Profiteering? Goodness gracious, no!
by sarabeth at 9:00 am on April 27th, 2006 in EconomyLast night, on The Daily Show, Jon Stewart’s guest was Kimberley Strassel, senior editorial page writer for The Wall Street Journal. Stewart tried to get her to explain why oil company profits should go up just because crude oil and gas prices do. It was a simple question, pretty clearly put: if crude oil prices go up, oil company revenues may go up, but why should profits go up too?
This was a question she totally failed to answer. Since she’s on the editorial staff of The Wall Street Journal – and she giggled a lot – we’ll put it down to nervousness. Stewart gallantly took the blame for being too retarded about economics to understand her, but the truth of the matter is that she totally failed to articulate any kind of answer.
As best as I could make out, the answer she was trying to give was the standard oil company PR response. This was the argument we heard a lot, for example, in October 2005 when Exxon announced those obscene profits for the third quarter of 2005, and again in January 2006 when Exxon announced obscene profits for the last quarter of 2005 and for the full year. In a nutshell, the argument is that the oil companies are really not responsible in any way for the obscene profits they’ve been making recently. The obscene profits just happened to them as they were walking along, innocently going about their business.
Jon Stewart’s question was that oil companies may have higher revenue because gas prices have gone up, but why shouldn’t their profits be the same, since their crude oil cost went up too? That premise would be true if oil companies operated by buying crude at market prices, refining it and then selling the gasoline. But they don’t. Most oil companies start by extracting crude oil. When crude oil prices go up, they make a bigger profit on extracting the crude. Their profits would increase even if they weren’t in the business of refining crude and selling gasoline.
The claim that oil companies are making is that when global supply and demand (and those evil OPEC guys) make crude prices go up, the price you pay at the pump for gas increases only to reflect the increase in the cost of crude. The higher retail price of gas does not reflect any increase in profit once you take the higher crude price into account. Refining and retailing profits don’t increase. In short, oil companies don’t tack on a little extra for themselves when they adjust the price of gas for the cost of crude. That is to say, we are not being gouged.
And so, oil companies maintain that yes, their profits go up when crude oil prices increase, but not because of anything that they have done. The higher profits just happen to them when crude oil prices happen to go up. And they don’t control crude oil prices, OPEC does. So only OPEC is responsible for the recent humungous profits of oil companies.
Unfortunately, as anyone who represents The Wall Street Journal in a national TV discussion of oil company profits should be aware, this is absolutely untrue. It is known to be untrue. Kimberly Strassel is guilty not just of nervously failing to articulate her reply. She is guilty of either being criminally ignorant of the basic facts (which are amply documented) or of deliberately misrepresenting the truth so that oil companies don’t look bad.
Let’s go to the facts. (I did a google search, and picked out two respectable studies at random. If you had the stamina, and I had the sadism, I could quote you fifty.)
A U.S. Department of Energy study titled “2003 California Gasoline Price Study: Preliminary Findings” documented the following (all figures are national averages*):
So the retail price of gas didn’t increase just because crude oil prices went up. The increase in the retail price was more than double what was warranted by crude oil prices. Somehow, by a huge cosmic coincidence – warranted no doubt by the accumulated karma of oil companies – the retail price of gasoline behaved in such a way as to produce a handsome increase in oil company profits over and above what resulted simply from crude prices going up. The study estimates that “Distribution Costs, Marketing Costs, Refining Costs and Profits” went up over this period from 30.1c per gallon to 48.6c per gallon. No one, not even the oil companies, is claiming that “Distribution Costs, Marketing Costs, Refining Costs” went up significantly over this period. So most of it is an increase in refining and retailing profits.
The crude oil component of the cost went up by 17.4c a gallon. Refining and retailing profits went up by roughly the same amount. Under cover of higher crude oil prices, oil companies have managed to tack on a tidy extra profit for themselves. Now you can call this adding insult to injury, or you can call this price-gouging, or you can call it profiteering. Jon Stewart called it “the distinct sensation of being boned up the a**”. Once the initial spate of “for-window-dressing-only” statements is over, the Bush administration and Congress will, no doubt, call it business as usual.
Those numbers were from 2002-03. It’s the same story if you look at 2006. According to the California Energy Commission, during the 6-week period from March 6, 2006 to April 17, 2006 the crude oil cost of a gallon of gas went up by 20c (from $1.43 to $1.63). The retail price before taxes went up by 39c per gallon. Some things never change, huh? Every time crude oil prices increase, oil companies manage to tag on a stealth component of extra profit for themselves.
The crude oil cost of a gallon of gas has gone up by roughly a dollar since 2002, and oil company profits benefited handsomely in the process. Then, over and above that, refining and retailing profits went up handsomely too—roughly 60c a gallon, by my estimation. It’s easy to understand why oil companies have been making those obscene profits lately.
