Recently I have been hammered by people who are once again accusing “Big Oil” of making obscene profits and gouging customers. These accusations seem to be just a knee jerk reaction to gas pump prices fueled by various politicians who find Big Oil to be a Big Target. But efforts to explain the fluctuations in oil prices or even how business – any business – operates seems to fall on deaf ears; therefore I guess this is a lesson in elementary economics -- the law of supply and demand. Economics has laws that are as immutable as the laws of physics but for some reason the laws that govern our economy are rejected out of hand by glib politicians and those who can't look beyond the immediate impact to discover the force behind that impact.
Wealth and Taxes
It is always popular for a politician to demand that the rich pay more, that we should tax the rich. Ignoring that these politicians almost never describe who is rich, but lets just follow that reasoning to its conclusion, which is that higher taxes lead to lower revenues! How can that be? The reality is that taking money (capital) from the rich (the capitalists) and giving it to the poor means the rich have less money to invest. With less capital available businesses cannot expand and add new jobs and may actually have to contract and lay people off. With fewer jobs there are fewer people earning money and paying taxes and many may become non-tax paying or even consumers of tax dollars in the form of unemployment benefits. Once the rich have had their capital reduced through taxation they have less to invest and so their income goes down and the taxes they pay are reduced. If the government responds by raising taxes even higher then we enter a downward spiral leading to greater unemployment and reduced revenues and a declining standard of living. Once this spiral begins it is very difficult to reverse because politicians are allergic to the solution which is lowering taxes.
Revenues and Profits
The favorite target here seems to be big business but especially the oil companies who are accused of making obscene profits. Of course this accusation of obscene profits comes from politicians who are almost always lawyers with no experience whatsoever in business and the man-on-the-street who just sees the price of gas at the pump. All he knows is that the ignoramus he voted for is telling him the cost of gas is because of greedy oil moguls and not the taxes they put on the gas or the restrictions they have placed on the oil companies, or the distinctions between profit and revenues, those are ignored.
Yes the revenues of the oil companies are substantial but surely most people know that their annual salary is only a fraction of what they take home in their paycheck. So the annual salary is the revenue, the paycheck is income after tax, and the take home pay is the profit. This is very analogous to how business operates. Those so-called obscene profits are in reality the gross revenues. Once the taxes have been paid to the federal authorities, the state, and local governments (and in some cases foreign governments as well) the companies have their after tax revenue, then they must deduct their expenses, which include exploration, salaries, transportation, environmental costs, etc etc. The actual bottom line profits have historically been in the 10% to 12% range and this is over decades. Even though this information is readily available from the Federal Government the politicians don't want to acknowledge that because it might draw attention to their regulations and taxes that lie at the heart of the cost of gas at the pump.
Law of Supply and Demand
The complaint has been that oil companies are cutting back on production and the cost of gas is sure to rise because the oil companies are run by greedy businessmen who are out to gouge the consumer. In reality this is an example of "The Law of Unintended Consequences". Like all businesses the oil companies are governed by the law of supply and demand. The Department of Energy, the Environmentalists, the EPA, and of course all of the politicians have been pounding the drum and beating on GM to reduce gas consumption. Surprise!! This is actually working and the result has been that OPEC is wallowing in oil because the demand has gone down as refineries cut back their production as the demand for gas goes down. Is there cheering in the streets? Is GM up for any medals from the DOE? of course not -- the hue and cry is that the price of gas may (or is) go up. Well the taxes haven't been reduced, the restrictions on the oil refineries hasn't changed -- just the demand for a finished product. This is where mass production comes in -- the more units I produce the lower the cost per unit and as I reduce the number of units produced the cost per unit increases. So as the demand for gas declines the refineries cut back on production and as the volume decreases the cost per unit increases. These changes in volume and revenues do not fall to the bottom line because all of the parameters remain the same. So in effect the environmentalists have succeeded in reducing the demand for oil but were unprepared for the success of their program. The Law of Unintended Consequences strikes again as the demand goes down the price goes up.
Energy Independence
The cry has been that America should be Energy Independent and this is the mantra of most politicians because it is popular with the people. Although the DOE was created for the sole purpose of making America Energy Independent no one seems willing to point out how bloated this organization has become in spite of it total failure to achieve its objective.
