A dear friend of mine politely asked what I thought was going on with oil prices. He thinks they are increasing at a ridiculous rate, and questioned the oil companies’ explanation that this was part of a cycle, and questioned whether oil companies ever experienced a bad time …
This is certainly worth talking about. I am not an oil industry apologist, but I think your anger is a bit more than misdirected in this case.
- The 90s were actually a pretty bad time for oil companies. People seem to forget that one of the many reasons that SUVs began to get so popular was that as recently as 1996 gasoline was $1.00 per gallon and oil was trading at $10 per barrel.
- Oil company margins (see me for a definition, basically what percentage of their revenues end up as profits) are BELOW the average margin of publicly traded companies, somewhere in the 8% to 9% range.
- There have been many other downsides – particularly since many of the oil companies made heavy capital investments in teh early 1980s under the expectations that oil prices would remain high – and they did not.
- Oil companies, unlike virtually any other companies, face regular scrutiny from unscrupulous, populist legislators seeking to win brownie points with voters for “doing something about” high energy prices. Excess profits taxes?
- Oil companies regularly face risks that most other companies are not subject to. The major risks include being expropriated by dictatorial rulers (remember Venezuela), bearing the brunt of virtually all climate change policy (but I can show you a case where they will stand to benefit! That’s politics for ya), and facing extreme regulatory restrictions on where they can drill, and what they are able to produce.
- Listen, I like cheap gas as much as the next guy, but how am I supposed to interpret the phrase, “ridiculous rate” at which prices increase, What is appropriate? Who deems it to be appropriate?
- Explanations that rely on oil company greed simply do not make sense. Ask yourself, are oil companies suddenly greedier today than they were a month ago? Than yesterday? Why? And if they had the ability to influence prices up to $4.00 per gallon, why weren’t they doing it years ago? This is not to say that they aren’t greedy, but to analyze changes in prices like this, you need to understand what else is changing. I will assert that greed doesn’t change that rapidly.
- Remember that most of us have retirement money invested in oil companies.
- Remember that when we pay high prices for oil and gas, that this money does not disappear. I am not saying it ends up in yours or my hands, but it is either distributed to shareholders, paid out in higher salaries, retained and reinvested, …
- Now, for some explanations. It is very likely, perhaps unfortunately, due to basic supply and demand factors. While oil output has somewhat stagnated for a variety of reasons, we are seeing demand pressure for two reasons. One of these reasons is to be absolutely celebrated. The second makes me queasy. The large increase in demand for oil, particularly for refined diesel, has been due to rapidly advancing standards of living and growth in developing countries – particularly China and India. This is a glorious thing, is it not? And we must keep in mind that Chinese and Indian individuals and companies cannot simply demand more oil – they must be producing goods and services (that were not being produced earlier) in order to exchange for that oil, and they are making investments with oil and energy so that they can produce even more in the future. This production not only helps bring hundreds of millions of desperately poor people out of poverty, but it also benefits us – after all, it deepens the global division of labor, and extends our network of trading partners. The second reason demand has increased is because it is much easier for institutional investors to invest in oil markets – leading some (many) to believe that a good share of the oil price spike has been due to speculative pressure. This may not necessarily be an awful thing (ask yourself if you think it is OK for farmers to sell their crops forward, or to sell puts on their crops), but if it is happening with skinny margins, then I might have some serious reservations against it.
- US devaluation of the dollar has likely contributed somewhere between $20 and $50 to the increase in the price of oil we have seen. Note that oil prices have risen worldwide, so this cannot explain ALL of the price increase. The weaker US dollar is a direct function of absolutely horrible fiscal and monetary policy. On the fiscal side, persistant federal budget deficits are primarily the culprit. On the monetary policy side, easy money policy by the Fed is the culprit. You might have something to say against oil companies if the prices of virtually every other commodity have not been going up, but oil prices are somewhere in the midrange of price increases for other commodities. Listen, I am both annoyed and confused, but railing on oil companies is probably not the most useful way to explain what has been going on (do you think they want this scrutiny?). There is more to say, but I don’t wish to bore you much more.
Hope this didn’t come off as too cranky. I am a 90 year old trapped in the body of a 30 year old. Happy reading!