Big Oil, Big Profits

ByMike Layne

Missing Milk Crates & Burning SUV’s

What’s the Connection?

• The high price of oil and petroleum-based products

• When the price of gas in California rose to $3.50/gallon in 2005, the resale value of SUV’s plummeted.

SUV’s

• SUV owners were “upside down”• They owed more on their vehicle than it

was worth• The economic solution? –ARSON• Pay someone to steal the car and set it

on fire• Collect from the auto insurance

company and start over again

Got Milk Crates?

• As oil prices climbed, the prices for petroleum-based resin climbed too

• Milk crates are made of such resin• Resin is recyclable • At higher resin prices there were

greater incentives

Nominal vs Real Prices

• Nominal Prices: “Nominal prices are those stated in today’s dollars.” (Gruber, 97), i.e. the Face Value.

• Real Prices: “Real prices are those stated in some constant year’s dollars.” (Gruber, 97). They have been corrected for inflation.

The Common View

• Big Oil manipulates the Big Prices.• …which in turn leads to higher gas

prices at the pump.• But what does “BIG” mean?

Does “BIG” Matter?

• In 2006, the market value of ExxonMobil was $400 Billion

• Shell and BP were both worth $200 Billion

• Chevron was valued at $125 Billion

Size Isn’t Everything

• Collectively, ExxonMobil, Shell, and BP –are smaller than the Saudi Arabian Oil Company.

• Not one of the Big Three are larger than any of the national oil companies of Mexico, Venezuela, or China

Saudi Aramco

• Saudi Aramco is responsible for 99 percent of the Kingdom's proven crude oil reserves of 259 billion barrels -- about a quarter of the world's total conventional oil reserves.

• That is more than double the total of Iraq, the country with the world's second largest conventional oil reserves, and nearly 12 times the reserves of the United States.

Monopoly Power

• Absolute size of a corporation is rarely a good indicator that it is a monopoly.

• In order to effectively raise prices above the competitive level –the corporation must have a large share of the total market.

Zone Pricing

• Big Oil can -and do influence the price we pay at the pump.

• Zone Pricing – Oil companies vary their prices depending on local market conditions.

• For example, upscale neighborhoods may be a nickel or dime more than other neighborhoods 1-2 miles away.

Inflation

• Talk about $200/barrel oil means very little

• Why? Because those price discussions are always presented as uncorrected for inflation.

• Need to correct the price of oil for inflation

More on Inflation

• Consider the price of oil and gas in the 1800’s.• In 1859, you could buy oil for $4/barrel.• However, if you adjust that $4 for changes in

the price level and in the standard of living between now and then, the price would be $1,200 a barrel today.

• In 1896, gasoline was about $10 a gallon in term’s comparable to today’s income

Global Supply & Demand

• In the 1970’s OPEC cut production sharply, which pushed up the price by a factor of five (5).

• In today’s prices that resulted in a shift from $70 per barrel to $350 per barrel

Law of Demand

• In response to the OPEC cuts and resulting price increases, oil users around the globe became more energy-efficient.

• Today –we use only 50 percent as much energy for every dollar of production as we did in 1973.

• Since 1980, the share of consumer spending that goes for energy has been slashed by over a third.

Moral of the Story

• Although the real price of oil more than doubled from 2007-2008, it was a lot less painful than it was in the 1970’s.

The X-Files

• In 1914 the U.S. Interior Department announced there was only a 10-year supply of oil left.

• Same Department told us in 1939 that we only had 13-years left.

• In 1951 we were told that all oil wells would dry up by the mid 1960’s.

• In the 1970’s President Jimmy Carter announced that we would use up all of the global proven oil reserves by the end of the 1980’s.

The Truth

• Global oil reserves are increasing –not decreasing.

• Real Price of oil over time has not risen, which we would expect under these circumstances

Facts

• In 1970, Saudi Arabia had about 90 billion barrels of proven reserves.

• Since then, Saudi Arabia has pumped out and sold over 100 billion barrels.

• The wells did NOT dry up• Today, Saudi Arabia claims to have 270

billion barrels left in the ground.• The proven oil reserves in Canada,

which were tiny in 1970, are now bigger than Saudi Arabia’s.

The Explanation

• Every time there is a sustained jump in oil prices, exploration for more oil increases.

• Improved technology for finding and extracting oil and with more oil reserves.

• Today, companies extract oil from the bottom of the ocean at the same real cost they spent 40 years ago just 100 feet down into the earth in Texas.

• Long-term, this process has resulted in real prices trending downward.

Elasticity of Supply

• The Price Elasticity of Supply measures the rate of response of quantity demand due to a price change.

• The process of oil and gas discovery is a long-term process…i.e. decades

• Short-term, which can take several years, the elasticity of supply of oil is relatively low.

• A large percentage increase in price will result only in a small percentage increase in quantity supplied in the short-term.

In Conclusion

• BIG oil companies take BIG risks and make BIG profits.

• Zone pricing may contribute to BIG profits, but does NOT contribute to BIG price swings in a gallon of gas or a barrel of oil.

• The real culprits are the old familiar forces of Demand and Supply.

Works Cited

• Gruber, J., Public Finance and Public Policy, 2nd Edition, Worth Publishers (January 5, 2007)