Common Sense Politics

Are Big Oil Company Profits the Reason for Extreme Gasoline Prices?

Oil prices have been discussed for as long as we can remember, but never with the scrutiny that we see today. Not only do we read or hear about it every day, but it is thrust into a negative light in most every case. Common Sense Politics has written several other articles referring to the dynamics of oil that are worth one’s time, but this one will focus on the dynamics of oil pricing between 2000 and 2007.

As oil has eclipsed $120 per barrel, gasoline has eclipsed $4 per gallon, and we are bombarded with the “record profits” of today’s large oil corporations; the conclusion is drawn for us in that media wants us to believe that we are being taken advantage of by these American oil corporations. Investigative hearings in Congress further this conclusion. Unfortunately, very few watch these hearings or read about them so public knowledge of their answers (summary) is hardly known.

The data for this article is from the Department of Energy data sheets. This article will attempt to explain the percentage each component represents of the cost of a barrel of oil between 2000 and 2007. The trends and conclusions one draws from this are quite different from what the media wants us to believe. The data is factual, non-partisan and speaks for itself when analyzed as we have done.

A Barrel of Oil

Yearly One-Gallon Average Gasoline Cost and Component Percentage Breakdown

Although initial response to this chart is “of course 2007 prices have doubled since 2000″ (nearly tripled when compared to 5/14/2008 prices), a closer look reveals the breakdown of the percentage of the component costs. See a similar chart below that doesn’t show the cost of gasoline.

Yearly One-Gallon Average Gasoline Cost and Component Percentage Breakdown Chart

While the first chart showed that gasoline costs have risen by over 104% between the end of 2000 and the end of 2007, the percentage cost of each processing step has gone down while the cost of the crude oil has dramatically increased. For those of us that deal with numerical values better than charts, here is a summary that would interest you.

Gasoline Percentage Cost and Component Percentage Change

It is easy to surmise and very logical that the cost to process oil should remain reasonably stable, but as the cost of the gas rises, each represented percentage should go down, and this is seen through both methods above. However, although the cost of the crude oil has risen steeply over this time period (an OPEC thing that is outside the scope of this article, but will surely be discussed in future articles), the percentages kept by the host countries has increased as well. Monies from crude oil kept by host countries have risen 51% since 2000 and, after a brief drop in 2001, have rose 78.2% since the end of 2001. As an extreme, let us examine the difference between the end of 2001 and the end of 2007. This shows the dollar contribution toward each processing step, taxes and amount kept by the host country.

Yearly Average One-Gallon Gasoline Cost and Component Cost Breakdown

Crude Oil Price Trend lines Pockets of Host Countries

Although the percentages were very revealing, the actual cost of each component might be more telling, as it factors in the rising cost of gasoline. Looking at this you will see that, forgetting cost of money differences over the years, the actual cost of refining, distribution & marketing have approximately doubled over seven years, taxes have remained pretty stable, actually slightly lower at the end of 2007 than the end of 2000. The rise in the cost of getting gasoline to the pumps can be explained by seven years of inflation, additional refining requirements, extra cost of transportation, and inflated advertising costs. However, the government short-changed itself by not indexing gasoline taxes to the actual price but rather the quantity. The big surprise is the increase in value to the country that the oil was removed from. For a given gallon of processed gasoline the host country received 68 cents at the end of 2000, while this grew to $1.62 at the end of 2007. Applying current prices of $4 per gallon to this 57.9% kept by the producing nations would mean that over $2.30 of every gallon is kept by the country that the oil was removed from. Wow!

What does this tell us? It says that refining, distribution and marketing costs have risen slightly, but have lowered dramatically as a percentage of a gallon of gas. Taxes have remained absolutely stable, but have also dramatically lowered as a percentage of the cost of gasoline. Both of these are understandable, and explained in preceding paragraphs. The kicker and reason that the price of gasoline is where it is today is that the founding countries demand a much higher percentage of these inflated gasoline prices.

One could then deduce that the large corporations that process, distribute and market this oil are not guilty of the deceit that our media wants us to consider and believe. Although their profits may be large, the data shows that their actual costs have only marginally increased over time. A large reason for their record-setting profits is that the increased cost of gas has increased their revenue, and applying the same rate of return to this larger number would make for an absolute record profit.

Page 44 of Exxon Mobil’s Annual Report shows that they processed 11,260 million barrels of oil. Exxon Mobil’s Annual reports data is summarized below.