Generally when this subject of energy independence comes up, it is interpreted to mean independence of imported crude oil and independence of OPEC. However it is the Federal Government that has prevented the development of proven reserves or offshore exploration while foreign governments are actively exploring the very areas the American companies are seeking to explore. So it is the Federal Government that is directly increasing our dependence on foreign oil by placing environmental restrictions and legislative roadblocks on the American companies that prevent these companies from actively adding to the domestic supply of oil.
But suppose the US stopped importing any oil what would happen? Certainly the price at the pump would decline since the price would be determined by the domestic market but the real impact would be on those countries that currently sell oil to the US. Canada and Mexico would be hurt but Venezuela would be devastated. If the US were to suddenly become oil independent it would have destabilizing impact on the world economy, so even if the US did have the ability to be oil independent this independence would have to be phased in.
But there is another dimension to the price of gasoline and that is the dollar. The American Dollar is the reserve currency of the world and the price of oil is tied to the dollar so as the value of the dollar declines the price per barrel goes up and this translates directly to a higher cost of gasoline. The value of the dollar is driven by many factors but not the least of which is the supply of dollars. As the supply increases the value declines so as the government continues to fund these huge stimulus packages and social programs by printing dollars, the value of those dollars decreases, which drives up the cost of everything including oil. If the government were to reduce the supply of money then the value of the dollar would rise and the price of oil would decline since a dollar would buy more.
Showing posts with label big oil. Show all posts
Showing posts with label big oil. Show all posts
Wednesday, October 21, 2009
Wednesday, August 27, 2008
Oil and Energy 2012
Our dear friends in OPEC have had the world and the US in particular in stranglehold since the 1970’s but they may have finally overplayed their hand. Actually, it isn’t just their greed that may bring them down but the greed of Wall Street Speculators who drove the price of a barrel of oil to an unprecedented $147 / barrel. The price of oil has fallen from that ridiculous high and in all likelihood will continue to fall and some forecasters are predicting $65 / barrel by 2010.
How is this possible? Several things seem to be driving the price of oil down and the slide seems to have begun on a rumor that the US Government was launching an investigation into oil speculation. Note that this was just a rumor but that was enough to drive the speculators into a selling frenzy which drove the price down. If the demand for oil worldwide was rising then the speculators would not have had such an impact when they sold, but the reality seems to be that the oil supply was meeting – if not exceeding – world demand. In effect the speculators were driving the price of oil up to artificial highs. This created a worldwide scare and reaction as the usual left wing politicians got on their demagogic bandwagon and began calling for punishing the Oil Companies for their obscene profits, when in actual fact the oil companies had lower profits than almost any other large company. But the critical point here is that the speculators created a scare and OPEC could not correct it because they were already producing more oil than the demand and that scare may have far reaching consequences.
Although the price of oil may fluctuate in the near term the long range trend will most likely be down as the dollar strengthens against the Euro and other world currencies. This fluctuation according to some analysts will center on the $100 / bbl mark but once that barrier is breached the slide will be steep and within six months the price of a barrel will be $65 or less. But all of this could be attributed to the usual swings in every commodities market, except this time it seems that maybe the realization that oil is a finite resource and an alternative must be found has gotten some traction with consumers. In fact it seems this scare may have actually shocked consumers to the point where they may actually take energy conservation seriously. Auto companies are sharply focused on hybrids and electric cars but more importantly consumers seem to have rediscovered public transportation and the logic in turning off lights when not needed. The day of the SUV seems to be ending as consumers are looking for ways to reduce the cost they pay for gasoline and as this trend grows it drives down demand which in turn drives down price, so the return of low priced (relatively) gasoline may be in the near future and certainly by 2012.
If this trend to develop alternative energy sources and reduce our alliance on oil and oil based products is sustained it will have far reaching consequences. Perhaps the greatest impact will be on the oil producing countries in the Middle East, especially Saudi Arabia, Kuwait, and the other Arab countries. These countries have failed to establish any sort of economic base other than oil and they have squandered the billions in revenue they have received on palaces and luxuries. The result is that if their oil revenues decline they really have no way of offsetting the decline. Worse they cannot rely on tourism due to their religious fanaticism and draconian laws. Furthermore they have become highly dependent on foreign workers and if these imported workers leave the over indulged citizens will be unable or unwilling to take up the slack.
Naturally the attitude among many as they see OPEC choking on an oil glut and declining revenues, will be that it is well deserved. Well deserved it may be but if this happens it could have far reaching consequences. Saudi Arabia and the oil producing Islamic countries are all highly unstable and any dramatic decline in revenues that impacts their social programs could trigger massive political change. Certainly the House of Saud could fall and would be replaced by an Islamic government similar to Iran’s, but other governments currently friendly to the west could also fall. This would create chaos in the oil markets but it would also provide massive amounts of cash to various terrorist organizations.
