Remember when we heard about the huge oil company profits in the months after Hurricane Katrina? I remember the initial indignation but then we were told that it was all a result of market forces, reduced supply because of damaged oil refineries in the Gulf of Mexico with the same or increased demand, and not to worry because the world was running out of oil so these companies wouldn't be making these profits for much longer. Nothing to see here. Carry on.
A recent articleon the CBC website suggests that oil companies are actively "crimping" oil supplies to drive up prices at the pump. And the US Federal Trade Commission is turning a blind eye to practices that "maximize profits."
The article quotes an AP study that turned up evidence based on government and industry reports that oil companies were making deliberate choices to tighten the supply side of the economic equation.
Yet the AP analysis found evidence of at least an underwhelming industry performance in supplying the domestic market, when profits should have made investment capital plentiful:
- During the 1999-2006 price boom, the industry drilled an average of 7 per cent fewer new wells monthly than in the seven preceding years of low, stable prices.
- The national supply of unrefined oil, including imports, grew an average of only 6 per cent during the high-priced years, down from 14 per cent during the previous span.
- The gasoline supply expanded by only 10 per cent from 1999 to 2006, down from 15 per cent in the earlier period.
The findings support a conclusion already reached by many motorists. Fifty-five per cent of Americans believe gas prices are high because oil companies manipulate them, a Pew Research Center poll found in October.
The article gives the example of a refinery in the San Joaquin valley in California. The refinery, owned by Shell, was slated to be shut down in 2003 because it was old and the company didn't want to invest anything to keep it current, citing the limited supply of crude oil nearby. The company wasn't even planning to sell the refinery, painting the picture that no one would want to buy it.
Imports were impractical at inland Bakersfield, Shell explained. Lynn Laverty Elsenhans, the head of Shell Oil Products US, said the refinery here just wasn't viable anymore.
"For this reason, we have not expended time or resources in an attempt to find a buyer and do not intend to do so," Elsenhans wrote to U.S. Sen. Barbara Boxer, D-Calif.
Once the Senate and federal regulators started looking into the matter, Shell decided that maybe it would try to sell the refinery, and guess what, someone was willing to buy. A small independent firm bought the refinery, kept it going at the same rate that Shell had it going at, processing 2.7 million barrels of crude per day. They are making enough of a profit to be willing to sink several hundred million dollars in the outfit to double its output and profitability.
How can it be that just closing down and not even trying to sell a refinery seemed like a good business decision to Shell, when another company deems it worth 100's of millions of dollars to upgrade the same facility?
Let's take a look at this reportby Public Citizen, a public watchdog group, published in March 2004.
The United States has allowed multiple large, vertically integrated oil companies to merge over the last five years, placing control of the market in too few hands. The result: uncompetitive domestic gasoline markets. Large oil companies can more easily control domestic gasoline prices by exploiting their ever-greater market share, keeping prices artificially high long enough to rake in easy profits but not so long that consumers reduce their dependence on oil (after all, if prices went up too high for too long, then we'd seek alternatives to oil).
What does this mean?
The giant oil monopolies are vertically integrated, meaning that they all are involved in the oil and gas industry at every level, including exploration, production, refining and wholesale and retail marketing. This is important to remember when we hear the oil companies' mouthpieces talking about "supply and demand" determining prices at the pump. Often, what that means is that ExxonMobil's wholesaler had to pay ExxonMobil's refinery more, and therefore ExxonMobil's gas stations have to raise their prices. The increased profits all end up in ExxonMobil's bank account. It is what used to be called a shell game.
From the Public Citizen report, if we compare the top 5 oil companies in 1993 with the companies of 2003, we see the following:
- Global crude oil production: 7.7% vs 14.2%
- Domestic crude oil production: 33.7% vs 48%
- Domestic refinery capacity: 33.4% vs 50.3%
- Retail gasoline market: 27.0% vs 61.8%
- Domestic natural gas production: 12.7% vs 21.3%
OK, so they own about half of domestic crude oil production and refinery capacity but they're competing with whoever owns the other half of those industries, right?
Not exactly. The report gives the specifics of who owns refinery capacity in the US and it is a pretty small group. In 1993, the percentage of refinery capacity owned by the top 5, 10 and 15 companies was 34.5%, 55.6% and 68.6%; 2003 percentages were 52.2%, 78.5% and 88.6%. That's right. In 2003, 88.6% of the refinery capacity in the US was owned by only 15 companies.
According to an industry spokesman, dozens of refineries in existence in 1990 were not very profitable, so when environmental restrictions were imposed, they were closed rather than upgraded.
Even as smaller, inefficient refineries closed, some in the industry still worried about having too much refining capacity to turn a profit, according to highly confidential internal documents exposed in a 2001 investigation by U.S. Sen. Ron Wyden, D-Ore.
An internal 1995 Chevron memo relays the warning that an energy analyst made at an American Petroleum Institute convention: "If the U.S. petroleum industry doesn't reduce its refining capacity, it will never see any substantial increase in refining margins," which are earnings divided by operating revenue.
Similarly, a Texaco executive in 1996 complained of "surplus refining capacity" and wrote that "significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline."
Already we have seen a couple of examples where the federal government has become aware of oil companies deliberately limiting oil supply by cutting refinery capacity. Haven't there been any investigations, warnings or fines?
