Opinion: Big Oil profits are not excessive

Lately, news about rising gas prices has taken covid off the front pages. We hear prices of $5 or even $6 per gallon. The world average is around $5 per gallon. We in Mississippi have it a bit better with an average price of around $4.40. How mad should we be at Big Oil?

Some back-of-the-envelope calculations might shed some light on this question. According to the US Energy Information Administration, a barrel of oil contains 42 US gallons and produces 20 gallons. of gasoline, 12.5 gal. of diesel, 3.5 gal. of jet fuel and 8 gallons of other products such as asphalt and heating oil. How 42 gallons of oil makes 44 gallons of product is beyond me. My calculations will be limited to the quantities of fuel available from a barrel of oil.

As of June 13, average prices for a gallon of gasoline, diesel, and jet fuel were: $5; $4.34; and $4.24. On that day, oil was selling worldwide at $128.09 a barrel. Keep in mind that there is considerable daily variability in all of these prices. Given these prices, the revenue from the sale of the products of one barrel of oil was $169.09. This means that the oil companies’ gross profit from the sale of petroleum products was $41 per barrel.

Big Oil’s dollar earnings for the first quarter of 2022 looked pretty, to say the least. Together, the top five oil companies made profits totaling $35 billion. You can probably guess who the top five are; Shell, ExxonMobil, Chevron, BP and ConocoPhillips. Before the fuel price spike, each earned between $3 billion and $5 billion. Their profits did not exceed that until April of this year. In fact, in 2020, from January to April, three out of five reported no profit or loss.

The measure of profit most consistent with economics is return on investment, not absolute profit dollars. ROIC tells us how efficiently a company uses its resources, resources that are not available to be used for other purposes. When a company uses its resources in a particular way, society loses the opportunity to benefit from them if they are put to better use. It is a very real and relevant cost to society, but it is invisible. A company’s income statement does not report opportunity costs. There is no concrete way to measure opportunity costs.

This means that economists need to find a reasonable proxy for opportunity costs. A frequently used proxy is the industry-wide average ROIC. If a particular company’s return on investment is lower than the average return on investment across all industries, it is not using the company’s resources in the highest and best way possible. In other words, the cost of the resources that the firm uses outweighs the benefits to society of consuming its products.

In the first quarter of 2022, the returns on investment of Shell, ExxonMobil, Chevron, BP and ConocoPhillips were respectively: 10.86%, 5.78%, 9.64%, 15.15% and 24.78%. Shell would have earned more but it took a long time to shut down its Russian operations. The five oil companies together operate more than 100 refineries around the world, each of which costs between $7 billion and $10 billion. Therefore, collectively, the refining capital structure of these companies is between $700 billion and $1 trillion.

In order to determine whether oil company returns are excessive, they must be compared to the ROICs of other companies. According to NYU’s Stern School of Business, in January 2022, the average return on investment for a large number of US non-financial industry sectors was 10.58%. This average includes ROICs for the advertising industry of 50% and almost 65% for the tobacco industry. A number of high-tech and electronics-related industries also have aggregate ROICs well above those of the big oil companies.

If 10.58% is a reasonable estimate of the return on investment of companies that make the best use of their resources, Shell, ExxonMobil and Chevron are not making excessive profits. ConocoPhillips and BP could be open to criticism or profit. But even they are pikers compared to advertising and tobacco companies.

The two main drivers of fuel prices are the price of oil and state and local taxes, which together account for approximately 70% of the price of a gallon of gasoline. With the exception of a brief spike in 2008, the price of oil is as high as it has been for the past 25 years. Oil is a commodity, so everyone pays roughly the same price for a barrel of oil. Even if the big oil companies could agree to lower gas prices, we would probably still be paying around $4 a gallon. Of course, it would be blatantly illegal for their CEOs to discuss gas prices, even if the purpose of the meeting was to lower gas prices.

However, if Big Oil’s profits are believed to be unreasonably high, the government could impose a windfall tax. Or it could force oil companies to increase their investments in producing more oil domestically or in ways to reduce our dependence on carbon-based energy. In fact, ExxonMobil, Shell, Chevon, and BP are all using a portion of their current earnings to buy back their own shares, which boosts their stock prices.

The repurchase of shares has no advantage for the company; it only benefits shareholders and managers whose remuneration is linked to the companies’ share price. I am more inclined to blame Big Oil on this account rather than them being responsible for the current high gas prices. That blame lies primarily with Mr. Putin and OPEC, which has just agreed to increase production.

Patrick Taylor lives in Ridgeland.

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