On Thursday, Shell U.S. delivered an absolutely classic example of how the biggest factor determining prices at the pump isn’t war, or even the price of oil. It’s greed. Pure, 103-octane, high-test, unadorned greed that takes money from the pockets of commuters trying to get to their jobs, and deposits it directly in the bank accounts of speculators and oil executives jetting to their vacation homes.
As CNN reports, Shell announced a share buyback program on Thursday in which it will purchase $4 billion of its own stock, which has already had the effect of generating a spike in the stock price. At the same time, Shell is increasing its dividends by 15%, rolling out the cash to big investors. And Shell can do all this because it “posted net income of $9.45 billion in the third quarter, more than double the $4.1 billion it recorded a year ago.”
Oil prices are down $3 this week, but at $89/barrel, they’re still high. However, the last time oil was this high, gas prices were much lower—and so were energy company profits.
How does all this look for Shell? It looks great! That $4 billion buyback locks in a floor price for Shell’s stock, and the 15% increase in dividends bolsters returns for those who decide to sit pat on their stack of Shell shares. And record profits never hurt. The result is about what you would expect.
Shell’s announcement of record profits, a stock buyback, and dividend increase.
But how did they do it? If you look at a chart of gas prices vs. oil prices over the last dozen or so years, things at first don’t seem that odd. Gas prices have always been tied closely with rising oil prices, and that doesn’t seem to have changed.
Oil prices ($ per barrel West Texas Intermediate) vs gas prices (national average, regular formation). Data from EIA.gov
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But there are a couple of things going on. Sure, that relationship between oil prices and gas prices is still there. Only, if you look closely, things have changed. The biggest part of that change came back at the tail end of 2014. That’s when, in spite of rapidly declining oil prices, gas prices failed to keep up. The way oil companies paved over that dip helps to explain why recent years have been so good for them: Over the course of this period, what consumers were charged for a gallon of regular gas changed from about 3% of the cost of a 42-gallon barrel of oil to more than 5%.
That’s one thing that’s changed. But it’s far from the biggest factor in those record profits.
A barrel of oil holds 42 gallons. That barrel produces around 20 gallons of regular formulation gas. That makes it seem as if consumers are getting a bargain. Why, gas costs only $3.77 today when the material cost alone is $4.45! How do these oil companies stay in business?
The answer is in two parts. First, that barrel makes 20 gallons of gas, but it also makes other things—from jet fuel to fuel oil to lubricating oil to asphalt—all from that same barrel. Gas is just a part of the potential profit. If there weren’t at least $89 to be squeezed from that barrel, it would be cheaper.
But the bigger reason is that Shell—and, with few exceptions, all the other companies making the gas that goes in your car—are racking up record profits is that these companies don’t buy oil. They produce it. That $89 barrel price is the asking price. It’s a long, long way from the production cost. In the United States, the production cost of a barrel of oil in 2022 can run as high as $69 from new wells, or as low as $23 from existing wells. The overall average cost is about $48. Cost of processing that oil into gas is about $3 a barrel. Plug in those numbers, and the actual cost of producing a gallon of regular gas in the U.S. right now is about $1.21.
That cost actually fluctuates much, much less than the price of oil. That’s because the price of oil is driven primarily by speculation. It ranges widely. Production costs are just production costs. They go up and down like other industrial costs, but they’re much less subject to large or abrupt changes.
When the price of oil goes up, the price of gas at the pump goes up … but it doesn’t have to, because the cost to the gas companies is tied to their cost of production, not to the sale price of oil. That difference between what it actually costs to produce a gallon of gas and what it sells for … that’s the real Texas tea.
On the other hand, those gallons of gas are actually competing with the profit the company could turn by just selling the oil to someone else. One way of viewing the connection between gas prices and oil prices is that it’s a competition taking place on the balance sheet of oil companies. What consumers will pay for gas is being weighed against what a company could get for a barrel of unprocessed oil. If Shell (or Exxon or BP) can actually find a taker for $89 barrels of oil, then gas prices go up—not because the cost of making that gas has gone up, but because the company is seeking to maximize profit over every barrel it makes. And, of course, if a company has to buy some of its oil to make gas, every barrel purchased cuts into those profits gained by selling produced oil at a 100% (or higher!) markup.
Maximizing profits is, of course, the modern view of capitalism. Once upon a time, there was a general agreement that corporations had an obligation to their shareholders, their employees, and their communities, and had to balance the benefits to all three. Then somewhere along the line, those second two items got nixed, and shareholder profit became the only thing. It’s simpler that way. And an excuse to do pure evil.
It’s worth remembering that the cost of gas isn’t just the price you pay to get to your job every morning and your kid’s baseball game on Thursday night. Energy costs are baked into everything. A big part of the price increases on everything from food to furniture comes right back to what those companies are paying for fuel.
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