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Oil Company Economics

by: Felix Salmon July 17, 2008 | about stocks: BP / XOM    
Felix Salmon

Felix Salmon

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What would constitute price manipulation in the oil industry? Howell Raines doesn't blame speculators for high prices in his latest column; instead, he blames the oil companies themselves.

Supply and demand? Sure, but as John Lee, a business journalist at the Wall Street Journal and the New York Times for many years, reminds me, supply and demand in oil are not just "two pie charts-- where it comes from, where it goes, measured maybe five years ago." There are more complex reasons for pain at the pump. "American gasoline prices have always reflected the latest spot price, namely what you have to pay to buy bulk gasoline on the open market. This is last-in pricing, rather than pricing based on inventory costs."

Now, let's say you're an oil company selling bulk gasoline, and suppose your inventory contains some gasoline made from $140-a-barrel oil and some that was purchased for $75 a barrel. That leaves a lot of room for price manipulation.

It seems that Raines thinks the oil companies should sell gasoline according to what they paid for it, rather than what they could sell it for on the wholesale market. But they're privately-owned companies: they have an obligation to their shareholders to sell at the market price, when prices are rising. Gasoline prices are always determined primarily by the latest spot price for oil, rather than inventory costs, just as you'd expect: there's nothing new going on here.

Raines does make one intriguing point:

As journalism has passed from a hungry to an elite profession, there's no shock value in the fact that Exxon Mobil paid only $5 billion in U.S. income taxes last year while it paid $25 billion to foreign governments. Even with Exxon Mobil making $76,000 a minute, the last thing that occurs to many assignment editors and reporters is to investigate whether a windfall-profits tax would drive Exxon Mobil, BP, and other oil companies to invest in the alternative-energy strategies they boast about in their television commercials.

I don't know what to make of the first comparison without knowing much more about what the $25 billion figure represents: if it's royalites for oil rights, it's very low. But what of the second point? Would a windfall-profits tax drive investment in alternative-energy strategies? I can see how it would drive investments overall, if those investments came out of profits, thereby bringing profits down. But it's easy to invest enormous amounts of money in hydrocarbon exploration and development with reasonably certain returns. Investments in alternative energy, by contrast, tend to be much smaller and be much less likely to generate future profits. So I suspect that insofar as a windfall profits tax would spur investment, it would be much more on the fossil-fuel side of things than on the alternative-energy side of things.

 

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This article has 7 comments:

  •  
    Jul 17 02:54 PM
    Brilliant! Mr. Raines beleives that some arbitrageur should pocket the delta between what something is "worth" according to the market, and what the raw materials "cost" to the manufacturer. I'll bet this arrangement works great when the demand side dips, and the "cost" of inventory is now greater than the market is willing to pay -
    Reply
  •  
    Jul 17 05:21 PM
    Repeal the $.54/gal import tax/tariff on imported ethanol. Collect a windfall profit tax on oil companies and use it to provide a subsidy for oil drilling and building refinieries anywhere in the world including sugar cane refinieies in poor countries that will reduce gas and food costs as well as illegal alien invading the USA. Presemtly, oil companies are using profits to buy back their own stock.
    Reply
  •  
    Jul 17 09:00 PM
    What's happening right now is the only way to reduce gasoline costs. That is use less. XOM buys 70% of the feed to refineries. They pay market rates. Several of their refineries are losing money right now. Look at Valero, et al and see how just refinering profits jump around. If demand is cut, oil prices will drop, speculators will lose big time. Ethanol is a joke. Look at the food prices in the world. Buy it and see your mileage drop like a rock. Starvation is not a good tradeoff for oil. If the process for nonfood ethanol could be competitive, then go for it. Brazil does it with cheap manual labor. Use modern machinery and see what your overall energy ratio is to produce the ethanol. If the oil companies are such a great investment, please invest in them to keep my stock price up.
    Reply
  •  
    Jul 18 08:30 AM
    ". . . suppose your inventory contains some gasoline made from $140-a-barrel oil and some that was purchased for $75 a barrel. That leaves a lot of room for price manipulation."

    Crude oil was last priced at $75 per barrel in the September 2007 timeframe. Could you provide crude oil inventory turnover data that would give the reader a more realistic idea of what this scenario might actually look like? I seriously doubt that under any circumstance would it take 10 months for a refiner to turn its crude oil inventory. A refinery processing 200,000 BPD would have to have storage tank capacity of 60 million barrels.
    Reply
  •  
    Jul 18 09:06 AM
    The NYTimes should bulldoze their HQ and drill 3 miles into the earth. At the very least, we can get rid of a major source of public ignorance.
    Reply
  •  
    Jul 20 08:45 PM
    Felix, was this trip really necessary ?
    Reply
  •  
    Aug 02 06:21 PM
    Do any of these socialists -- sorry unbiased journalists -- stop to think who owns Exxon and Chevron? Whose "windfall profits" are they wanting to tax?

    Someone at the NYTimes ought to look at all the pension funds, insurance funds and mutual funds where Americans (and NY Times readers and "journalists"... have our money.

    The largest cap company in the S&P is Exxon Mobil.

    So how many NY Times journalists will it take to figure out the largest holding in every S&P500 and quasi S&P fund in the country? No cheating now...

    The NY Times isn't losing readers just because of the internet. They are losing readership because their reporting is nothing short of moronic; their "journalists"... have less ability to connect the dots than does the CIA.

    Of course, a truly investigative journalist (or anyone who is literate) could easily look up what happened in the 1970s, the last time we imposed windfall profits tax on oil companies. US oil companies lost market share, while foreign state run oil companies gained market share. Some of these windfall profit winners diverted some of their profits into funding extremist schools and indirectly terrorism.

    So you have to infer the NY Times would rather support terrorism against Americans, than a fiscally prudent retirement for Americans.
    Reply
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