It's the Economics, Stupid

Columnist Charles Krauthammer reveals the shocking truth behind the skyrocketing gasoline prices.

It's ... SUPPLY AND DEMAND!

Actually, he ticks off a number of interesting underlying factors that have restricted supply and increased demand to their current extremes: among them, the American public's intransigence, the boom in China and India, environmentalists, and Iowa farmers.

Give it a read, especially if you sit around all day scapegoating the oil companies.

Comments

[Jamie]

Supply and demand is indeed one of several current factors, but an underlying factor is the lack of competition in the industry. The monopolies that were once broken up are remerging in several industries, and Oil is merely one of them.

But surely the amount of oil we're using in the Gulf necessary to supply the current military effort is a significant drain on supply as well. Bush said initially that military efforts would be paid for, at least in part, by revenue from the Oil that would be recaptured and made available. Has that happened? Denying the connections between Bush, Cheney, and the petroleum industry seems delusional to me.

[Tom]

Thanks for the good doctor's article. I'll forward it to Bill O' Reilly and Chuck Shumer.

[Malcontent]

surely the amount of oil we're using in the Gulf necessary to supply the current military effort is a significant drain on supply as well.

You can dig up some figures and show me otherwise, but I find this highly specious. The amount of petroleum consumed by 150,000-odd troops and their equipment is a drop in a vast oilwell, compared to 300 million Americans and their cars, as well as 1.3 billion Chinese and 1.1 billion Indians.

I'd also be curious to see evidence of how the mergers have affected price in any substantial way. Yes, there has been consolidation in the industry, but a monopoly is one company, and there is still a lot of competition. In fact, the mergers have been designed to make them more competitive with each other.

We have a smaller number of huger telecommunications companies, for instance, and the relative price of communicating with other people is lower than ever.

[GayCowboyBob]

Does supply and demand justify $8.4 billion in first quarter profits for Exxon? Again, that's just one quarter's profits...profits. And this is at the same time companies including Exxon are still receiving government sponsored grants for research. If you remember last year from the congressional hearings, it was reported that oil companies had a 62% jump in profits in 3Q 2005 with Exxon posting the biggest corporate profit in history. The oil company executives were waved of testifying under oath, an unusual move for a congressional hearing. And remember all those undisclosed energy meeting with the Vice President's office? This is an industry whose profits are soaring across the board implying that somewhere along the chain of production the element of competition goes out the window.

I have an amazingly hard time attributing the high cost of gas simply to a short-term squeeze on the market. As the oil company CEO commented at the congressional hearings last year, you don't apply short-term corrective measures to control upward swings in the industry. But obviously with gas consumption a long-term issue we should begin now to apply long-term corrective measures. I don't want to deprive anyone of the wealth they should receive by buying into a lucrative market but at the same time, from the pumps in the oil field to the pumps at your gas stations, this particular commodity's price is jacked up in any way it can be.

[Malcontent]

Does supply and demand justify $8.4 billion in first quarter profits for Exxon?

It's called "capitalism." Look into it.

The oil company executives were waved of testifying under oath, an unusual move for a congressional hearing.

How many congressional hearings have you been to, GCB? I have been to scores of them, and never once were witnesses sworn in. It is a highly unusual move to swear in witnesses at a congressional hearing.

[Jamie]

Tanks, Aircraft Carriers, Bombers, etc, use far more fuel than cars do Mal. I didn't mean to imply that it was equivalent to our national usage by any stretch, but it's a damn sight more than a drop in the bucket.

As an aside, Petroleum is also used in construction, mixed with concrete, and no one thinks of that either. When there's a construction boom the price of Oil tends to rise as well.

Many, many factors to consider.

[Josh]

About Exxon's profits: they're under 10% of their total gross revenue. That's not extreme or outrageous in any way. Since production capacity has beenn limited for many years, and refinement capacity even more severely limited (the US hasn't built a new refinery in three decades), that means there is a fixed amount of supply. During the summer, demand spikes (and don't forget India and China are dramatically ramping up their oil needs as well). When you have a rising demand and a fixed supply, price will spike as well. Since Exxon can't force Saudi Arabia to build new wells and refineries, it is stuck importing a fixed amount of oil in a demand-driven market. If they didn't rise prices, they'd be stupid.

This is a product of our own shortsightedness, not any nefarious scheme to "make money" (i.e. profits).

[Jamie]

I have my problems with the oil industry, as you can tell from my previous remarks, I'm sure. But you know, I find it hilarious how we as a people bitch about paying $3.00 a gallon for a refined product that is shipped to us from halfway around the world, but we think nothing of paying $1.50 for bottled water that, in equivalent measures, would be $6.00 a gallon.

And water falls from the sky.

[Queer Conservative]

The federal government collects 18.4 cents per gallon in tax. Federal, state and local taxes total an average of 46 cents per gallon, a lot more than the 28 cents Exxon earned on a $3 gallon of gas.

Also, that $8.4 billion is out of $100 billion in revenue. That's pennies on the dollar folks, and a reasonable profit margin. People are letting all the extra zeros drive them bonkers.

[GayCowboyBob]

How many congressional hearings have you been to, GCB? I have been to scores of them, and never once were witnesses sworn in. It is a highly unusual move to swear in witnesses at a congressional hearing.

From what I understand, it's the discretion of the committee chairman to require testimony under oath if he chooses. The Democrats specifically asked for it but the Chairman, a Republican, denied the request. As you might recall, it was a rather testy debate before the testimony of Gonzales during the NSA hearings. And oil executives were asked to be sworn in in 1974. So whether it's not typical, it has precedence. It was asked of tobacco CEOs during the congressional hearing in 1994 where even then, under oath, they all said they "didn't believe" nicotine was addictive despite all the science. Maybe testifying under oath really doesn't indicate a higher standard to telling the truth.