But not all oil producing countries are Islamic and countries like Canada, UK, Russia, etc, would not be greatly affected but some of the poorer countries like those in Africa might weather the storm politically but socially the impact could be devastating. These countries do not have the infrastructures or solid economic base that would allow them to compensate for reduced revenues. In these countries the impact could be reflected in even greater unemployment and reduce the standard of living from its already low level.
So while the price of oil and gas may decline as alternative fuel sources come on the market, the impact may not be all positive.
How is this possible? Several things seem to be driving the price of oil down and the slide seems to have begun on a rumor that the US Government was launching an investigation into oil speculation. Note that this was just a rumor but that was enough to drive the speculators into a selling frenzy which drove the price down. If the demand for oil worldwide was rising then the speculators would not have had such an impact when they sold, but the reality seems to be that the oil supply was meeting – if not exceeding – world demand. In effect the speculators were driving the price of oil up to artificial highs. This created a worldwide scare and reaction as the usual left wing politicians got on their demagogic bandwagon and began calling for punishing the Oil Companies for their obscene profits, when in actual fact the oil companies had lower profits than almost any other large company. But the critical point here is that the speculators created a scare and OPEC could not correct it because they were already producing more oil than the demand and that scare may have far reaching consequences.
Although the price of oil may fluctuate in the near term the long range trend will most likely be down as the dollar strengthens against the Euro and other world currencies. This fluctuation according to some analysts will center on the $100 / bbl mark but once that barrier is breached the slide will be steep and within six months the price of a barrel will be $65 or less. But all of this could be attributed to the usual swings in every commodities market, except this time it seems that maybe the realization that oil is a finite resource and an alternative must be found has gotten some traction with consumers. In fact it seems this scare may have actually shocked consumers to the point where they may actually take energy conservation seriously. Auto companies are sharply focused on hybrids and electric cars but more importantly consumers seem to have rediscovered public transportation and the logic in turning off lights when not needed. The day of the SUV seems to be ending as consumers are looking for ways to reduce the cost they pay for gasoline and as this trend grows it drives down demand which in turn drives down price, so the return of low priced (relatively) gasoline may be in the near future and certainly by 2012.
If this trend to develop alternative energy sources and reduce our alliance on oil and oil based products is sustained it will have far reaching consequences. Perhaps the greatest impact will be on the oil producing countries in the Middle East, especially Saudi Arabia, Kuwait, and the other Arab countries. These countries have failed to establish any sort of economic base other than oil and they have squandered the billions in revenue they have received on palaces and luxuries. The result is that if their oil revenues decline they really have no way of offsetting the decline. Worse they cannot rely on tourism due to their religious fanaticism and draconian laws. Furthermore they have become highly dependent on foreign workers and if these imported workers leave the over indulged citizens will be unable or unwilling to take up the slack.
Naturally the attitude among many as they see OPEC choking on an oil glut and declining revenues, will be that it is well deserved. Well deserved it may be but if this happens it could have far reaching consequences. Saudi Arabia and the oil producing Islamic countries are all highly unstable and any dramatic decline in revenues that impacts their social programs could trigger massive political change. Certainly the House of Saud could fall and would be replaced by an Islamic government similar to Iran’s, but other governments currently friendly to the west could also fall. This would create chaos in the oil markets but it would also provide massive amounts of cash to various terrorist organizations.
But not all oil producing countries are Islamic and countries like Canada, UK, Russia, etc, would not be greatly affected but some of the poorer countries like those in Africa might weather the storm politically but socially the impact could be devastating. These countries do not have the infrastructures or solid economic base that would allow them to compensate for reduced revenues. In these countries the impact could be reflected in even greater unemployment and reduce the standard of living from its already low level.
So while the price of oil and gas may decline as alternative fuel sources come on the market, the impact may not be all positive.
