Oil Profits and Energy Independence

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.

Surprisingly Rich

Imagine my astonishment today when I found out precisely who the politicians mean when they say we need to tax the rich. I have always wondered precisely who these rich people are they need to be more heavily taxed. Well I nearly fainted when I found out that virtually everyone I know is “rich” in the eyes of the government. It seems the Federal Reserve Board is very diligent in tracking the financial wealth of Americans – apparently excluding all of the illegal immigrants. According to the Federal Government 40% of Americans are poverty stricken (family income of $25,000) with another 30% falling into the middle class with a median family income of $65,000. What is astonishing is that the remaining 20% are “rich” with the top 10% showing a family median income of $170,000. This means a husband and wife each earning $85,000 are rich, which I’m sure would come as a total shock to them. Looking at this from another perspective if you take average salaries a husband and wife team of a teacher and a policeman their combined incomes would place them in the top 75% or upper middleclass. In fact any family whose median income is in six figures, they are in the top income bracket targeted by the politicians who are always trolling for votes on the basis that the “rich need to pay their fair share”.

Income Level Percentile Median Family Income
Rich 90% - 100% $170,000
Upper Middle Class 80% -- 89.9% $99,000
Middle Class 60% -- 79.9% $65,000
Lower Middle Class 40% -- 59.9% $40,000
Poverty 20% -- 39.9% $24,000
Level II Poverty Less than 20% $10,000

So after looking at these numbers it is easy to see why the politicians are so vague about precisely whom they mean when they are on their annual electoral crusade to “tax the rich”.

But as we all know what you bring in goes out pretty much as fast as it comes in and the real test is how much can you keep after the government takes as much as they can because after all the rich should pay more because they make more – I think this is the precise position of the American Democratic Party and the Socialist Parties of various European countries. So does making over $100,000 a year make you rich? The reality is that very few people in these upper income levels feel rich or even consider themselves rich.

Of course income really doesn’t mean much in defining where you stand overall. The better measure would be net worth, that is the total sum of a family’s assets minus all outstanding liabilities. When viewed from this perspective it seems that the national median net worth of the average American Family is $86,000 and this includes all assets like home equity, jewelry, savings, autos, collections, furnishings, etc.


Income Level Percentile Median Family Income
Rich 90% - 100% $833,000
Upper Middle Class 80% -- 89.9% $263,000
Middle Class 60% -- 79.9% $141,500
Lower Middle Class 40% -- 59.9% $62,500
Poverty 20% -- 39.9% $37,200
Level II Poverty Less than 20% $7900

At first glance it would appear that the top 10% (approximately 30 million people) have more substantially more money than the remaining 70% of the population. But included in that top ten percent are Bill Gates, Donald Trump, Warren Buffet, all of those professional athletes, and most assuredly all of those actors in Hollywood who command multi-million dollar salaries while crusading for the poor and demanding that the rich should pay their fair share. Of course at these multi-million dollar income levels, taxes are for the “little people” because batteries of accountants and lawyers insure that little to no tax is paid. These tax loopholes are carefully protected by judicious political contributions (to both parties) while the recipients beat the drum for higher taxes on the rich.

If you would believe what you see on television there is a whole segment of society living the high life in retirement communities. You see them every night as they dance the night away on their Caribbean vacations, where they jog, they fish, they bike, and in general live a great life in retirement because they are rich. Well I think if you would talk to most seniors you would quickly discover that few – very few – can live like these advertisements. In fact even those people in these median income brackets can not afford to live lavishly. Suppose the entire income tax structure were abolished and instead a flat tax was installed with no deductions whatsoever. Everyone and all businesses would simply pay a flat tax on their gross incomes. Do you think the people in the very top brackets, those who support the various politicians would ever allow this to happen? Can you imagine a George Soros, or George Clooney, or MicorSoft paying a flat percentage of their gross incomes to the government? Not a chance! These people want to tax the rich – not themselves. It is important that all of us rich people keep this in perspective when we go to vote for those candidates who think the rich should pay their fair share – that my friend is YOU and you clearly aren’t paying your way. Think about that!!