Tuesday, May 02, 2006

It's not gouging, but the oil companies aren't making things easier...

I'm afraid I am going to have to come to Russert's defense over the claim that he doesn't understand basic economics...

According to the transcript, Russert was NOT asking why prices are high if supply is down and demand up... but was asking how oil company profits were so high if they had less gas to sell. There's a difference... a big difference in those two questions; the former is indicative of a lack of basic economic knowledge, the latter, given that it now takes me two credit cards to fill up my 42 gallon Suburban, is one I would like to know the answer to.

Practically speaking, there are only two ways that oil companies are making even more money this year than they did last year, with Exxon Mobil alone making $8 BILLION in profit during the first quarter of this year, up 7% from the same period last year...

The first is if Exxon sold 7% more gas the first quarter of this year than they did during the first quarter of last year.

While it is possible that Exxon shipped 7% more gas this year than they did last year, I doubt it. Our use of gas doesn't rise at an annualized rate of 7%. According to Newsweek's Robert Samuelson, since 1995, demand world-wide has risen (if I have my math right) only about 2 percent a year (from 70 million barrels daily in 1995 to almost 84 million barrels daily today)... and a lot of the world-wide increase is attributable to China's increasing use of energy.

The second way for Exxon to have made more money is if Exxon made 7% more of a profit per gallon of gas they sold during the first quarter of this year than they made during the same period last year.

And that turns out to be exactly what has happened. While supposedly the oil companies haven't raised the percentage profit they make on each gallon of gasoline, by keeping their margin at 2 1/2% profit per gallon of gas sold, they make more dollars of profit per gallon of gas sold.

Spelling it out, when gas is selling for $2 a gallon, the 2 1/2% cut the oil companies take amounts to 'only' 5 cents per gallon. But when gas is selling for $3 a gallon, the 2 1/2% cut the oil companies take amounts to almost 8 cents per gallon... a big jump in oil company revenues and a big enough jump to translate to higher profits....even if, as Russert suggested, oil supplies are down.

In other words, had Exxon simply maintained their profit margin of 5 cents per gallon, they would NOT have reported the significantly higher profits than what they pulled in last year. It is only because they 'float' their profit margins as a percentage of the overall price of oil (and the underlying production costs) are they able to make more money when oil prices go up.

And it looks like others in the distribution chain are doing the same thing, passing along price increases that have nothing to do with the cost of a barrel of crude oil. - as the price of gas has gone up more than can be attributed to the hike in oil prices.

To illustrate, refer to this chart that claims, at $3 a gallon for gas, that $1.71 is made up of the cost of the oil that goes into making that gallon of gas. If so, then 2 years ago, when oil prices were only about $40 a barrel , instead of the $70 it is today, the oil component in a gallon of gas would have been roughly $1 per gallon (75% lower than it is today). And had this been the case, then - were all factors kept the same - then a gallon of gas would 'only' cost us 75 cents more today than it did two years ago. Yet, the price of gas has gone up from $2 a gallon to the $3 a gallon we're paying now.

So somebody is making an extra 25 cents per gallon of gas sold these days than they were two years ago. A couple of these cents are found in the above described hike the oil companies are adding to the price of gas by keeping their margin pegged to 2 1/2% of the price of a gallon. But where is the rest of the price hike coming from?

Take a look at the list of factors that make up the price of a gallon of gas. It ought not to cost any more to refine a gallon of gas when crude oil is at $70 a barrel than when it was at 'only' $40 a barrel. Nor should transportation costs be expected to rise much, as it ought to cost no more to ship expensive oil and gas than it is to ship cheaper gas and oil.

So I don't know where, but somebody somewhere is slipping in a few cents here and a few cents there that, together with the higher costs for the underlying crude oil, is making it more expensive for us at the gas pumps than would otherwise be the case.

Notes (for the nit-pickers):

* Yes, I am ignoring other factors at play, like revenues Exxon gets from other sources, efficiencies in drilling and exploration, currency valuation swings and so on. If someone has evidence that it was these other factors that accounted for the big boost in Exxon profitability, please let me know and I'll be more than willing to eat crow.
* I don't care that Exxon made a whole lot of money, it's what they're supposed to e trying to do. It's simply that I think Exxon and their defenders are being a bit disingenous when they portray these profits as just sort of falling into Exxon's lap - when in fact Exxon consciously decides how much of a profit to try and get from each gallon of gas they sell.
* I know that even if Exxon had kept their profit margin at 'only' 5 cents a gallon, it would have made next to no difference in the overall price of gas.
* I know Exxon makes less per gallon of gas than what the federal and state governments take out in taxes.
* I know (and I knew when I bought it 9 years ago) that a Suburban is a gas hog (12 miles combined for me, an admitted leadfoot).