Exxon Mobil’s Yearly Financial Summaries

Making Sense of Big Oil profit nonsense

The above chart tells us that in a year-to-year comparison Exxon Mobil’s income/revenue has grown 3 years and shrunk 4 years, while this ratio grew from 7.6% to 10% over this seven year stretch. Might this inconsistent growth be the reason for our expensive gas prices? We look further.

Corporations are publically held and need to submit their financial results quarterly. They also project what their earnings will be for upcoming quarters. It is quite involved, but the simple version is that forecasted and past performance contributes to the company’s value. This penalizes companies that don’t grow their earnings. Well, to me it looks as if there have been more bad years than good years, but the overall income/revenue ratio has grown nearly 30% over 7 years. This equalizes to just over 4% annual growth every one of the 7 years. Not a windfall, but good enough for the investors, apparently.

Let us ignore the above facts and imagine that the increased profit had contributed to our high gasoline prices. With some assumptions we can estimate how much of a difference the added income would have made when compared to the 7.6% income/revenue ration from 2000. Cutting the 2007 10% income/revenue ratio to 7.6%, 2000’s equivalent is a 24% drop, and assuming that revenue remained the same, the net income would reduce 24%, dropping about $10 billion. Let us now apply these $10 billion to the 11.260 billion barrels of oil that Exxon Mobil produced - page 44 in linked report. Quick searches on the Internet reveal that a barrel of oil is 42 gallons and of that 23 gallons turn into refined gas, the other 19 gallons turn into other oil-based income producing products. So let us multiply 23 gallons by the number of barrels that Exxon Mobil produced to get approximately ^a259 billion gallons of gas. Applying all the added savings only to this part of each barrel would lower the cost of a gallon of gasoline by $10 billion / 259 billion gallons, or ^b3.9 cents/gallon.

ExxonMobil’s Revenue, Income and Gasoline Prices

A Dramatically Conservative Oil Pricing Example

We can even get more dramatic and apply all profit by Exxon Mobil toward the gallons of gas that they provided. Sure, this isn’t a proper comparison since Exxon Mobil profits from many other ventures other than gas, but the exaggeration will help make a point. Applying every dollar of profit would make Exxon Mobil very altruistic, but also enrage all the shareholders and likely be a reason that gasoline prices would increase. This would increase demand for other oil companies, and increase in demand is one component that increases prices. Anyway, back to Exxon Mobil’s altruism. Let us divide $40.61 billion by 259 billion gallons of gasoline, resulting in 15.7 cents per gallon. That is right, if Exxon Mobil were to apply every bit of money they made in 2007 to lowering the cost of the gas they produced, prices would lessen by fewer than ^c16 cents per gallon, hardly the difference the media wants us to think.

Oops. I forgot this until now, but oil companies don’t have anything to do with establishing the price of a barrel of oil, as OPEC sets production quotas and supply/demand establishes prices. This exercise was interesting nonetheless.

Now if the host countries were to lower their take from 57.9% to 44.3%, what it was at the end of 2003, everything else being equal, this would lower prices by nearly ^d50 cents per gallon at current gas prices, while still providing over $1.10 per gallon to the producing countries in 2007 costs. These end-of-year 2007 numbers are very conservative in today’s terms, as current gas prices are over 30% more now than then.

Although it may be tough to make it through my lengthy analysis, it should be enlightening for those that do spend the time to follow my reasoning. I am not a college professor or someone that has intricate knowledge of the oil industry, but someone that applied common sense to data and forming my own conclusion.

As a very quick ‘what determines the price of oil’ recap:

Gasoline prices are determined by oil prices, which are affected by OPEC and Supply and Demand. The amount that oil companies influence these prices is nearly negligible. The media wants us to believe that large oil companies are the reason for the inflated prices we see at the gasoline pumps. I hope my analysis and this document shed light on this common misconception. The bulk of the money spent on a barrel of oil goes to the host countries, and is increasing as prices rise, opposite from what one understands from reading and listening to the main-stream meida, and THE REAL REASON for our high gasoline prices.

Sources for items discussed above are referenced in hot-links throughout this article.

Additional Information and computations:

What is made from a barrel of oil.

^a - 11.26 billion barrels * 23 gallons of gas / barrel = 259 billion gallons of gas
^b - $10 billion / 259 billion gallons of gas = $0.039 per gallon
^c - $40.61 billion / 259 billion gallons of gas = $0.157 per gallon of gas
^d - (57.9% - 44.3%)/44.3% = 30.7% * $1.62 = 49.7 cents per gallon of gasoline