That pool of cosmic karma must be almost as vast as Saudi Arabia’s oil reserves.
* The numbers look even worse if you take California averages. The crude oil cost of a gallon of gas went up by 18.5c (from 59.c to 77.7c). The retail price before taxes went up by 53.9c per gallon (from $1.038 to $1.577).
sac wrote:
In the study you cite, the cost of the amount of crude required to produce 1 gallon of gas is half the cost of a gallon of gas, therefore it would make sense that the price increase for the refined gas is twice as much as for crude. The percentage of the increase is almost identical between the two.
I’m sure the oil companies are up to shady business, but unless my math is wrong (which is highly likely, I suck at math), the price increases of crude and of refined gas seem to be in line with each other.
Posted 27 Apr 2006 at 10:49 am ¶
sarabeth wrote:
When crude goes up by 17.4c per gallon and gas goes up by 35.9c per gallon, then assuming that Distribution, Marketing & Refining Costs stay the same, the refining and retailing profit goes up by 18.5c per gallon. That’s actually an astronomical increase.
Crude went up by 28%, gas went up by 27%. If refining and retailing profit were also going up by 27-28%, no one would have much of a problem with that.
The studies I cited don’t identify what the Distribution, Marketing & Refining Cost is per gallon.
If we assume it’s 20c, then the profit increased from 10.1c per gallon to 28.6c per gallon. That’s 183%. (10c per gallon sounds like a pretty reasonable estimate to me for the profit they were making in 2002.)
Posted 27 Apr 2006 at 12:14 pm ¶
sarabeth wrote:
Afterthought: another way to think of it is that if all your costs went up by 28% it would be reasonable to increase your price by 28%. And the effect would be to increase your profit also by 28%.
What’s happening here though is that all your costs don’t go up by 28%. Only crude goes up, and it’s roughly half your cost. When you increase your price by 28% anyway, it does these dramatic things to your profit.
Posted 27 Apr 2006 at 12:25 pm ¶
sac wrote:
I told you I suck at math.
Posted 27 Apr 2006 at 12:59 pm ¶
Shawn wrote:
Okay - good I came here to ask the same question as sac. Maybe here’s an easier way to put it:
You sell french fries and you say you base your price on the cost of potatoes, plus frying, and you sell them for $1 a bucket. In your case, it’s a good business because you grow your one potatoes in the back yard.
On year, there is a huge flood in Idaho and potato prices go through the roof (up 25%, which causes the price of most french fries to go up as well.
Seeing this, rather than taking in opporunity to increase your market share by passing your savings on to your customers you up your price by $.25 to take home the extra profit. Nothing changed in your cost equation, therefore you are gouging.
The one outstanding question is this, however. When I go to my local Exxon station, what percenatage of that gas comes from crude that Exxon aquired themselves? If it’s a large percentage, this holds. If it’s not, well, it gets fuzzy. And I think I’ve heard oil people claim the latter.
In any case, they’re making more money for no reason. Their product isn’t better, it’s not cheaper, it’s not more in vogue, it’s just more expensive and people can’t do without it.
Posted 27 Apr 2006 at 5:34 pm ¶
Shawn wrote:
Geez, I should try proof reading
“…grow your own potatoes”
“One year…”
Posted 27 Apr 2006 at 5:36 pm ¶
sarabeth wrote:
What you’re asking is not really the same question as sac’s.
Actually, whether you are gouging has nothing to do with whether you grow your own potatoes or not.
Say your cost is 90c to begin with and potatoes represent half that cost, or 45c (How do you figure your potato cost? By using the market price of potatoes, even if you grow them yourself. Because this represents what you could have sold your potatoes for if you hadn’t got into the fries business. This is what finance people like to call opportunity cost.)
When potatoes go up 25%, it’s totally fair for you - as someone who grows your own potatoes — to say your potato cost is now 25% more, which makes it 56c. Because those same potatoes which could have earlier been sold for 45c can now be sold for 56c. So that’s what you have to charge for potatoes when you use them to make fries instead of selling them. (Your total cost just became $1.01.)
The point is that whether you are gouging or not depends only on how much you now increase your price. If you increase your price by 25%, to $1.25, your profit goes up from 10c to 24c. The potato cost went up 25%; by increasing your price 25% you increase your profit by 140%.
What you could do instead is say that your total cost went up 12.2% (91c to 1.01). So you increase your total price 12.2% (from $1 to $1.122). Your profit now goes up from 10c to 11.2c. Your total cost went up 12.2%, and so did your profit.
(The key here is that the first time around, only part of your cost increases by 25% but you increase your total price by 25%. That’s what creates the huge percentage increase in profits.)
