laws.
I disagree and believe that these increases in costs are both correlated and caused by the increase in commodity prices. The exception to this is probably insurance costs, which mainly rose due to the storms. Rising prices increased domestic activity, which caused the demand for service companies to increase.
Also, I’m not saying that oil and gas companies were complaining about rising commodity prices because of the impact in fuel costs. I’m simply stating the fact that they increased, which means that expenses weren’t a constant.
It is my opinion that when politicians like Clinton talk about a windfall profits tax, they are somewhat meaning for it to be punitive. Well, maybe punitive isn’t exactly the correct word, but I believe she is preying upon the negative public opinion that oil and gas companies have in many American’s minds. She is essentially saying that these evil oil companies make so much money off of Americans that they need to be punished by paying more in taxes.
I agree with you that higher gasoline taxes would be a more effective way to encourage conservation and fund research into alternative fuels. I do not agree with the concept, but I think it would be more effective than a windfall profits tax.
Please cite data on number of refineries and their capacity over time in support of this claim. My dim recollection is that the oil companies over the past couple of decades have been busily shutting down refineries to keep profit margins high.
Triple of what? What scale are we talking about, compared to their profits?
I haven’t checked the details of her proposal, but a windfall profits tax would by definition only cut in after a certain level of profitability. So I don’t see why it would affect them. A gas tax would only impact oil prices indirectly, and so would be covered by the hedge. If they increased the base tax rate, then there would be an issue, but that wouldn’t make any sense.
Expense rise for all companies. I know they aren’t complaining, but a lot of the increase in commodity prices is a function of the price of oil, so these companies, unlike most others, at least get something out of it.
In the late '70s, the tax was definitely punitive, since I don’t recall any plan to use the money to reduce our dependence on foreign oil, or for alternatives. To a certain extent the idea of a windfall profits tax only comes up when there are windfall profits, which is exactly when people are pissed off at oil companies, so it is probably hard to separate punitive from valid reasons.
As far as I know, there have not been any details released, so it is very difficult to talk about specifics. In general, I do not see how a windfall profits tax would ever work.
I think that most people would agree that using profit margin as opposed to net profit makes more sense. As is commonly brought up, the high dollar amounts of profit for the major oil companies is more a function of their size than huge increases in their profit margins. As was brought up in this thread, the profit margins of the majors are not out of line when compared to other industries (although I personally do not think comparisons of these types are meaningful).
Neither net profit nor net profit margin are good indicators to me of the real “profitability” of a company anyways. Maybe it is for some mature companies but not for all. For example, let’s say a company sells their properties and records a big gain on sale of assets resulting in a high net profit and margin. You might think that they should be able to pay a big tax bill, but what if all of the proceeds from the sale were needed to pay off the company’s debt leaving no cash left over? A high tax on this type of company would seem somewhat unfair to me.
Another concern I have is which companies would be subject to this tax. I realize that when people think of oil companies, they think of BP, Exxon, Chevron, and Shell. This is simply a problem due to a lack of knowledge about the industry. There are thousands of companies that are in some form in the oil and gas industry. Surely the tax would not only impact the majors (of course BP and Shell aren’t even U.S. companies). The majors are large integrated companies. They are active in many different businesses. Would the tax only affect large integrated companies? Would it instead affect anyone that has upstream exposure? Would it also affect midstream, downstream, and service companies?
Would the profit margin number that triggered the higher tax rate be the same even for different types of companies? Midstream companies can be enormously successful but have a lower profit margin than an upstream company simply due to the nature of the business. Profit margins are not comparable from one type of business to another.
I see no workable way to address these problems.
I think the reason this even comes up is the amount of profit coupled with a “virtue” issue. Say the refiners figured out a way to refine for 1/10th the cost they do today. That should result in a big increase in profit margin, but I doubt there would be any call for a windfall profits tax. People are usually happy to let companies keep profit that is the result of innovation. If a company found a big new field, ditto no doubt.
The problem with the majors is that their increased profit is not a result of innovation on their part. With the same margin, thus with no change in process, they have made a lot more money solely (or primarily) from an increase in prices from their suppliers. In most cases (like in groceries) this would lead to a decrease in sales, so it would be self-correcting. However oil is inelastic.
There are two causes. The first is OPEC setting prices, which we can’t do anything about. The second is the growing use of oil by China and India, creating a scarcity situation. The only thing we can do about that is to consume less, and like I said we can finance research into ways to reduce consumption.
