Oil Pricing Conspiracy

So we are back to demagoging the oil companies again. We’ve been here before. Back when I first started this blog we were blathering about oil company “windfall profits.” We were wrong then, and we are wrong now.

Center for American Progress published this chart along with an article filled with outrage about oil companies, their “record profits” and the criminality of their pricing policies. It’s always kind of fun to see people trying to prove one thing with a chart and actually wind up illustrating the precise opposite, because what the chart actually shows is that oil company profit margins have remained constant throughout the price increase. Oil companies have, in fact, behaved with completely proper fiscal discipline, that there is no improper profiteering, and that oil companies clearly are not at fault for high gas prices.

While the amount of profit may be a record highs, the margin of profit is precisely the same as it has been for years. The profit records are being set because sales records are being set, not because the oil companies are engaged in profiteering.

Sellers always set a target of profitability as a percentage of revenue, much as you would set desired rate that you want to obtain on your savings. If costs go up they will raise prices to maintain their profit at the same percentage of revenue, unless market forces prohibit them from doing so. Since we are using gasoline at pretty much the same pace as ever, oil companies are able to pass their costs on and maintain the same level of profit, as is shown by that chart. They have not reduced their level of profit, but neither have they engaged in “profiteering” by increasing it.

Reflecting on that rate you set as the target rate that you want to obtain on your savings; if you had more money to save would you be willing, then, to earn a lower rate on it just because there was more of it? Neither is the oil company willing for the income portion of their revenue to be smaller just because the revenue is larger. And there is no reason for them to do so.

The writer says that “oil prices have risen by a third in just more than two months, spurred largely by speculators capitalizing on unrest in North Africa and the Middle East,” and President Obama has opened an investigation to root out speculation and evil doing in the oil trading markets. Yes, we heard that in 2008 too and it was as nonsensical then, as later investigations revealed, as it is now.

Ezra Klein wrote a piece in the Washington Post the other day on the subject in which he reached the right conclusion about speculation as a cause, but for the wrong reason. He said that, “if you’re seeing speculation, you should be seeing a massive run-up in inventory.” Sadly, no. Holding a commodity off the market and then selling it after the price goes up is only one form of speculation, and it’s not one that works very well in the oil market. In land speculation, for instance, holding land off the market is hardly likely to make its value increase, other than in special and rather rare circumstances.

The land speculation that fueled the S&L crisis in the 1980’s took the form of selling a piece of worthless land repeatedly, each time at a larger price using a bogus appraisal. Similarly, a tanker-load of oil can be resold several times while it is in transit from the Middle East to its destination refinery. Unfortunately for the conspiracy theorists, there’s no evidence that any such speculation is happening.

Ezra Klein gives as the reason a lengthy description of production in Saudi Arabia and consumption in China, which sounds very expert and knowledgeable, but which doesn’t really hold up well to rigorous scrutiny. Actually, it doesn’t even hold up very well to even casual scrutiny, which is all I gave it before his theory pretty well collapsed as a prime mover of the major basis for the huge rise in prices.

Not that these factors are not contributing to the problem. Oil companies could reduce their profit margins slightly without economic harm to themselves or their investors, speculation in the trading market does raise prices a bit, and prices do go up as the demand increases, but none of them is the real issue that has caused the major change in the cost of oil out of the well or the price of gasoline at the pump.

The real driver of that change is the dramatic drop in the value of the dollar. Whether drilled in America or Brazil, oil is traded on the international market and we pay for it in dollars. When the dollar decreases in value it takes more dollars to pay for a barrel of oil, and the international value of the dollar has dropped enormously in the past few years. The cause of that drop is a bit complex, but it is largely due to the economic policies of our own government, policies which have allowed it to continue spending more money than it takes in.