How can the oil companies profit?

I don’t understand this statement from the linked article,
“Surging oil prices don’t hurt everybody in the United States. Oil companies, for example, stand to gain. In 2008, Exxon Mobil Corp. earned $45 billion — a record for a U.S. company — after oil prices hit a record $150 a barrel.” On page 2.

Why does the price of gas go up, yet they make a record profit? Is it greed? Obviously, rising oil prices don’t hurt them.

Maybe I’m misunderstanding. They make more money because they’re selling their product for more money. Production costs don’t increase with the price of oil.

Your typical oil company is vertically integrated, i.e., they run the whole process from well through refinery to pump, So an increase in price does not mean an increase in costs.

Although if the price goes too high, demand drops and less of their product is sold.

Yes, but with the sorts of prices we have been experiencing, demand is very inelastic.

Do you think that they should lower their prices? Why would they want to do that, other than to be nice to us?

Greed, for lack of a better word, is good. – Gordon Gekko

This is a repeat of an earlier thread. Many oil companies OWN their wells, so they pay royalties etc. but essentially they take the oil out of the ground for free, and make it into gasoline, WD40 etc. and sell that for the going rate. When the rate is going high, so are profits.

The price of oil is based in part upon speculation of what the availability and price will be in the future, it is a lot like gambling.

Say I’m an oil broker and I need 1000X barrels of oil to supply my customers for the next 6-9 months. If prices are low and I don’t think they will go much lower I will lock in a contract for 12 months at the price of, say $80 bbl. I will buy as much for as long a term contract that I can. Sellers in a stable market will offer longer term contracts and in an uncertain market will shorten the terms.

But then something happens to worry the market. Unrest in Egypt, war in Libya, rhetoric from Venezuala, whatever the issue. Buyers start getting nervous that the supply might not be there 8 months from now so they pay $90 to lock in a supply for their customers. Maybe even on a short term contract of 5 months. Others who have waited start to panic and buy at $100, $110, etc and the future supply gets locked up in contracts at an artificially high price.

Then the crisis all blows over and nothing ever did really happen to affect the supply of oil or change the demand. But the cost of gas is now much higher because the price of oil was bid up/bet on and indeed does cost more for the user.

For no reason at all.

And all during this speculation the cost of getting the oil out of the ground never changed.

Saying that companies essentially take the oil out of the ground for free is unbelievably ridiculous. You may as well say that Apple owns the patent on the Iphone so they get the product for free as well. Even if you want to disregard the leasing costs, and costs to drill a well, there are still significant ongoing operating costs to produce the well.

Also, while there may be petroleum products used in the making of WD40, that is not made by an integrated oil company. Again, to draw an absurd analogy, you might as well say that oil companies make corn since oil is used in the production process there as well.

So, if the cost of oil is not a big factor, then I am paying $3.69 a gallon (for now, soon to go up) because Exxon wants to charge more and increase their profits?

It’s not for no reason at all. It was uncertainty of the future price of a highly volatile commodity that caused the run up.

Not true. Service companies are likely to increase their costs resulting in higher Finding and Development costs and higher operating costs. Also, land leasing costs are liekly to increase.

But these costs don’t chance with the cost of a barrel of oil, or the cost of a gallon of gas. If the cost of oil goes from $90 to $110, the oil companies just pocket an extra $20/barrel (I assume minus some taxes.)

Except at the time, the situation DID change. They legitimately thought prices were going to be higher and they hedged. If you were a plastics company who had a broker who prudently hedged your oil at $90, and then oil ran to $150, would you be critical of the $90 purchase?

Very incorrect. It’s getting tougher and tougher to extract oil and gas - consider the oil sands and off-shore drilling. Part of the expense of extraction is also reflected in increasing fuel prices / barrel of oil, but it’s not the only reason they raise it.

And it’s not oil and gas companies that control the cost of a barrel of oil, it’s OPEC (if irc).

Oh, nevermind, it’s not OPEC anymore, it’s international oil markets and supply and demand.

Heavens, no. It’s because a bunch of insanely wealthy people in the Middle East wanted to charge more and increase their profits.

No, you are listening to completely uneducated people give completely incorrect information. Exxon does not make any meaningful money on the retail sale of gasoline. They make money, predominantly on the sale of oil, natural gas, and the refining of oil. If the price of oil rises, their profit margins are likely to rise as well considering how much of their business is related to the production and sale of crude oil. The price of oil is obviously a big factor in the price of gasoline. Exxon has very little to do with the retail gasoline selling business. That is predominantly done by franchise owners. Their profitability is usually negatively affected by the rise in the price of gasoline as their profit margin per gallon sold usually declines and the units sold usually decline with a rise in the price of oil. Of course it is not a big impact for them though because they are primarily in the convenience store business simply using the sale of gasoline to draw people in to buy drinks and snacks and other stuff.