Sunday, July 06, 2008
A Perspective on Big Oil
Even as the Bush Administration fades into history, the poisonous rhetoric continues. We continue to hear the calls by one demagogic politician after another to tax the oil companies and their “windfall” profits. Of course the sums being reported are indeed huge but these are big companies and like all big companies their revenues are truly large but no larger than any other large company. Then there is the idea America is being held hostage by the Arabian States. Well not exactly. The fact is that country that holds the place as our largest importer is Canada who sends us 1902K barrels of oil per day. Saudi Arabia is second with 1519K barrels and Mexico third with 1230K barrels. Fourth place falls to Nigeria and Venezuela is in fifth place. Then there is the blather coming from those who opposed the Iraqi War but feel that we should just take the oil because after al “they owe us”. Talk about a mixed message! But Iraq already is in sixth place as a source of oil. So it seems we are already getting oil from Iraq and will undoubtedly get more as that country stabilizes. It is worth noting that Iran, Dubai, the Arab Emirates, Yemen, and other sunny and delightful places peopled by colorful natives are not on the list of the top 15 suppliers.
It is also worth noting that in general that the oil these countries are exporting are government owned and controlled by OPEC, an organization that is illegal in the United States. But it is this organization that sets the price for oil and that price can be set arbitrarily according to what the market will bear. So they could charge $200 a barrel and drive the cost of gasoline to $20 a gallon if they chose. So if the oil companies are behind this and they are only after bigger and bigger profits why don’t they set the price higher? Outside of what it would do the world economy, the reality is that the oil companies don’t control the price of gasoline.
So what about those HUGE oil profits that Obama and Hillary want the congress to take (steal) from these oil companies who are gouging us at the pump. No one seems to have actually looked into these HUGE profits and oil company profits have historically run between 7% and 12%. These irresponsible calls for robbing the oil companies on the basis of their ‘OBSCENE” profits are simple demagoguery.
But what about those OBSCENE profits the oil companies are making?. A little perspective seems to be in order. Speaker of the House Nancy Pelosi (D) calls oil company profits obscene and at first blush many – if not most people – agree. Over the past 12 months, for example, ExxonMobil has made pre-tax profits of $164 billion on sales of $369.5 billion. That’s a lot, but is big oil company profits behind these increases in pump prices?
First, Big Oil can't dictate gasoline prices. Markets determine the price of oil. It's supply and demand that sets the price at the pump. So what you pay at the pump is the market price not a price set by the oil companies. This issue was resolved by the Supreme Court decision last year when they ruled unanimously that oil companies have not been colluding to set prices.
So once again I say that oil prices are high today because the economies of huge nations like China and India are developing rapidly. More oil is being demanded in the world market and there are few new sources of supply, like ANWR or the California Coast. Also if you remember Hurricane Katrina destroyed a lot of oil processing capacity around the Gulf of Mexico so not surprisingly less oil is being processed. .Econ 101 tells us that when less oil is supplied, gasoline prices rise. WOW – what a concept!!! Do you think any of the liberal community has grasped this simple fact or are they ignoring it in hopes of getting a vote??
But let’s get to the nub of the matter. What does the average oil company get out of your $4.50 gallon of gas – ten cents!! The federal tax on gasoline (hello Obama and Pelosi) is nearly twice that (18.4 cents) but then the states get a share also. The price on a gallon of gas in New York is 68 cents and roughly the same in California but virtually every state gets a cut larger than the ten cents the oil company gets. Do any of these politicians call for a reduction in taxes on gasoline – don’t bet on it. That would reduce their income because the government feeds on tax revenues so they want to take more from you and from business – especially oil companies and their “windfall” profits.
So if Exxon made $369B in revenues and $164B in “profits” where did the money go? Well there is a difference between gross profits and net profits. Exxon must spend billions on exploration, billions more on development, and further billions on refining and transportation. When all of these operating costs are figured in those OBSCENE profits evaporate pretty quickly. So when you actually examine where the money goes it becomes evident that these oil companies are hardly making money hand over fist. In fact earnings at Exxon rose 9% last year but fell 4% in the fourth quarter, underscoring the challenges of rising costs and lower commodity prices. The reality is Exxon's profit margins are only 10.7%, while profit margins at Microsoft, on the other hand, are 26% -- so who is gouging whom?
Perhaps we should pass a windfall profits tax on software companies because what the liberals want with their windfall tax on oil companies is to fund the search for alternative sources of energy, such as ethanol and nanotechnology. But when John McCain offered $300M as a reward for anyone who could come up with a viable electric battery operated or other viable alternative he was scorned. The reality is the liberals love throwing money around on in federal research grants to create alternative energy sources and satisfy the academics who live off of those research grants and vote liberal. So given that these giveaway grants are to be used for alternative sources of stuff why shouldn't Uncle Sam give grants to:
• Dell… to create more powerful computers?
• Boeing… to build faster aircraft?
• McDonalds… to make low-fat French fries that taste good?
