Why the big profits for oil companies?

Factual Questions
21

I hit submit too quickly.

So here’s the way I look at this, and why I still think that there’s a type of collusion in play. I’m going to be using hypothetical numbers for illustrative purposes. When gas was $2.00 a gallon at the pump for a reasonably long period, let’s just say that after all costs, the average gas seller was netting $0.20 profit per gallon. This was achieved by paying $1.50 per gallon wholesale for oil and $0.30 for fixed costs, variable costs and overhead.

At this point, in a competitive marketplace, it would have been impossible to raise the price of gas without losing customers (and sales volume). When the wholesale cost increased to $2.30 (due to the higher price of the natural resource), the new “natural” price at the pump should have been $2.80. This would have yielded the same profit of $0.20 per gallon. But since customers were now forced to pay more at the pump, and since they really don’t have a way of distinguishing between the resource costs and the operating costs, it was an opportune time for the gas seller to bump up it’s profit by charging $3.00 at the pump. But the problem was that every gas seller had to do the same, or it just wouldn’t work.

So, a few sellers started posting a $3.00 price, while some others stuck to the “natural” $2.80. At this point, the $3.00 sellers should have dropped back down to $2.80 in order to compete. But they held their ground, knowing that the $2.80 sellers would soon join them at the higher price. This is collusion.

22

Another reason is volatility. The higher the volatility of crude prices, the larger “cushion” they place in their margins.

23

A quick question: take an oil company like EXXON/MOBILE; they have substantial oil deposits that are non-Opec. So they get crude from two main sources (OPEC=$70.00/bbl) and non-OPEC (say at $30/bbl). I’m sure they charge the OPEC price and pass it on to the customers…so the huge profits are no mystery. Now, suppose a new oilfield comes on-line-production cost is $12/bbl-will they ever reduce their price? No way-they will price everything at the OPEC/monopoly price.
I hear Russia is rolling in money-they are raking in more than $500 million/day.

24

Well, they should. The historical cost of oil has been $20-25 (adjusted 2005 dollars), a price that remained consistent from 1865-1972 and then from 1986-2001. Cite.

However, what most don’t realize is that most oil fields have become nationalized since the 1920’s, starting with Mexico - in 1972, Exxon used to primary produce 5,000,000 barrels a day pre-OPEC, a number that declined by 2/3rds over the next 20 years as they lost their concessions, to 1,700,000 barrels by 1995 (Cite (PDF)), increaseing to 2,500,000 barrels last year (Cite, page 86).

So the argument that they “make” all the oil they produce isn’t correct, nor is the implication that their out-of-well costs nears $0. For example, excise and use taxes are based upon the market price of oil, not on the production cost. So even if XOM produces oil at $12/barrel, they still have to pay taxes on the market rate ($70).

25

[QUOTE=ralph124c]
Now, suppose a new oilfield comes on-line-production cost is $12/bbl-will they ever reduce their price? No way-they will price everything at the OPEC/monopoly price.
[/QUOTE]

Oil is a commodity. That oil is worth $70/bbl, regardless of how much it cost to produce. Once it’s out of the ground it’s exactly the same as all other oil and should be priced accordingly.

And it’s not like that oil has no impact on the price worldwide. If enough new oil sources are found, the supply goes up and the price goes down.

26

What Telemark said.

It’s all supply and demand. It’s $70 a barrel because that’s what people are willing to pay for it. It doesn’t matter what it costs to produce. We just happen to aware of the raw material cost in the case of this commodity and it makes people upset It isn’t usually so clear in commodities such as orange juice or toliet paper or bacon.

If people will pay $70 today, the companies will ask $71 tomorrow and more the day after until people say they don’t want it that bad or someone has a better deal. Collusion occurs when the companies all say they want $74 and won’t budge on the price because they have agreed on the selling price in advance.

27

Osip as already described how inventory is purchased forward to maintain a specific rate of profit and what kind of net profit oil companies normally make (as a return on investment).

To anwer Shadowfyre’s original question about the recent big profits for oil companies it’s simple, they don’t exist. I was watching broadcast TV during the week of peak gas prices when they announced record profits for Exon (pretty sure it was Exxon). In the same report they went on to say that the company fell short of their projected profits and the price of the stock went down. They said this with a straight face. That means they either didn’t understand what they had just reported on or they were sensationalizing the news.

The term “record profits” is a meaningless term unless they are referring to rate of return. Example:

Exxon generates 5.5 billion dollars in sales and incurs $5 billion in expenses (500 million dollar net profit or 10% return on investment). The next year they generate 6.54 billion dollars in sales and incur expenses of $6 billion ($540 million net profit or 9% return on investment). It’s a record net income for the company because $540 million is greater than $500 million. However, their profit margin went down (9% return on investment vs. 10%).

28

[QUOTE=EvilGhandi]
The candy bar salesman analogy helps to explain (though not entirely accurate).

