Friday, August 1, 2008

Exploring Big Oil Profits

Exxon mobile set an all-time record profit this last quarter by earning more than $11.7 billion. Defenders of big oil are trying to muddy the waters by comparing Exxon's profit margin to that of other companies in completely unrelated business sectors. These defenders say to look at Microsoft, whose profit margin is a staggering 29.26%, and try to justify Exxon's massive profits as somehow being inferior because they are only at 8.7%.

When you compare Microsoft's profit margin to similar companies in their industry you can see their profits are not that far out of line. Google has a profit margin of 24.63%, for example. These tech companies benefit by making non-tangible products that have little production costs. It is also worth noting that not every person has to buy a Microsoft or Google product and certainly not multiple times a week just to survive.

So what happens when we compare big oil's profit margins to other companies that produce necessary commodities, like say supermarkets?

Safeway, Inc, one of the nation largest grocery retailers, had a profit margin last quarter of 2.13%. Kroger Co, another major supermarket chain has a margin of 1.69%. Similar numbers exist across the sector. While corn, milk, rice, and meat prices continue to climb dramatically like oil, these supermarkets have managed to control their own profits.

Why are other commodity based companies, that are also experiencing rapid price inflation, not raking in the massive profits big oil is?

There are a couple of reasons. First, these other companies don't base their markups on percentage of acquisition costs, but on actual production costs needed to operate their stores while still making a respectable profit for their shareholders. For example, grocery store A knows they need $X to pay their bills, employees, and have a little left over for profits. So, when their costs for goods increases by Y dollars, they can just increase their cost by $Y and still have $X left to cover the bills and maintain their profits.

The second reason just boils down to moral values and social responsibility. These supermarkets know families rely on them to feed their children. They also know that if a family has to spend all their money on food, they won't have anything left to spend on luxury items which keep other local businesses growing and creating news jobs that bring new families to the community and thereby increasing the store's customer base and profits.

Big oil bases its markup solely on a percentage. If oil costs them $X they will charge $X times Y. Let's say their markup is 8.7%, thus if the cost of oil rises from $100 to $140 per barrel, their profits rise from $8.70 per barrel to $12.18 per barrel. Since they state the demand for oil continues to grow, they have little to no fear of selling less barrels tomorrow than they are today.

If big oil operated like grocers, they would decide on how much profit they really need per barrel and just base their markup on a set dollar value per barrel. Their shareholders would still see rising profits because the demand for oil continues to grow letting Exxon sell more barrels. More barrels sold equals more profit.

Oil and gas prices would still be rising, but at a much slower and manageable rate. Consumers would still have money left over for luxury items after they fill the tanks of their cars and trucks. Other companies would continue to sell their goods and grow their businesses, which in turns grows wages and jobs, which in turn takes care of any minor commodity inflation.

In staying with our Teddy Roosevelt Republican values, the government does have a responsibility to regulate businesses whose activities are having a dramatic and negative effect on society. There is no doubt that Exxon, Shell, and other big oil company actions through mergers and acquisitions, for the purposes of restricting competition, and their insistence on not managing their profits more responsibly warrants some regulation.

We would not suggest weird tax schemes on big oil profits like Sen. Obama and the Democrats. Those tax increases would only be passed on to consumers. Doing nothing is not the answer either. Maybe price controls that require big oil to justify a specified dollar per barrel markup that is based on actual production costs and not on the whims of speculators on the open market would be more appropriate. Heck, just the threat of a united Republican and Democrat response considering doing just that would be enough to get Big Oil to regulate itself.

1 comment:

george said...

You correctly identified one red-herring that big oil supporters use, the fact their profit margin is less than other companies.

Another one being circulated attempts to defend Exxon-Mobil and other US oil companies on the basis that they are not even the major players on the world stage. In fact, Exxon-Mobil, is not even one of the 10 largest oil companies in the world. Hence, they are just a little guy trying to make a living and have little control over their profit.

It is true, if you base the size of an oil company on its PROVEN RESERVES, Exxon-Mobil, is not among the 10 largest oil companies in the world. That honor belongs to Saudian Arabian Oil Company.

However, if you base the figure on revenues the list changes. In 2007, Exxon-Mobil had gross revenues of $400 billion, number 1 in the world. But the entire country of Saudi Arabia had gross exports, oil and everything else, of $230 billion. Therefore, even though their national oil company is the "largest", the entire Saudi Nation exported less than Exxon-Mobil's gross revenue.