What is confusing you is the integrated aspect of the major oil companies as well as the fact that their name may be on the gas stations that you see. Break up the industry into its major component lines of business and it will make much more sense.

You have the exploration and production companies (upstream). These are the companies that actually produce the oil and natural gas, and natural gas liquids by either drilling wells or buying already producing wells. Obviously it is easy to see that a rise in commodity prices benefits them.

You have the transportation companies (midstream). These are the companies that own pipelines and transport the oil or natural gas that is produced by the E&P companies to refineries and gas processing plants. They may or may not stand to gain with a rise in commodity prices. Usually they try to operate in a manor that leaves them insolated from price changes so their profitability is based primarily on the volume they transport. This may be accomplished by the contracts they have in place to transport the throughput or by hedging.

You have the refineries and gas processing plants. These are the companies that turn the oil into useful products such as gasoline, jet fuel, diesel, asphalt, tar or they strip the natural gas liquids like propane, butane, natural gasoline, isobutane, etc from the natural gas. They may or may not make money with a rise in commodity prices. Often times a rise in the price of oil hurts refineries as the cost of the product they buy (oil) has risen while the demand for the product they sell (gasoline etc.) has fallen. They’re margins have squeezed. The margin of refineries is called the crack spread, and the common crack spread to look at is the 3-2-1 crack spread. This margin difference between buying three barrels of oil, and selling two barrels of gasoline and one barrel of fuel oil. This is an overly symplistic way of looking at refinery profitability, but it gives you the basic picture. Refineries were significantly hurt by the run up in oil prices in 2007 and 2008 as their crack spread significantly fell. Many refineries were in very poor financial shape during that time.

You then have the companies that sell and distribute the end products from the refinery process. These companies usually are hurt by rising commodity prices as the demand for their product decreases.

Then you have the small retail sellers of products like gasoline. These guys usually never make much money. They many times are more of a real estate play than anything else. They really might make good money if they own the land that the gas station is on and it becomes more valuable. Beyond a cash windfall from something like that they usually operate at a very small profit with most of that coming from the sale of items from the convenience store.

The term downstream is used to refer to the sellers and distributers of the products. Many times refineries are also lumped into that group. Sometimes people use downstream to refer to the essentially everything but the upstream segment.

Of course their are also service companies that specialize in various theings. For example, you could have a company that specializes in selling pipe to the E&P companies. You could have companies that specialize in the actual drilling operation. You could have companies that handle hydraulic fracturing. There are all sorts of different jobs that get lumped into the service industry. These guys make money when people are using their service not when commodity prices go up or down.

Of course their are other somewhat related industries like the chemical industry.

There are big companies at each of these different levels that are not integrated. On the upstream end you have huge independent oil and gas producers like Anadarko, Apache, Devon, EOG, Occidental, Chesapeake. On the midstream end you have companies like Enterprise, Kinder Morgan, Oneok. One the refining end you have companies like Valero and Marathon.

The major oil companies like ExxonMobil, BP, Conoco Phillips, Chevron Texaco, Royal Dutch Shell are integrated meaning they operate in more than one of these segments. Exxon is a huge upstream company that is also a huge downstream company. They also have a chemical group, alterantive energy group, and a host of other random stuff. They are just a big diversified energy company. They make most of their money on the upstream and refining end. These guys may also have their name on the local gas station you use, but that does not mean they own it. For example, BP owned none of the gas stations in the U.S. that had the BP brand on it. If you don’t like Exxon and think that boycotting their gas stations is a good way to not give them any of your hard earned money, you are wrong. They likely do not own the gas station and you are only hurting the little guy who owns the station.

You also have the big national oil companies like Aramco (Saudi Arabia), CNOOC (China), Pemex (Mexico), Petrobras (Brazil), Statoil (Norway), ENI (Italy), Gazprom (Russia), etc. These are obviously just state run oil companies. They are primarily in the upstream business.

Saying the term oil company doesn’t really mean a whole lot. You could conceivably call Exxon, Halliburton, Apache, Valero, Aramco, or the thousands of small companies in each of these lines of business “oil companies”, but they are completely different and make money in completely different ways. It is sort of like using the term banker to mean the teller at your branch, the mortgage officer, the large corporate lender, the derivatives trader, the investment banker, the back office HR person, the CEO of JPMorgan, the mutual fund salesman in your local branch, etc. You might technically be correct in calling them all a banker and they might refer to themselves that way, but it is at that point a pretty meaningless descriptor.

That’s not true at all. Operating costs usually rise on a per barrel of production basis as oil prices rise. I’m not saying they don’t make more money with a rise in prices because they obviously do, but all of the service companies usually raise their prices as well when oil prices rise. Look at historical lease operating costs per barrel of production, and you will see a correlation with commodity prices.

Wow, what an excellent explanation LonghornDave! Thanks!

Explain why they decided to let the price of oil go from the $140s in June 2008 to the $30s in December of 2008. Did they just decide they didn’t need to be wealthy any more?