The Federal Trade Commission looked into this issue and published a report in 2001. If you read articles on this issue by authors sympathetic to the oil industry, you will find that they quote the first line only:
The completed [FTC] investigation uncovered no evidence of collusion or any other antitrust violation.
But take a look at a longer excerpt (from Public Citizen):
In fact, the varying responses of industry participants to the [gasoline] price spike suggests that the firms were engaged in individual, not coordinated, conduct. Prices rose both because of factors beyond the industry's immediate control and because of conscious (but independent) choices by industry participants...each industry participant acted unilaterally and followed individual profit-maximization strategies...It is not the purpose of this report - with the benefit of hindsight - to criticize the choices made by the industry participants. Nonetheless, a significant part of the supply reduction was caused by the investment decisions of three firms...One firm increased its summer-grade RFG [reformulated gasoline] production substantially and, as a result, had excess supplies of RFG available and had additional capacity to produce more RFG at the time of the price spike. This firm did sell off some inventoried RFG, but it limited its response because selling extra supply would have pushed down prices and thereby reduced the profitability of its existing RFG sales. An executive of this company made clear that he would rather sell less gasoline and earn a higher margin on each gallon sold than sell more gasoline and earn a lower margin. Another employee of this firm raised concerns about oversupplying the market and thereby reducing the high market prices. A decision to limit supply does not violate the antitrust laws, absent some agreement among firms. Firms that withheld or delayed shipping additional supply in the face of a price spike did not violate the antitrust laws. In each instance, the firms chose strategies they thought would maximize their profits.
See, it's OK for oil companies to choose to "maximize their profits" by keeping market prices high, as long as the FTC doesn't find any evidence of an agreement between them to do so.
What's really interesting is that the federal government doesn't take such a generous view of overconcentration of production within the ethanol industry:
The U.S. Government Accounting Office (GAO) issued a recent report raising concerns that "high concentration would tend to limit competition" in the domestic ethanol-producing industry because the top eight ethanol-producing firms controlled 71% of the national market.
The top eight oil refiners control 70% of the domestic oil refinery market (ConocoPhillips, Royal Dutch Shell, ExxonMobil, BP, Valero, ChevronTexaco, Citgo-Lyondell, Marathon-Ashland). In comparison, the top eight oil refineries controlled 48% of the national market in 1993. So, concerns raised by the federal government regarding overconcentration of domestic ethanol markets should also apply to domestic oil refinery markets, since the structure and economics of the two industries are similar.
Public Citizen goes on to suggest that there may be a link between the government's attitude towards oil companies' profits and the $9.5 million in political contributions made by the top 5 oil companies between 2000 and March, 2004. Oh, and did I mention that 80% of those donations went to the Republican Party?
Having said all of that, I want to be sure to bring you a balanced analysis of this issue, so let us turn to National Review Online's Rich Lowry:
Even in this boom, there's nothing untoward about ExxonMobil's profits. They are big, but it is a big company with big expenditures. What is important is the profit margin. For every dollar in sales, ExxonMobil makes 9.8 cents. McDonald's and Coca-Cola make 13.8 cents and 21.2 cents, respectively. Google makes 24.2 cents, and Merck, Bank of America, Microsoft and Citigroup all make more than that.
As an industry, oil and natural gas are less profitable in terms of cents per dollar of sales than banks, pharmaceuticals, software companies, telecommunications, insurance and a host of others. The most outrageous oil profiteer is government, which has collected $1.34 trillion in revenue from local and federal gas taxes since 1977, more than double the domestic profits of major oil companies during that time, according to the Tax Foundation.
In any case, in a market economy, high profits and high prices are essential. They eliminate scarcity. Investors with visions of dollar signs filling their heads are now rushing into the oil business. That will increase supply. Pinched consumers, meanwhile, are already pulling back on their consumption. Compared with a year ago, gasoline deliveries declined 4 percent in September, the biggest drop in a decade. That will decrease demand. These two trends make for falling prices. Any political interference with this process through price controls or a tax on companies' "windfall" profits will only preserve the conditions for scarcity.
Those poor oil companies! They're not making anything compared to McDonald's, or banks or pharmaceutical companies. Not to mention that damn federal government collecting those damn gas taxes! What do they do with all that tax money anyway? Build roads and schools and hospitals, for crying out loud.
And anyway, it is a simple case of economics, supply and demand: Now that the demand is so high for gas, lots more investors will get into the business and increase the supply, and then the profits for the poor oil companies will fall even further. And people have already cut back on their consumption, so demand is falling, which means the profits will be even less. Simple, right?
Uh, Rich? If oil companies are less profitable than so many other businesses, how can they afford to pay their executives such generous retirement packages?
(Lee) Raymond, the outgoing CEO of ExxonMobil--the biggest of the giant oil monopolies--was paid a reported $51 million in 2005. This is roughly $141,000 per day for every day of the year, or around $6,000 per hour--if you include the hours he was asleep.
ExxonMobil could afford Raymond's exorbitant salary. Last year, it reported profits of over $36 billion--the largest profits for any company in the history of the world. Raymond received a $400 million retirement package this year. (2006)
It is simple economics that gives ExxonMobil "the largest profits for any company in the history of the world."
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Cross-posted at The Next Agenda.