About Exxon's profits: they're under 10% of their total gross revenue. That's not extreme or outrageous in any way.

Maybe not to you, but when 10% profit equals $8.4 billion dollars, or said a different way $8,400,000,000, to me that's a lot of money. Especially when Congress is giving tax breaks to the oil industry of about $2 billion dollars, I think 10% profit is amazingly high. The outgoing chairman amassed over $600 million dollars during his thirty-some years there. You're telling me that these are signs of a competitive marketplace?

[Queer Conservative]

GCB - it's a big business that makes a lot of money, and that's okay, really. Capitalism and profit are good. It's also why the percentages are the numbers you need to look at. Not the zerooooooooooooooooooooooos.

[Jamie]

Especially when Congress is giving tax breaks to the oil industry of about $2 billion dollars, I think 10% profit is amazingly high. The outgoing chairman amassed over $600 million dollars during his thirty-some years there. You're telling me that these are signs of a competitive marketplace?

GCB makes a point I wanted to mention before but forgot: why ARE we giving tax breaks (although I was under the impression that they are actually getting REBATES), to Oil Companies? I have never understood why we subsidize profitable businesses. It seems very anti-capitalist to me.

[Queer Conservative]

I agree Jamie. The same goes for agricultural subsidies.

[Malcontent]

we think nothing of paying $1.50 for bottled water that, in equivalent measures, would be $6.00 a gallon.

Or pay what would be about $25 for a gallon of Starbucks coffee, when we could make the same amount ourselves for a couple of bucks.

[Malcontent]

I almost never defend corporate welafre, so I can't help you there. The energy sector is one of only a small handful of critical infrastructures, so if they collapsed it would have grave national security implications. But you'd hope the kind of profits they're making now would go into a rainy day account, or R&D or something.

[Queer Conservative]

I'm telling you it's the zeroes baby - people see more than six zeroes after a number and they flip out.

[Jamie]

But you'd hope the kind of profits they're making now would go into a rainy day account, or R&D or something.

I thought Robbie supplied the one-liners around here. lol

[Jamie]

Maybe you city folk (ha ha) pay that much for coffee, but I think Starbucks SUCKS. Green Mountain Coffee Roasters for me, tyvm, and I grind and brew at home.

Then I make coffee. *rimshot*

[Tom]

"The federal government collects 18.4 cents per gallon in tax. Federal, state and local taxes total an average of 46 cents per gallon, a lot more than the 28 cents Exxon earned on a $3 gallon of gas."

but, but gubmint GOOD; big oil-BAD.

[PatrickP]

Jamie, the Vermont superiority complex is so tired.

[Josh]

GCB, google the profit margins of other sectors... the software industry comes to mind. On most products, Microsoft makes in the neighborhood of 30% profit from each unit sold. Go farther, and look at clothing retailers: the average $50 sweater at the Gap costs about $2 in sweatshop labor and shipping. In the grand scheme of things, a sub-10% margin is minimal.

One other thing that is almost always forgotten in this kind of discussion is refinery capacity. The U.S. has not built a single oil refinery since 1976, yet our usage profile has changed dramatically. Around the world, refining capacity is stretched to its limit, and it is a major bottleneck for supply (which itself is nearing maximum given current investment). A combination of harsh environmental regs and NIMBY have crippled the ability of oil companies to build new capacity, so we're force into relying on other countries to pick up the slack, driving the price up.

As a last bit, GayCowboyBob, I'm curious to know your background in economics. Do you know what competitive markets look like, and how corporations behave in them?

[Jamie]

PatrickP: Prove me wrong.

[GayCowboyBob]

I admit I'm not an economics expert (yes, everyone insert your "duh" here). But I do try to learn.

As I understand, there are simple reasons why the refinery business has declined in the US as you mention above.

However, I think it's difficult to compare gas profit margins to clothing profit margins or software. This comparison on Yahoo shows an average profit margin of just over 5% for all the variety of industries surveyed, apparel products being right around the average. Now within that industry you see there is a wide spread in profits from company to company, Cherokee, which retails in a number of low end outlets, is the most profitable at 44% and Mossimo, another well known brand, lost some profits. Clothing manufacturers made a little over 1% net profit margin this year so far.

The same is seen in software. The industry as a whole currently sees a -8.5% profit margin in this comparison but there is a wide spread between winners and loser. Speechswitch is -229% net profit margin while Microsoft sees a healthy 30.86%, something we expect of a company with a near monopoly on operating systems.

But Gas and Oil? Well the major manufacturers actually posted a negative number, about -16% here but if you remove one failing company from the equation suddenly you have a profit margin of almost 8%, better than clothing and software so far. But a striking difference is when you survey independent oil and gas companies and find almost 12.5% profit margin here.

By the way, Gap only posted slightly above the average of the industry in apparel stores.

Have I done my homework correctly or am I missing something? Gas and oil companies seem to be doing healthy consistent business much more than other industries on the whole.

[John in IL]

Gas at $1.89/gallon costs me 10.5 cents of fuel to drive a mile.
Gas at $2.89/gallon costs me 16 cents of fuel to drive a mile.

Am I willing to either not go that mile or choose to walk that mile for 5 1/2 cents? I don’t think so.

Americans are whiners. They forget the absolute luxury of going where you want when you want for such a bargain price. Gas will have to cost much more than this for me to curb my driving habits. If that time comes, I'll give up one of my other more expensive vices.

[John in IL]

Eeeeevil Wal-Mart has a profit margin of 3.6%