As demonstrated at this week’s Senate hearings with oil industry executives, most of our elective representatives, just like most of our presidential candidates, wouldn’t know sound energy policy if it bit them on the ass, and many of them appear not to understand even the most basic workings of business or the economy.
As Senator Dick Durbin and the other brainless demagogues on Capitol Hill grilled representatives of the major oil companies, what few actual questions they managed to get in between self-promotional speeches and spouting irrelevant sound-bytes, seemed to betray a fundamental ignorance of how the oil industry works, how companies make profits and what the real problems are at the root of current high gas prices.
To a large extent they just kept making the same statement disguised as a question – a statement which came down to accusing the oil companies of profiteering and somehow creating the current climate of high prices. To their credit the company executives were relatively calm and tried to methodically explain basic principles of supply and demand and teach some third-grade level math to the Senators, but they ended up being repeatedly berated and insulted for their efforts.
The questioning appeared to be based on the assumption that high gas prices were part of a conspiracy to get more profits for the oil companies and the Senators seemed unable to comprehend that higher prices produce higher profits, but that those higher profits are not the cause of the higher prices. Some of the basic math involved seemed to consistently elude the Senators as they stubbornly refused to see the issue from any perspective other than the presumption that the oil companies were out to get the American people. Republican Senator Arlen Specter may have asked the stupidest question when he asked why “why profits have gone up so high when the consumer is suffering so much,” making the bizarre suggestion that there is any kind of connection between how oil companies make their profits and consumer suffering.
It became quite clear where the hearings were going when the Senators began to change the direction of their questions and started asking the executives what their salaries were, on the assumption that gross profits were the result of gross personal enrichment by executives. This was a line of questioning which didn’t exactly pay off when they discovered that most of the executives they questioned earned considerably less than most of the Senators would make just from speaking fees if they were to retire from public office.
The truth which the Senators seemed unwilling or unable to come to terms with is that oil prices are high because demand is high and supplies are limited. One would think that any idiot could see that if raw crude is selling at $120 a barrel, then the oil companies which manufacture it into gasoline would have to increase their price proprotionately to cover that increase in their cost. It doesn’t even take a genius to understand that a company might want to spread the cost increase out over time, because while that might raise prices a bit in the short term it would hold the consumer price down and keep it more stable in the long term.
Despite the massive amounts of money involved, the oil industry falls into one of the most basic business models, one which ought to be easy to understand. They take a resource, manufacture it into a final product and then sell it to consumers. The end price is derived from the cost of the raw materials, the cost of processing it into the final product, plus a small percentage of profit. Limited supply has raised the cost of the raw materials. Limited processing capacity has raised the price of processing the final product. But the irony is that as businesses go, the actual rate of profit of the oil companies is relatively low compared to many other industries. Net profits for oil companies average around 8%, slightly lower than the 8.5% average net profits of Fortune 500 companies as a whole. That is also considerably lower than companies in some sectors like the tech industries where typical profits are closer to 20% or even higher, such as Google and their impressive 25% net profit.
What’s more, despite the accusations of profiteering, oil companies have actually reduced their net profits by about 1.7% since March of last year, so while prices have been going up they have actually been cutting their profits to try to keep prices down at least a little bit. Some companies are an exception to this. The smaller companies which usually have the lowest profit margins like Murphy USA have actually slightly increased their profits, while some of the larger companies have reduced theirs more than the smaller companies.
Of course, the way these profits work is what has created the false impression of price gouging which these opportunistic politicians have been plahing up. Net profits are set as a percentage of gross profits. So if oil products are selling at a higher price, that same percentage of profit will end up being more money as a result. Most of us should be familiar with this phenomenon even if we aren’t involved in business. We can see it just by looking at the sales tax we pay on things we buy. If you buy something for a dollar with 8% sales tax, you pay 8 cents. If the price of the item goes up to $1.50, you pay 12 cents in tax. So if the price is higher the state makes more money without ever changing the tax rate. Oil company profits work in pretty much the same way. If oil is at $2 per gallon they make 16 cents. If it goes to $3 per gallon they make 24 cents.