Candy bar salesman buys his bars for a $1.00 each and marks them up 10% selling them at $1.10 each, for a profit of 10c per bar.

Suddenly the price of cocoa skyrockets, causing his cost per bar to be $2.00 with a ten percent markup they are now $2.20 per bar a net profit of 20c per.

This increase can cause an actual loss in profit because even though the candy bar guy is making 20c per bar he is selling far fewer bars.

But our candy bar guy is in luck, his primary customers are serious chocoholics who will buy the same amount of candy as before.

His biggest problem is money to buy candy, he needs twice as much so he has to hit up a couple of friends all of whom want money back on their investment. When he tells them he can give them back $1.08 for each buck, many of them laugh at him and give their money to the guy who sells coffee for $3.00 a cup.
Probably not all that helpfull.
[/QUOTE]

Well it helps me segue into the other sources of profit for the oil companies. For our domestic market at least, more profit is made selling candy bars and soft drinks at the convenience store portion of the gas station than by selling gasoline. At least, that’s what the guys over in Retail brag about. If every third customer comes in to buy a Coke, a lottery ticket, cup of coffee, donut, beer, maps, motor oil, air freshener, and so on, the gas station is making a killing on the margins there.

Energy companies also engage in oil and natural gas trading on commodity markets. The traders buy and sell all day long, and they ALWAYS make money. Even if the price of oil is going down, they will sell short and still make money. As long as there is activity in the markets, those groups will prosper. So it’s not just as simple as pumping it out of the ground and selling it, there are lots of ways to make additional profits along the way.

29

Guys and Gals,

Mr. John D. Rockefeller learned way back that ALL the profit was in the refining end of the business. I bought oil for 22 cents a barrel (42 gallons) and turned it into something like 19 gallons of gasoline, 4 of kerosene, 3 of fuel oil, 2 of lubricants and the rest in various residuals, most of which are products today that were not back then. He actually dictated to the railroads and they had to pay him kickbacks to haul his oil and would refuse to haul the oil of his competitors giving him leverage to build his monopoly. Before Standard Oil was broken up to form
34 companies, not least of which became Exxon (Std of New Jersey), Mobil (Std of New York), Conoco (pre merge with Phillips was Std of Rocky Mts), Chevron (Std of California), Amoco (Standard of Indiana), Sohio (Std of Ohio), now is BP of North America, Atlantic Richfield (another part of BP of N.A., and Marathon (bits and pieces of Ohio not included in Sohio.) One only has to do the math and see that a $70 barrel of oil if refined into only 30 gallons of gasoline translates into 82.50 at the pump. Of course your price may vary after you add the federal state and local taxes. I can save .15 a gallon by merely drivng outside the city to fill up here in Houston. That leaves another 12 gallons of sundry products the oil companies can make money on. Having been in the industry for 25 years in both exploration and having worked at refineries in the environmental end of things as well, I can say that not much is wasted these days compared to the old days. Back then production was wide open regardless of whether the storage tanks were full or not. they just damned up the nearby creeks to catch the runnoff and stored the black stuff in open pits till they could load it in rail cars. It was a race by producers to get it out of the ground and to the refinery before the price fell.

In the event I think it is funny that Congress talks of levying taxes on oil discovered years ago just because the international price has risen due to competition from China and India for available supplies. Are we going to pass laws on the windfall profits realized by speculators in inflated real estate markets? Talk about windfalls. The Oil Industry just has black reputation (pun intended) because it does little to educate the public, who still thinks oil was formed from dead dinosaurs and is sitting in big caverns beneath the ground just waiting for us to stick in a straw and suck it out. Like so many things the public perceives what it is told to perceive by those with an agenda. My suggestion is to buy stock in oil companies, then see if you want Congress to tax your dividends away. More socialistic redistribution of wealth by another means.

30

RE: the $100 dollars the Gov was thinking about giving away to taxpayers.

What if they (the Gov) bought 20 billion or so dollars of oil stock? Is such a thing possible? What would happen to the price of other share holders stock?

They should, course either not spend it or put it towards alternative energy research. 100 bucks isn’t going to really help anyone.

Just an odd idea I had.

31

[QUOTE=enipla]
What if they (the Gov) bought 20 billion or so dollars of oil stock? Is such a thing possible? What would happen to the price of other share holders stock?
[/QUOTE]

Well, the apparent value of the stock would soar, and all of those evil grandmothers would become millionaires.

kanicbird, you had a point that I forgot to mention… but!: the value of non-divendend-paying stocks still go up. I’m not going to do an analysis of energy companies, but I think part of the old-people attraction is that they mostly pay divendends, right? Even if not, they build equity. Auto stocks, on the other hand… well, don’t get me started. :wink:

32

Exxon pays $1.32 dividend per year.
ConocoPhillips pays $1.44
Chevron (which I bought as Texaco a LONG time ago) pays $2.08