OIL: A Dangerous Love Affair

We need professional counseling for this addiction
We need professional counseling for this addiction

 

 

I had the pleasure of recently seeing a repeat on the History channel of a program entitled “Crude”.  Its a great summary of the development and current state of the oil industry from the first discoveries in the US to the later mammoth find in Saudi Arabia.  I am convinced, as many of my friends and colleagues, that the current price of oil at sub-$50 a barrel is not sustainable.  Let’s face it the massive run-up to oil at $150 was equally not viable unless we were dealing with a radically altered new world order where the Suez Canal was closed and Iran was rattling sabers and throwing the US into a new skirmish.  No – the hard, cold facts are simple – the world depends on oil and we Americans are the poster-children for oil consumption.  

 

It is this last point that I find so interesting.  In one environment we are completely in love with cheap oil, SUVs, road trips and all the other benefits and lifestyle augmentation it provides.  But like most love affairs, when it is good, it is really good, and when its bad it looks like a scene out of Fatal Attraction complete with boiling bunnies and some crazy Glenn Close hair.  We saw just how bad this love affair can turn during the summer when oil was approaching all-time record prices and the effect at the pump was translating into $4.00 a gallon gasoline. Oh! the inhumanity!  The response was interesting and traumatic. The series of events that unfolded included general outrage followed by calls for government investigation followed by a modern day witch hunt against the oil executives and companies that produce the coveted black gold.  What was interesting was the American public actually got pissed that the oil companies were making a profit.  That analogous to holding a grudge against your corner crack dealer for making money from your addiction.  To take this ridiculous analogy one step further – why does your crack dealer make a profit, well because he takes the risk, he invests his own capital to buy the product, refine it and get it distributed, packaged and ready for sale and most of all … he supplies something you want, need, have become addicted to.  The fact that we as Americans are going to be pissed at Exxon and other corporations for making money is ridiculous.  Its even more ridiculous that the government hauls in the CEOs of these companies and asks them …”why Mr. CEO are you making so much money?”.  The point of this great thing called capitalism is that it creates incentive.  The incentive is simple – do good, be innovative, bring a product to market that others want and need and you can profit. 

 

The witch hunt held by Washington forgets basic economic fundamentals.  The debate that raged on appeared to be premised on the idea that Exxon was pocketing an extra $2 a gallon in profits when the price of gasoline moved from $2 a gallon to $4.  This is plain wrong.  Exxon like any other corporation has a cost of inputs and sale price of their output.  When the inputs price goes up (in this case crude /un-refined oil) then the output (gasoline) must also go up.  To drive this point home I looked at Exxon’s quarterly financial statement for Q4 2007 and Q2 2008.  Here are the findings. 

 

Exxon Q4 2007 Financials

Revenues = $116.6 Billion

Gross Profit = $47.3 Billion

Net Profit = $11.7 Billion 

Net Profit Margin = 10%

 

Exxon Q2 2008 Financials  

Revenues = $138.1 Billion

Gross Profit = $51.0 Billion

Net Profit =  $11.7 Billion

Net Profit Margin = 8.5% 


*Link to financial statement reviewed

 

What you see from the above financials is that Exxon’s revenue grew considerably in Q2 2008 but the actual profit per dollar of additional revenue was lower than what was experienced in Q4 2007 when oil was considerably lower. 

 

The point of all of this is that demonizing the oil companies for providing a valuable service and commodity that we all need is not the answer.  Instead why don’t we start by recognizing that we are part of the problem and in order to truly be free from high crude prices we need to curtail our consumption and look to more compelling and environmentally friendly alternatives.  The reality is that this is not an easy process.  As we are seeing now – gasoline is back under $2.00 a gallon and everyone has already forgotten the pain and outrage they felt just a few months ago.  Guys like Boone Pickens should be commended for helping to brainstorm alternatives and bring these ideas to the forefront.  With the current rate of population growth and migration of developing countries into the middle class – energy usage is and will be one of the greatest challenges of our generation.