Note that the argument is exactly the same whether you grow your own potatoes or whether you buy them in the market. Either way, your potato cost goes up 25% from 45c to 56c. Either way, the fair thing to do is increase your price 12.2% and not 25%. Either way, if you increase your price 25%, your profit on the fries operation goes up 140%.
The difference in the two cases is that when you are growing your own potatoes, you also benefit from the 25% increase in potato prices in addition to the increase in the profit on the fries operation. But no one grudges you that. That’s what you’re entitled to for having chosen to grow potatoes. The gouging doesn’t come from increasing your selling price to compensate for the increase in the price of potatoes. The gouging comes from increasing your price by more than the 12.2% increase in your total cost.
Posted 27 Apr 2006 at 6:48 pm ¶
Shawn wrote:
Well put, thanks. See, that’s why you’re a world-famous-blogger and I’m not. :)
Posted 27 Apr 2006 at 10:39 pm ¶
sarabeth wrote:
I don’t know about that. But I’m certainly proud to be part of the best political team among blogs whose name starts with three of a kind.
Posted 28 Apr 2006 at 6:27 am ¶
Mags wrote:
What about the fact that we import the majority of our oil from Canada, not OPEC countries? Is the price of Canadian crude as high as OPEC?
Posted 28 Apr 2006 at 9:27 am ¶
sarabeth wrote:
I don’t know, but I’m not sure why that’s relevant to the argument I was making.
Posted 28 Apr 2006 at 11:35 am ¶
Shawn wrote:
You guys are certainly better than the clowns over at 2226.org
Posted 28 Apr 2006 at 12:04 pm ¶
sarabeth wrote:
Likewise, we get better comments and questions from you than we ever got from Rove, Rumsfeld and Rice put together.
Posted 28 Apr 2006 at 3:56 pm ¶
JDL wrote:
I found your blog because I couldn’t get over Strassel’s obvious evasiveness and my frustration with Stewart’s question not being answered. I can’t come to any conclusion other than the senior editorial writer for the WSJ is a shill for the oil companies! I had to see if anyone else out therel felt the same way. It was a really Orwellian moment - a form of double speak, where she actually made Stewart, a smart guy, feel stupid for asking the very question that all of us are asking, and desparately wanted to know the answer to.
Strassel was stating that the ethanol legistlation is responsible for the gas increase, but she was so inarticulate that I couldn’t figure out what she was saying. Did you?
Posted 28 Apr 2006 at 7:47 pm ¶
sarabeth wrote:
I don’t think Stewart actually felt stupid for asking the question or not understanding the answer. I think he just decided to be nice to her (as he sometimes does) and let her off the hook.
The ethanol issue, as I understand it (this is just off the top of my head, some of the facts could be a little off), is that in January it was mandated by Congress that the fuel additive MTBE must be replaced by ethanol starting in April. This has led to gas shortages in the North-east (pumps temporarily without gas), but not in other parts of the country. The reason is that MTBE blends were more prevalent in the North-east. The shortages result from the fact that gas stations need to flush their storage tanks as they make the switch. I think Strassel may have said that gas shortages were due to ethanol shortages, which is not true.
Anyway, Strassel’s argument was that oil prices are high partly becasuse of the shortages created by the switchover from MTBE blends to ethanol blends. This may be true if prices in the north-east went up more than in other parts of the country. But it doesn’t explain gas prices going up elsewhere. (California, for example, switched over to ethanol blends 2 years ago, so this had no impact there now.)
Posted 29 Apr 2006 at 4:47 am ¶
WJGollatz wrote:
I came across this site while doing some research and I read most of it until I realized that the blogger and the commentators have little understanding of the tables they used, and have come to wild conclusions with little basis in reality.
To go over one set of data. The 2003 Preliminary CA findings. The retail cost of gas went up 35.95 cents. The cost of crude went up 14.45 cents. The cost of refining and profit making by oil companies went up 9.3 cents. THE INVOLVEMENT OF OIL COMPANIES ENDS AT THE SPOT PRICE. For every penny of refining/profit increase, the price of gas went up 2.86 pennies in other areas.
Oil companies only operate 3% of retail gas stations, despite whatever sign you may see on them. Someone else buys gas from oil companies AT THE SPOT PRICE and sells the gas to gas stations. 9.21 more cents were built into the gas price to fund the activities of the distributors (the people that own the trucks that delivery the gas to stations) and the stations themselves. Almost all gas station operate on a just-in-time marketing method, in that they need constant resupply of gas. So yes, many of the distributors and large gas station enterprises will use computers to see what the spot price of gas is, and change the prices accordingly, because of the spot price goes up too much, these retailers which typically profit just 3 pennies per gallon may not have enough money to make the next delivery, so they try to anticipate price changes.
If you want to talk about profiteering, discuss why the 2nd highest component in a gallon of gas is taxes.
