Oil Company Economics

What would constitute price manipulation in the oil industry? Howell Raines doesn’t blame speculators for high prices in his latest column; instead, he blames the oil companies themselves.

Supply and demand? Sure, but as John Lee, a business journalist at the Wall Street Journal and the New York Times for many years, reminds me, supply and demand in oil are not just “two pie charts–where it comes from, where it goes, measured maybe five years ago.” There are more complex reasons for pain at the pump. “American gasoline prices have always reflected the latest spot price, namely what you have to pay to buy bulk gasoline on the open market. This is last-in pricing, rather than pricing based on inventory costs.”

Now, let’s say you’re an oil company selling bulk gasoline, and suppose your inventory contains some gasoline made from $140-a-barrel oil and some that was purchased for $75 a barrel. That leaves a lot of room for price manipulation.

It seems that Raines thinks the oil companies should sell gasoline according to what they paid for it, rather than what they could sell it for on the wholesale market. But they’re privately-owned companies: they have an obligation to their shareholders to sell at the market price, when prices are rising. Gasoline prices are always determined primarily by the latest spot price for oil, rather than inventory costs, just as you’d expect: there’s nothing new going on here.

Raines does make one intriguing point:

As journalism has passed from a hungry to an elite profession, there’s no shock value in the fact that Exxon Mobil paid only $5 billion in U.S. income taxes last year while it paid $25 billion to foreign governments. Even with Exxon Mobil making $76,000 a minute, the last thing that occurs to many assignment editors and reporters is to investigate whether a windfall-profits tax would drive Exxon Mobil, BP, and other oil companies to invest in the alternative-energy strategies they boast about in their television commercials.

I don’t know what to make of the first comparison without knowing much more about what the $25 billion figure represents: if it’s royalites for oil rights, it’s very low. But what of the second point? Would a windfall-profits tax drive investment in alternative-energy strategies? I can see how it would drive investments overall, if those investments came out of profits, thereby bringing profits down. But it’s easy to invest enormous amounts of money in hydrocarbon exploration and development with reasonably certain returns. Investments in alternative energy, by contrast, tend to be much smaller and be much less likely to generate future profits. So I suspect that insofar as a windfall profits tax would spur investment, it would be much more on the fossil-fuel side of things than on the alternative-energy side of things.

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