November 04, 2005,
Congress is clamoring for an investigation into why it is that when the price of oil spikes, oil companies make higher profits. This shouldn’t be a mystery for anyone with a high-school-level knowledge of economics, but that exalted category apparently doesn’t include much of the Democratic caucus nor Senate Majority Leader Bill Frist, all of whom favor a probe. The twin villains of the oil-profits story are easy to identify: One is called “supply,” and the other “demand.”
ExxonMobil has stoked the congressional outrage by having the temerity to make a $9.92-billion profit in the last quarter. Anyone who even scanned the headlines in recent months might find this unremarkable, since they have been blaring news of the price of a barrel of oil hitting nearly $70 in reaction to surging world demand, turmoil in the Middle East and monster hurricanes hitting the Gulf Coast.
If executives of ExxonMobil had anything to do with these circumstances, they are the most powerful people on Earth, and perhaps Congress really should try to prevail on them to create harmony in the Middle East and less cyclonic activity in the Atlantic Ocean. ExxonMobil stockholders, on the other hand, might have grounds for a shareholder lawsuit if the company’s executives have always been capable of manipulating world conditions to their advantage and have negligently failed to do so. Where were these executives when the price of a barrel of oil was dropping to $10 a barrel in 1998?
ExxonMobil and other oil companies are riding the crest of a boom in what is a notoriously boom-and-bust business. Economics writer John Tamny recalls that when oil prices last soared, around 1980, oil companies were 28 percent of the S&P 500’s value. Investment in the industry fell along with oil prices throughout the 1980s and 1990s, and oil companies’ share dropped to 7 percent of the S&P 500. Now it is 10 percent and will probably go higher with the prices, before dropping again when prices fall, and so on and so on.
Even in this boom, there’s nothing untoward about ExxonMobil’s profits. They are big, but it is a big company with big expenditures. What is important is the profit margin. For every dollar in sales, ExxonMobil makes 9.8 cents. McDonald’s and Coca-Cola make 13.8 cents and 21.2 cents, respectively. Google makes 24.2 cents, and Merck, Bank of America, Microsoft and Citigroup all make more than that.
As an industry, oil and natural gas are less profitable in terms of cents per dollar of sales than banks, pharmaceuticals, software companies, telecommunications, insurance and a host of others. The most outrageous oil profiteer is government, which has collected $1.34 trillion in revenue from local and federal gas taxes since 1977, more than double the domestic profits of major oil companies during that time, according to the Tax Foundation
In any case, in a market economy, high profits and high prices are essential. They eliminate scarcity. Investors with visions of dollar signs filling their heads are now rushing into the oil business. That will increase supply. Pinched consumers, meanwhile, are already pulling back on their consumption. Compared with a year ago, gasoline deliveries declined 4 percent in September, the biggest drop in a decade. That will decrease demand. These two trends make for falling prices. Any political interference with this process through price controls or a tax on companies’ “windfall” profits will only preserve the conditions for scarcity.
Jerry Taylor of the Cato Institute points out that at a time of a record run-up in oil prices in the late 1970s, President Carter stripped away most of the counterproductive price controls that were in place when he took office. Running against him, Ronald Reagan promised to deregulate even further. So it isn’t inevitable that politicians have to react stupidly to high oil prices. There appears, however, during the past 30 years to have been a dramatic increase in economic illiteracy in Washington. Maybe Congress should investigate.