Posted 28 Dec 2007 at 5:33 pm ¶
sarabeth wrote:
This comment makes no sense whatsoever. Most of what you’re saying is totally irrelevant to the issue at hand.
Oil companies extract and/or buy crude. They refine it into gasoline. They sell gasoline AT THE SPOT PRICE (there; my argument is now as impressive as yours) into the wholesale market where it is bought by retail outlets who typically earn just 3c a gallon, whether crude prices (or gasoline prices) go up, down or sideways.
So, when the retail price of gasoline shoots up, this potentially affects the profits of the crude oil extractor and the crude oil refiner, but not the retail outlets.
If the retail price of regular unleaded gas shoots up by 35.9c a gallon when the cost of the crude oil required to produce one gallon of regular unleaded gas goes up by 17.4c (and Distribution and Marketing Costs don’t change), it is indubitably true that the profits of the crude oil refiner went up.
This fact remains true even if Distribution and Marketing Costs goes up up by 9.21c (though I have no idea where you’re getting that number from).
That’s all the post argues. Oil company profits soared to obscene heights not just because crude prices went up but because the oil companies increased their refining profits too under cover of the crude price increase.
Nothing in your comment explains why you think this is wrong.
From where I’m sitting, the little understanding of the tables used, and the wild conclusions with little basis in reality are all yours. And unlike you, I’m explaining why.
Posted 29 Dec 2007 at 8:27 am ¶
LarryT wrote:
It seems like the issue may be more simple than that. Most business tracks performance based on gross profit margin ( what pct. of your selling price is profit). If you sell a product for $1 and your input costs are 50 cents, your gross profit margin is 50%. If your input costs go up by 10% to 55 cents, in order to maintain a 50% gross margin, your sale price has to go to $1.10, assuming nothing else changes. This is a 10 cent price increase even though your input costs only increased by 5 cents. In a true competetive market, a company would try to reduce their internal costs so as to keep their sale price as close to the original $1 price as possible, while still maintaining their net profit margin ( which includes all costs, admin., sales, etc) as close to the original % as possible.. In this way they increase market share, revenues and profits.
In the case of the oil companies, it seems there is no real competetion, which allows them to not only pass along thier increased input costs, but to also add their profit margin on top of it. Simply put, they can add their profit margin to their increased costs because they all agree operate the same way.
Posted 06 Jun 2008 at 9:09 am ¶
sarabeth wrote:
What this post doesn’t need at this point is retarded mathematical analysis.
Input costs went up by 10%, the price went up by 10%, and lo and behold the profit goes up by 10% too. Even though the cost only increased by 5c. Wow! Be sure to tell the little children when to clap.
If you go back and read the post and comments 1 and 2, you’ll see (or maybe not?) that we already went over this.
Posted 06 Jun 2008 at 11:44 am ¶
LarryT wrote:
Sarabeth, excuse me, I was not aware that the “Pope of Blogs” had died and you had been appointed replacemnent. If we don’t need retarded mathematical analysis, we certainly don’t need childish sarchasim. You refer me to comments 1 and 2, I’ll refer you to the original question, “why do oil companies profits go up just because the price of crude oil does”? The point I was making, which you chose to ignore, was that, due to consolidation, mergers and acqiustions, there is no real competition . This allows the oil companies to not only pass along their cost increase, but add their profit margins on top. It is so nice to be a part of mannerly discouse isn’t it?
Posted 13 Jun 2008 at 11:02 am ¶
sarabeth wrote:
Your “childish sarchasim” “Pope of Blogs” notwithstanding, your opening mathematical analysis was retarded. Not only that, it was a pointless rehash of ground already covered.
If you can’t take criticism, maybe you should stay home and not venture out into comment-land?
As for “why do oil companies profits go up just because the price of crude oil does”, that was Jon Stewart’s original question, not mine.
My original question, in this post, was:
Do gas prices and oil company profits go up a lot more than warranted by the increase in crude oil prices?
And I crunched the numbers to show that they do.
I didn’t comment on the point you seem to be so proud to have made because:
a) I didn’t have any problem with it
b) it’s perfectly obvious; companies are able to make excess profits only when there is imperfect competition.
You evidently expected some kind of standing ovation for that, huh?
Posted 13 Jun 2008 at 11:27 am ¶
LarryT wrote:
I’m just happy that someone wrote something here that you “didn’t have a problem with” other than what you wrote yourself. No one expects a standing ovation. Where I come from we have something called “manners”. When you use them, it facillitates communication and seperates one class of people from another. That seperation is quite eveident in what has transpired here. Since we are discussing the related topic of energy, I won’t waste any more of mine with this mental masturbation.
Posted 13 Jun 2008 at 8:40 pm ¶