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Thursday, February 02, 2006

Obscene Oil Profits and Who Really Profits

It seems that the recent profits posted by Exxon have the anti-business left, ill informed consumer groups and some of the media in a tizzy (Bill O'Reilly). Claims of price gouging and suggestions that we should have a windfall tax to punish the big bad oil companies for making a profit have been raised. These ideas are proposed by people who have no idea how the oil industry works (or any other industry for that matter). These ideas are also proposed and accepted by people who haven't the slightest idea of how economies work or how supply and demand affects prices. Unfortunately these people are our Senators and Representatives, who make the decisions that will affect our lives. Scary isn't it? Just to think that Ted Kennedy and his ilk are in control of our economic health is enough to make me want to go back to bed and stay there.

Here is a very, very simplified example. The market and market traders set the price of oil....not the oil company. The cost of producing oil is controlled by the company, to some extent, but the market price is set by futures and options traders who base their prices on expectations of supply and demand. When supply is expected to be ample and demand is down compared to the amount of supply, the price is down and the companies make less or even lose money. If the supply is expected to be short, as it was directly after Katrina, the demand for oil is high and so market prices are higher and the oil company makes a profit. The oil companies hope for a stable supply and demand in order to be able to predict their profits and be able to know how much to reinvest into exploration and processing.

A windfall profit tax would be a huge mistake. A windfall profit tax is actually an excise tax on the difference between the market price of a commodity and an arbitrary figure determined by the government. The prices were obviously different in 1980 the last time we did this, but the effect of the tax would be the same, a decrease in domestic production and a increasing dependence on foreign sources Here is why. In 1980, the excise or "windfall" tax was 70% For example if the market price of oil is $60 a barrel and the government determines that the price should be $30 a barrel the difference of $30 is taxed $21 which leaves the oil company $39 (60-21=39). If the real cost of producing oil is $40 the oil company has just lost $1 per barrel of oil. What's a company to do? Increase the demand by reducing supply, of course. Dairy farmers have used similar tactics to raise the price of milk, why should oil producers be any different.

So the oil companies are making huge profits right now. Who is really profiting? Oil companies pay huge taxes to State and Federal Governments. Taxes in the billions of dollars that benefit schools, road projects and other expenditures that our politicians spend on our (supposed) behalf. Do all the profits go back into the oil company executives pockets? No, of course not. Exxon has spent an average of 10 billion (that is with a B) dollars annually in development and exploration. If development of our existing and potential oil sources and expansion of our refining capabilities were to be allowed, instead of being blocked by environmentalist, it would benefit us all.

Anyone remember the 1970's oil shortage? The 1973 oil crisis began in earnest on October 17, 1973, when Arab members of the Organization of Petroleum Exporting Countries (OPEC), during the Yom Kippur War, announced that they would no longer ship petroleum to nations that had supported Israel in its conflict with Syria and Egypt -- that is, to the United States and its allies in Western Europe. At around the same time, OPEC members agreed to use their leverage over the world price-setting mechanism for oil in order to quadruple world oil prices. The complete dependence of the industrialized world on oil, much of which was produced by Middle Eastern countries, became painfully clear to the U.S., Western Europe, and Japan Hmmmm. Does this have a vaguely familiar ring to it????

Ben Stein has an excellent article that explains this much better than I ever could. I bow to the master. Read the whole thing.

"Meanwhile, why is it so bad for oil companies to make a profit, even a big profit? That profit doesn't go into the pockets of Dr. Evil. It doesn't go to Saddam Hussein (not anymore). It goes to tens of millions of stockholders who use the dividends and the increase in share price to pay for their RV's and retirements and their (ungrateful) kids' college education. John D. Rockefeller is long gone. Anyone in America with a few twenties in his pocket can become a shareholder of a big oil company and share in those profits. Those profits go to teachers' unions and policemen's unions and to any person on this earth who cares to speculate that the big profits will continue. Or, as my father once said to me, and I have said before, "If you think oil company profits are obscene, buy stock in the oil companies."

I love this last remark!! If you have a mutual fund, a profit sharing plan, a company or State funded pension plan.....YOU are the beneficiary of the profits. Your share prices are up and you are receiving a dividend on your investment.


  1. Great Post!!!!
    What these ill informed folks don't look at is the consolidations and selling of assests that also increased the bottom line.
    I love big oil. I thank god every time I have a warm house or cool house turn the tv on. Thanks to big oil we have plastic wax electric, water at the sink.
    There is so much more to big oil than gas for the car. I wish they would find something else to harp on. Or go save a toad or something.

  2. You make really good points that are not universal at all. AS I wrote in another blog that blamed all the problems in the world on the big corporation, Who are the big corporations? They are us, if not personally then in our pension funds, IRA's, our 403's, even in our city bank accounts. (I do get a little tense about some executive goldern parachutes etc., but they are part of our game>