Oil Executives Face the Big Bad Government

On April 1st, executives from some of the world’s largest oil companies testified to a committee in Congress about their record profits in the last couple of years. Executives from Shell Oil, ExxonMobil, BP America, Chevron and ConocoPhillips argued to Congress that their profits were not a result of their greed, but rather a result of the rising costs of producing refined oil and investment costs.

While many feel the oil companies are sitting on their high thrones, not caring that all the while we are suffering the increasing prices, some lack a true understanding of how they really make and spend their money. Oil prices mainly fluctuate for many reasons, as described in another of my posts, but not always by corporate greed. The Congressional committee proposed to revoke $18 billion in tax breaks from the oil companies, and also challenged the companies to invest 10% of their profits to investing in renewable resources. This large reduction in profits will no doubt shoot oil prices even higher.

Oil companies, along with many other industries, make their money on a cost-plus basis, or via a profit margin. A simple understanding of Econ 101 explains basically that companies who work via a profit margin build in a profit percentage on the product they sell, and add it to the cost of the raw materials needed to produce the good. This cost is a “variable cost” in terms of a dollar, meaning it changes when cost changes. Simply put, if the cost to produce a widget is $10, and the profit margin is 10%, the company will profit $1 on the widget. If suddenly the cost increases to $20, the company will make $2 off the widget. They did nothing different, and did not manipulate their profits, however gained more profit because of the cost increase. This increase in price is not due to any greed by the company, as they do not control the cost of the raw materials to produce the widget.

On average, the profit margin of the oil industry is 8.3%. As a former retail employee in what feels like a past life, I can tell you that a profit margin that low is very atypical. Retailers such as Best Buy or Wal-Mart have massive profit margins on the goods they sell. For example, when working at Best Buy, I found that the cost of a simple printer cable was $1.21. We sold that same cable for $32 to the public, a 2,644% profit margin! Granted in dollars we are talking about profiting only $30 and some change off the cable. But, let’s put it into the proper perspective. With a barrel of oil teetering just over $100, and an average profit margin of 8.3%, the oil companies are making a whopping $8.30 off the barrel of oil! Hardly a wild profit to accuse an entire industry of price gouging over.

As stated to the Congressional committee, the major oil companies also use a portion of their profits for investment in other renewable fuels and new methods of energy conservations, as they understand their business is threatened by the eminent threat of oil “drying up”. Edward Markey, the main voice of the Congressional committee, proposed to repeal tax breaks to the oil companies that will amount to $18 billion over the next 10 years, and use the increased revenue collected to invest in wind, solar and other renewable fuel sources and incentives for energy conservation. Increased taxes on the oil companies will only increase the cost of producing oil as taxes are typically factored in with cost-plus pricing. Therefore, the government would single handedly increase the price of oil by $1.8 billion a year that we will share the burden of. Legislation has already been approved by the House to do this and is currently in the Senate. Thanks guys.

“To be vilified by our own government is an embarrassment for all of us.” said John Hofmeister, president of Shell’s U.S. division. He is right. The sooner the government realizes that the oil companies are the ones with capital, infrastructure and knowledge to bring about renewable, cleaner energy sources, the sooner we can accomplish our goal of weaning ourselves off oil.

What do the presidential candidates feel about all this? According to all of the candidates’ websites, Ron Paul is the only candidate to lay out an actual plan besides pointing out a “need for freedom from oil”. He is proposing, and has actually already sponsored legislation to give tax credits to solar property, fuel cell property and installation of wind energy property. The other candidates do not lay out any specific details on how they will achieve energy independence, or help to reduce gas prices.

It is unanimously agreed that America needs to wean itself off of oil. The higher prices we face are due to many different aspects, as described here, not necessarily extreme greed by oil companies. It would be nice if they could cut some profit to help us a bit at the pump, but on the other hand, the government could decrease the massive taxes on the oil companies, because that would reduce costs, and in turn reduce our prices at the pump. Just a thought…
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