This won’t happen of course because companies are profit driven and will do better on their own. A little less demagoguery about big oil would go a long way to solving the energy problem. Trust me, we will have alternative energy sources eventually. Many scientists believe that near incredible advances in nanotechnology will allow us to solve all our energy needs with solar power within 20 years.
It is also worth noting that in general that the oil these countries are exporting are government owned and controlled by OPEC, an organization that is illegal in the United States. But it is this organization that sets the price for oil and that price can be set arbitrarily according to what the market will bear. So they could charge $200 a barrel and drive the cost of gasoline to $20 a gallon if they chose. So if the oil companies are behind this and they are only after bigger and bigger profits why don’t they set the price higher? Outside of what it would do the world economy, the reality is that the oil companies don’t control the price of gasoline.
So what about those HUGE oil profits that Obama and Hillary want the congress to take (steal) from these oil companies who are gouging us at the pump. No one seems to have actually looked into these HUGE profits and oil company profits have historically run between 7% and 12%. These irresponsible calls for robbing the oil companies on the basis of their ‘OBSCENE” profits are simple demagoguery.
But what about those OBSCENE profits the oil companies are making?. A little perspective seems to be in order. Speaker of the House Nancy Pelosi (D) calls oil company profits obscene and at first blush many – if not most people – agree. Over the past 12 months, for example, ExxonMobil has made pre-tax profits of $164 billion on sales of $369.5 billion. That’s a lot, but is big oil company profits behind these increases in pump prices?
First, Big Oil can't dictate gasoline prices. Markets determine the price of oil. It's supply and demand that sets the price at the pump. So what you pay at the pump is the market price not a price set by the oil companies. This issue was resolved by the Supreme Court decision last year when they ruled unanimously that oil companies have not been colluding to set prices.
So once again I say that oil prices are high today because the economies of huge nations like China and India are developing rapidly. More oil is being demanded in the world market and there are few new sources of supply, like ANWR or the California Coast. Also if you remember Hurricane Katrina destroyed a lot of oil processing capacity around the Gulf of Mexico so not surprisingly less oil is being processed. .Econ 101 tells us that when less oil is supplied, gasoline prices rise. WOW – what a concept!!! Do you think any of the liberal community has grasped this simple fact or are they ignoring it in hopes of getting a vote??
But let’s get to the nub of the matter. What does the average oil company get out of your $4.50 gallon of gas – ten cents!! The federal tax on gasoline (hello Obama and Pelosi) is nearly twice that (18.4 cents) but then the states get a share also. The price on a gallon of gas in New York is 68 cents and roughly the same in California but virtually every state gets a cut larger than the ten cents the oil company gets. Do any of these politicians call for a reduction in taxes on gasoline – don’t bet on it. That would reduce their income because the government feeds on tax revenues so they want to take more from you and from business – especially oil companies and their “windfall” profits.
So if Exxon made $369B in revenues and $164B in “profits” where did the money go? Well there is a difference between gross profits and net profits. Exxon must spend billions on exploration, billions more on development, and further billions on refining and transportation. When all of these operating costs are figured in those OBSCENE profits evaporate pretty quickly. So when you actually examine where the money goes it becomes evident that these oil companies are hardly making money hand over fist. In fact earnings at Exxon rose 9% last year but fell 4% in the fourth quarter, underscoring the challenges of rising costs and lower commodity prices. The reality is Exxon's profit margins are only 10.7%, while profit margins at Microsoft, on the other hand, are 26% -- so who is gouging whom?
Perhaps we should pass a windfall profits tax on software companies because what the liberals want with their windfall tax on oil companies is to fund the search for alternative sources of energy, such as ethanol and nanotechnology. But when John McCain offered $300M as a reward for anyone who could come up with a viable electric battery operated or other viable alternative he was scorned. The reality is the liberals love throwing money around on in federal research grants to create alternative energy sources and satisfy the academics who live off of those research grants and vote liberal. So given that these giveaway grants are to be used for alternative sources of stuff why shouldn't Uncle Sam give grants to:
• Dell… to create more powerful computers?
• Boeing… to build faster aircraft?
• McDonalds… to make low-fat French fries that taste good?
This won’t happen of course because companies are profit driven and will do better on their own. A little less demagoguery about big oil would go a long way to solving the energy problem. Trust me, we will have alternative energy sources eventually. Many scientists believe that near incredible advances in nanotechnology will allow us to solve all our energy needs with solar power within 20 years.
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