The Feeding Frenzy Can Begin

The feeding frenzy that the media has been salivating over for days can begin, now that Exxon-Mobil (XOM) as announced quarterly profits.  They reported net income of $8.4 billion on $88.98 billion in sales, for a net income margin of 9.4%.  Previously I observed that 9.4% for a peak profit in a cyclical industry is pretty average, and that over the last decade oil company profits have been below average for the whole of US industry.

In fact, most investors found these profits to be disappointing.  You know you have a fun CEO job when half the country is pounding on you for profits being too high and the other half are pounding on you for profits being too low.  The fact is that XOM and other large US oil companies don't get the benefit of rising oil prices that they did, say, 40 years ago.  US oil companies no longer own most of their overseas reserves since many of their foreign operations were nationalized by countries in the 1960s  (with the US government refusing to lift a finger to protect these US assets, one of the early instances of the no-blood-for-Exxon argument).  Today, XOM must pay near market rate for much of this crude, either in arms-length purchases or through royalty agreements stacked in the favor of local governments.

So what can you folks who are screaming about high gas prices and obscene oil company profits do?  Well, you could tax all these "windfall" profits away, like Ford and Carter did in the late 1970s.  Of course, you would still be paying $3 for gas, but the profits would go to the US Congress to spend, who I am sure will do an excellent job.  Probably could pay for another bridge in Alaska.  Or, you could somehow ban oil companies from making a profit, and drop gas prices by that 9.4%, or about 28 cents.  This would get you $2.72 gas instead of $3.00 gas.  Feel better?  Of course, in either scenario, oil companies would stop making any investments in refining or oil exploration.  Supplies would quickly begin to fall (I won't go into it now, but take my word for it that refineries and oil wells require constant reinvestment just to keep running at current capacity) and I would bet it would take less than a year for that 28 cents to be right back in gas prices due to shrinking supply.

OK, what else could we do?  Well, we could cap gas prices.  Which is a fabulous idea, as long as no one who drives a car has anything better to do than sit in lines all day.  Or, we could regulate oil like we do telephones and electric utilities.  Highly regulated electric utilities make a net income margin of 7.1%.  If we regulated oil companies down to 7.1%, then this would reduce gas prices from $3.00 to $2.93.  So a huge and inflexible and costly national regulatory structure would save about 7 cents a gallon.  Oh, and since for most of 10 years oil company profits have been less than 7.1%, then, a utility type regulatory environment would likely raise gas prices and profits in most years. And of course you would get all the business flexibility, creativity, and customer service currently demonstrated by your local electric and phone company.

So what government action should a irate gasoline customer demand?  Well, I know this answer goes against years of education that the role of government is to step in and take over when any little aspect of life is not quite what citizens want it to be, but the correct answer is "none".  Its like the line from Wargames:  "A strange game. The only winning move is not to play."

More on why gas prices are still well below their historic peaks here.

  • Max Lybbert

    I've been thinking about this one for a while, and I think *one* of the causes for discontent is some general feeling that prices should only ever go up if costs go up. That is, there's an opinion that rising demand should not raise prices.

    Of course, the people holding this opinion would accept a pay raise, even if their "costs" didn't go up to justify the pay raise.

    I'd love to climb on a rooftop and shout out "If you make yourself more useful to your company, or if your job becomes more valuable, your pay raise is an example of rising demand leading to higher prices." Although if I did that, I'd probably get arrested for being a public nuisance, and I wouldn't get my point accross anyway.

  • http://voidwhereprohibited.typepad.com/right_to_keep_and_bear_ar/2006/04/think_gases_pri.html Right to Keep and Bear Arms

    Think gases prices are too high?

    Link: Coyote Blog. Coyote Blog has a good post on what can be done. The answer is basically nothing. Or rather nothing should be done. The government is racing to find answers to the gas price, but the problem is

  • Kevin

    I'd like to see the government take more of a role in funding long-term research into alternative sources of energy. Perhaps a prize-based system would work well.

  • http://politics.lel-hosting.com/ Matt

    Well, I'd disagree with you about that. "No action" is indeed preferable to any of the actions you listed, of course. But that doesn't make it best. There are three areas in which government could act to substantially cut the cost of gasoline at the pump without introducing perverse incentives.

    1. Stop blocking new refinery construction. We'd have enough refining capacity to meet our supply needs if it weren't for government interference. And projected supply shortages are the principal reason prices have been spiking lately, as they did last September after Katrina.

    2. CUT or, even better, KILL the outrageous taxes on gasoline. Even in the lowest-tax areas, government gets the lion's share of the pump price. In some places (such as where I live), more money from my gas purchase goes to government than to the oil company, the refinery, the station owner, the tanker truck driver, and OPEC _combined_. Government could cut the price of _my_ gas by more than _half_, _tomorrow_, without negatively affecting _anybody's_ incentives.

    3. Establish _national_ standards of gasoline blending, preempting localized standards and lifting the burden they place on the distributors and the supply chain.

    Of course, all of these could be interpreted as "government doing nothing"...but that sort of "nothing" would require specific, active steps by elected officials, to cease and undo the meddling that's currently going on automatically.

  • http://voidwhereprohibited.typepad.com/musings/2006/04/think_gas_price.html Void Where Prohibited

    Think gas prices are too high?

    Link: Coyote Blog. Coyote Blog has a good post on what can be done. The answer is basically nothing. Or rather nothing should be done. The government is racing to find answers to the gas price, but the problem is

  • gc

    I love this idea of increasing taxes on oil companies because, you know, like, taxing products brings prices down, right? Argh!

  • nopainnogain

    It just doesn't make sense to me. Why penalize a company just because they're profitable? A profitable company secures jobs for Americans and provides dividends to their stockholders. How is this bad?

  • fletch

    And when we go, nature will start over. With the bees, probably. Nature knows when to give up...

    I know I've given up on ever seeing any evidence of intelligence in our government...