Profitability of Big Oil

Max Sawicky had some fun with Rush Limbaugh over whether Big Oil gets $0.09 per gallon or a 9% operating margin. Unless a gallon of gasoline costs $1, there has to be a difference between these two statements. In his comment box, Max linked to something from ConocoPhillips:

An industry-wide study in the late 1990s showed that oil industry profits amounted to an estimated 7.3 cents on each gallon sold. More recently, ConocoPhillips reported that during the third quarter of 2005 earnings from its U.S. refining and marketing operations amounted to 9 cents per gallon. This compares with a national average retail price of $2.60 per gallon during the third quarter, the period of highest gasoline prices in 2005.

This statement does not say that Big Oil earns only $0.09 per gallon because much of the profits from a vertically integrated oil supplier come from its ownership of crude oil reserves, which are currently generating substantial economic rents.

In the ConocoPhillips link, you may have noticed that gasoline pump, which can also be found here. EIA also provides this breakdown monthly from January 2000 to March 2006. Distribution and marketing accounted for 4.5% of the reported $2.425 per gallon figure for March or almost $0.11 per gallon, while refining accounted for 21.7% or almost $0.53 per gallon. So how did $0.64 per gallon become only $0.09 per gallon. Perhaps because the EIA figures are the gross profits versus what ConocoPhillips is suggesting as operating profits.

Of course, the rightwinger arguments are contradictory in this regard. Rightwingers love to tell us that it is the lack of refinery capacity that is to blame for the high gasoline prices as if the refineries are collecting a lot of economic rent. But then Rush tells us that these entities are not making very much in profits. Clearly Rush is too eager to parrot what industry spokesman tell him without even bothering to understand the basic accounting issues.

Further down, the ConocoPhillips discussion compared operating profit margins to operating profit margins in other sectors:

For example, a software company that clears $90 million in net income on product sales of $1 billion would earn a profit margin of 9 percent or 9 cents on each dollar of sales. Traditionally, oil companies have trailed many other industries in this measure of profitability. As indicated in the graphic, the profit margin of oil and natural gas companies was slightly above that of all industry in the third quarter of 2005.

A software company that has an operating margin of only 9%? This can’t be Microsoft as its 2005 operating margin was almost 37%. The operating margin for ConocoPhillips in 2005 was over 13%, while the operating margin for Exxon in 2005 was over 16%. While we are talking about Exxon, let’s check out what Jack Kemp is arguing:

The retail market is competitive, and Exxon, for example, is but one-tenth of the total U.S. market. They get a 7 percent to 8 percent return on investment and face a 45 percent to 46 percent marginal tax rate on corporate income.

Exxon’s 2005 10-K reports only a 41% effective tax rate, but its reported return to capital is 31% not 8%. Of course, Exxon is much more than a retailer given that not only refines oil into gasoline but also owns much of the oil that it utilizes.

Let’s return to the EIA figures to note that crude oil’s contribution to the price of gasoline in March 2006 was 54.8% or $1.33 per gallon. Owners of crude oil – such as those OPEC nations – are earning very high economic rents. I have to wonder if Mr. Limbaugh and Mr. Kemp understand the simple fact that part of the accounting profits for companies like Exxon are attributable to this economic rent from owning oil fields. If we turn to page 54 of ConocoPhillips 10-K, which allocates income by each business segment, we that income from exploitation and production accounted for $8.43 billion out of $13.53 billion of total income. And yet, Rush fails to include the lion’s share of their profits in his spin.

Unocal, which was predominately doing oil exploration and production before it was acquired, filed its last 10-K for fiscal year ended 12/31/2004 and reported operating profits that exceeded 24% of its revenue even after deducting depletion, depreciation, and amortization expenses, which exceeded 12% of its revenue.

As much as Arlen Specter wants to impose anti-trust legislation upon Iran and Saudi Arabia, we as a nation really can’t. Some liberals have suggested we resort to price controls to limit oil company profits, which would be an awful idea. While I have suggested we tax some of the economic rent received on extraction of crude oil by companies like Exxon (or the former Unocal), other economists have disagreed with me. But to suggest Big Oil is not making significant profits is certainly fuzzy accounting.