If the majors had reduced their margins to keep profits more or less constant, there would be no call for a windfall tax. I’m not saying they were wrong to take advantage of the situation, just that it might come back to bite them.
This is not a good analogy, since the profits came from action by the company - and anyhow usually gets treated differently, by being separated out as an exceptional item.
Which of these are experiencing windfall profits by selling an inelastic product? I used to own stock in a company that build oil platforms. They did somewhat better in a boom, since there was more call for exploration, but since there was price pressure and competition, nothing like the majors.
I work in the computer business, and margins on sales (not profit margins) would make oil companies drool - 40 - 50% are typical. Profit margins are not nearly so high because of the massive amounts of R&D it takes.
It’s called windfall profits for a reason. Just like a windfall, the extra money fell into the hands of the oil companies without them doing anything new. I think a lot of people see the excess profits coming from the pockets of the American public who have little choice but to pay. Now I don’t have a lot of sympathy for the SUV owner, but I have a lot more for the little guy in a little car who is still getting screwed.
You can say whatever you want, but your analogy would be similar to Intel claiming that finding computer manufacturers to sell their chips to is R&D. Oil company R&D expenses are public knowledge, and are tiny. Here is a link that shows what Exxon reports. 1/3 of 1 percent. Intel on the other hand, had R&D costs of 15 percent. Considering that my response was to John Mace, who said they had R&D expenses like IC companies, I’ll let the numbers speak for themselves.
If you think major oil companies spend 15 (or 10, or 5) percent of their revenue on R&D, feel free to bring cites.
Yah? how’s that been working out so far? Consumers have been bitching about gas prices since the early 70’s.
Well, if you’d prefer, I’ll happily use actual profits in dollars, but that won’t generate much sympathy for the oil companies. At least in profit margins, they’re not at the very top. Again, as in my previous response, you need to actually note that I’m responding to points people are making. In this case, Magiver’s claim that they made “nominal” profits. If you wish to use a different metric, why don’t you tell us how we should judge their profits?
If they have higher profit margins on average, then they’re not taking a greater risk. In reality, I’d expect both to have profit-margins in similar ranges on average. The first would do so fairly steadily, but the second would have large ups and downs, with an average about the same as the former over time. If the latter behavior resulted in higher-profit margins over time, everyone with a decent wad of starting capital would go that route. To make sure we’re on the same page for future posts, do you have a different definition of “average” than I do?
Out of 51 industries, the following 31 rank below Exxon and friends in profit-margins:
Industrial & Farm Equipment
Homebuilders
Hotels, Casinos, Resorts
Utilities: Gas & Electric
Beverages
Chemicals
Computers, Office Equipment
Electronics, Electrical Equipment
Apparel
Telecommunications
Food Consumer Products
Aerospace and Defense
Health Care: Insurance & Managed Care
Packaging, Containers
Wholesalers: Diversified
Health Care: Medical Facilities
Specialty Retailers
General Merchandisers
Health Care: Pharmacy and Other Services
Food & Drug Stores
Airlines
Energy
Information Technology Services
Engineering, Construction
Pipelines
Wholesalers: Food and Grocery
Wholesalers: Electronics and Office Equipment
Automotive Retailing, Services
Wholesalers: Health Care
Food Production
Motor Vehicles & Parts
If petroleum refiners have nominal profits, I wonder what those other industries have.
I think it’s a perfect example. First of all, you are incorrect that a gain (loss) on sale of assets is stated as an exceptional item. Perhaps you are thinking of a income (loss) from discontinued operations. Gain on sale of assets is usually treated as operating income (but not revenues). For an example look up the 10Q for Pogo Producing Company from 9/30/07 (note that this particular company had a large gain from the sale but actually posted a net loss so it is not a perfect example). This can be found on either edgar or 10K Wizard. To your bigger point, the profits did come from action by the company and not simply higher commodity prices. I certainly agree. How exactly would a windfall profits tax, presumably on all domestic upstream producers that made above a certain profit margin or above a certain profit, take into account how much of the profit is due to actions by the company and how much is due to benefitting from higher commodity prices.
As with most issues here, this is not an easy question to answer. In general, I would say that upstream companies have benefitted the most. However, depending upon how the contracts are structured some midstream companies, they could receive the type of impact you are talking about. For instance, if a midstream company has a natural gas processing plant and the way their contracts are structured gives them the ownership of the NGLs (natural gas liquids), which are somewhat correlated with oil prices, then they have benefitted due to increased prices. In general though, midstream companies are usually fee based.
