As I understand it, the profitability of oil companies is strongly correlated with the price of crude oil. Oil compaines made huge profits during the OPEC embargo of the 1970’s, only to see them diminish in the 1980’s when crude prices fell.
Why does this relationship exist? Why should an oil company’s profit margin increase simply because the price of crude has increased, or vice versa??
Thanks.
I believe the short answer is that the Oil Companies use hedging. In other words they can use the financial markets to manage their exposure to the risk of prices swinging.
Example:
Today’s Oil price is $30, OC can sell it for $40 at the pump, OC makes a nice $10 profit.
OC pays $1 to guarantee a $30 price for the next year, and anticipates selling it for $40, forecasts a $9 profit for Tomorrow’s Oil.
OC is therefore hedged against a price rise because they have locked in a $30 price for Tomorrow’s Oil.
Tomorrow, the Market price rises to $35, so of course OC raises their pump prices to $45.
OC pays $30 + $1 hedging fee for Tomorrow’s Oil as per the contract, charges $45 for it = Profit of $14.
Of course if they didn’t hedge against a downward price move, then:
Tomorrow, the Market price falls to $25, so of course OC has to lower their pump prices to $35.
OC pays $30 + $1 hedging fee for Tomorrow’s Oil as per the contract, charges $35 for it = Profit of $4.
BCE
In general oil companies pump oil out of the ground. If they can sell this oil for more they make more money. I don’t really think that there is much more that needs to be said about this.
Nope, nothing to do with hedging which is not done by the majors/supermajors as a rule - only the province of exploration and production (“upstream”) independents who are highly exposed to oil price movements.
It is simply to do with the economics of the upsrtream projects they have invested in have an inelastic (ie tending toward fixed) lifting and transportation cost so when the spot market oil price increases (elastic demand) they pocket the difference - a higher profit margin. It works the other way around too - so the majors tend to be conservative with the oil price assumptions they use to justify and finance those projects. The smaller independents often use more aggresive assumptions together with hedging hoping to make up the gap by being able to move faster than the dinosaur oil majors.
There is also the factor that the majors tend to be integrated companies - involved in production but also refining. Refining margins tend to reduce when the feedstock price goes up but cannnot be passed on as economic activity (demand) tends to fall when foreseeing higher products prices.
Different majors have different splits between exporation and production (upstream), refining and marketing (downstream) and maybe chemicals (dog of a business). For instance Shell had always been net buyers of crude, having a strong Asian refining position. This benefited them in the past in the 1980s with low oil prices and booming Asian demand for products. Contrasted to BP who were always more E&P focused…
If I understand the OP correctly, then this doesn’t really address the issue. When the OP asks about the price of crude, I assume that means that the cost to the retailer is going up. If the cost is going up, why should the profit necessarily increase?
Now if the company pumping the oil is the same one that dispensing it at a service station, then that’s different.
Ah! Is it a matter of terminology? A petrol retailer may or may not be an oil company. Retailing of petrol is part of “downstream” usually bracketed with refining. Petrol (gas) retailers make no money on fuel no matter what the oil price - they make it on newspapers, soft drinks, cigs and sarnies…
You last sentence nails it - I refer back to my first post above.