The goal which these Senators are pushing towards with their efforts to paint the oil companies as piratical profiteers, is the institution of a Windfall Profits Tax similar to the one which we had in the 1980s, where the government just declares that certain companies are making too much money, and takes it away from them through a special arbitrary tax aimed just at them. This idea is being pushed particularly hard by Senator Hillary Clinton and some of her Democratic allies in the Senate. Putting aside the fact that such a tax is inherently unfair – with many companies in other industries making far higher profits and not being punished for it – it also doesn’t work.
The problem with a Windfall Profits Tax is that these oil companies are international operations. If the tax rate they are charged in the US goes too high or is seen as unfair, they can just move more and more of their operations overseas and outside of US jurisdiction. This is exactly what happened under the previous Windfall Profits Tax, with the result that domestic oil production fell, overseas oil production increased, and a tax which was supposed to raise $320 billion ended up bringing in only $40 billion.
What’s more, this sort of tax actually does nothing to help out consumers, because it is more likely to raise the price of gas at the pumps than to lower it. The tax is just figured into the overall price of producing the gas, plus that price might even increase slightly because of increased transportation costs associated with offshoring more production. Then, as an additional bonus, a side effect would be the shutdown of some domestic production and refining, costing jobs and incomes inside the US. Such a tax might even lead to gas shortages as the companies placed priority on selling gas in other markets where profits were regulated more fairly. The ultimate irony is that even if every cent of oil profits were returned to the consumer in the form of gas price reductions, it would likely only drop the price of a gallon of gas by about 30 cents – hardly the kind of massive relief people are looking for.
Accepting the idea of a Windfall Profits Tax means accepting the idea that government should decide how much profit companies can make on their products. If the government goes after the relatively modest profits of the oil companies why shouldn’t they go after the much larger profits in the tech industries and service sector? If this kind of tax caught on, the effects on the economy would be devastating, with more and more businesses moving out of the country, massive loss of jobs and chaos in the stock market. We’re already struggling on the brink of a recession. Unsound tax policy like this is one thing which absolutely would send us into a depression.
Through all of this the most ridiculous part is that the real solution to our problem with high gas prices has been staring us in the face for years. Real solutions have been part of energy plans proposed by the Bush administration since 2002 which have been voted down over and over again by ignorant legislators like Dick Durbin. All we need to do to alleviate the suffering of consumers is to increase domestic oil production and build more refineries to process the oil. Yet those solutions have been blocked at every opportunity, because of the same motivation which is behind these attacks on the oil companies, a virulent anti-capitalism masquerading as environmentalism which insists that no more drilling or oil processing be allowed.
We still have vast and untapped reserves of oil, not just in supposedly environmentally sensitive areas like the blighted waste called ANWR, but off the coast of Florida and in the Gulf of Mexico and even all over the west and midwest in areas which the current high oil prices make potentially profitable targets for alternative drilling and extraction methods. Lifting drilling restrictions in these areas and permitting the building a few new refineries would provide substantial short-term relief to the gas price problem and give us more time to work on positive long term solutions like expanding nuclear power and developing superior alternative fuel vehicles.
Perhaps the reason that these Senators are coming down so hard on the oil companies is that it distracts people from looking for the real villains in this story, and the truth is that our problems originate with the unwillingness of our legislators to pass any kind of realistic and responsible energy policy. They have to demonize Big Oil, because the real bad guys here are those irresponsible Senators who don’t have the vision or the will to use the resources we already have to solve a problem which they have essentially created through policies which serve special interest groups whose goals are incompatible with the best interests of American consumers.
These Senators are failing in their Constitutional responsibility to provide for the ‘general welfare’ and every overpriced gallon of gas we pay for ought to remind us to hold them accountable. What a sad commentary that all three of our major presidential contenders come from that chamber of foolishness and irresponsibility.