The fact is that most companies have either directly or indirectly benefitted from higher prices. Rig demand, for instance, has increased dramatically in the last couple of years. They have raised their prices in response.
Upstream has received the bulk of the benefit though. Of course I can name many upstream companies that have not done well in recent years. I can even name companies that are hurt by rising commodity prices that our in the upstream end.
If the purpose of the windfall profits tax is to charge a tax on profits gained through no credit to the company and entirely by rising commodity prices, then I would think it would be an incredibly difficult exercise to single those companies out.
If a company, through research and testing, determines a new methodology for producing a type of well that is more economic and efficient, how is that not analogous to research and development? I fail to see how your analogy about Intel finding a new manufacturer to sell their chips to is in any way similar to, for example, an oil and gas company through testing and research learning that by using a multistage fracture stimulation technique on multiple horizontally drilled wellbores they can extract natural gas from an area that was previously thought to be uneconomic at today’s prices.
The greater picture that you fail to realize is that both accounting and financial statement analysis are in many ways more art than science. In many cases it is unclear how something should be categorized.
I won’t pretend to tell you what percentage of expenses are R&D in nature for energy companies versus any other industry because I do not believe the factual answer is possible to be determined.
You are misunderstanding me. I think that profit margins are a perfectly good ratio to help determine how profitable a company is as long you are comparing it to another similar type of company. I don’t think it has any meaning at all when comparing accross industries. Similarly, I think that Debt to EBITDA is a great measure of leverage. It would, however, be stupid for me to compare a company that primarily earns their EBITDA through offshore exploration and production with a ratio of 2.00:1 to a pipeline company with a ratio of 5.00:1 and say the offshore company has better leverage. Why? Because the life of an offshore well may only be 3 years and the life of the pipeline may be 30 years. You may as well be trying to use tackles to determine who is a better football player between Randy Moss and Adrien Peterson. It shows a basic lack of understanding of financial statement analysis.
I will only politely tell you that you do not understand the fundamental nature of risk versus return. Out of curiousity, which has greater risk, an FDIC insured certificate of deposit or an investment in the stock market? Which has greater returns on average? How do you reconcile the results of these questions with your personal risk/return understanding?
Just to help you out again, please realize that it is incorrect to categorize Exxon as a petroleum refiner. They are a major integrated energy company. When comparing their financial performance, you should compare it to other majors. A petroleum refiner would be someone like Western Refining, Inc. Exxon has upstream, midstream, and downstream business units. You may as well be calling Walmart an electronics store. There would be some truth in your comment because they do sell TVs, but it would not make much sense to try to compare their financial statements to Home Theater Store.
Here’s just a few examples:
$7 Billion expansion at Motiva
$2 Billion expansion at Total SA
$3 Billion expansion at Marathon Oil
As for engineering costs, due to the demand for experienced design engineers their pay rates have increased from the mid $30’s up to $90/hr for those with experience on certain CAD systems.
Is gas even more expensive today than it was in the 70s after adjusting for inflation? I doubt it, and even if it is, it’s been made up for several times over by increased fuel efficiency across the board.
We’re actually seeing a trend right now toward more fuel efficient cars in the USA. Do you think that pressure from the cost of fuel isn’t driving that trend at ALL?
I think you can easily define a few indicators. For one thing, the entire segment must move (or almost the entire segment.) Second, there must be a link to a specific commodity. Third, there must be no evidence of significant improvements in manufacturing processes.
I agree that a generic windfall profits tax would be hard to implement, but what was proposed a while ago was a very specific one for a specific industry, so these questions can be addressed during debate on the bill. I don’t recall exactly which types of companies were targeted by the laws proposed 30 years ago, but I think that below a certain amount of profit the overhead wouldn’t be worth it, and the political support wouldn’t be there.
The elephant in the room is the majors making billions of dollars additional profit purely from a rise in commodity prices. A punitive tax might address all companies making money off the rise in commodity prices, but a tax for the benefit of research wouldn’t bother, since small companies making small profits wouldn’t contribute much to the funding.
For both of you - I don’t understand how profit margins and risk are related. Rate of return on investment, as in your example, and risk certainly are. Is Microsoft at significantly more risk than your neighborhood grocery? Their profit margins are very different.