Gaski on Gas

Dr. John F. Gaski, an associate professor of marketing at the University of Notre Dame, has an opinion piece in today’s Indy Star on the “causes” high gas prices. He boils it down to several causes, summarized below:

1. Legal restrictions on refinery construction and rehabilitation
2. Legal restrictions on drilling in off-shore areas
3. Legal restrictions on drilling in the Alaska National Wildlife Refuge
4. Legal restrictions on nuclear power plant construction
5. Strategic errors of the Federal Reserve that has allowed the collapse of the dollar
6. Legal restrictions requiring refiners to use “boutique” blends of gasoline to protect the environment

Notice five of the six reasons Gaski cites various forms of “legal restrictions”. Thus government is to blame. But not just any kind of government:

Note that all the cited policy mistakes are those of one political camp. For decades the liberal Democrats have done everything they could to raise domestic oil and gasoline prices, and now that those higher prices have come home to roost, the Democrats pretend not to like them. Currently, their anti-oil industry propaganda campaign is on track to create the abysmal public ignorance that is a precondition for the same base level of public policy, and policy outcomes.

Gaski blames “liberal” Democrats for our current gasoline woes; in fact, that seems to be the entire point of Gaski’s piece. This is especially ironic given that the GOP has controlled the House of Representatives for 12 of the last 13 years, the Senate for 4 of the last 5 years, and the Executive branch for the last 7. They’re the ones who have been at the helm. In addition, most of these regulations have been in place for decades, yet the price of gasoline (and oil) have skyrocketed only recently.

I’d rather not engage in partisan sniping, however, despite the fact that partisan sniping is exactly what Gaski intended. Instead, I was especially interested in this portion:

[W]hat do you think the oil company’s profit is? (Assume an integrated major oil company that even owns the filling station, so we don’t have to separate producer, refiner and retailer profit. That is, we identify profit for the whole oil/gasoline industry out of the purchase price.) Would Big Oil make a profit of 60 cents, 70 cents, $1, $1.50?

No. Try 25 cents.

That is correct. With an industry-wide average net profit margin on the retail sale price of about 8 percent, the net profit on your gallon of gas is about a quarter, give or take a penny or two depending on the size of the oil company. (About 3 cents net goes to an independently owned station, leaving 22 cents for Big Oil, but the total is still a quarter.)

An accurate understanding of oil industry profit levels dramatizes that it is misguided to accuse the oil industry of price gouging. Beyond the cited 8 percent profit on sales, the industry’s return on investment is right at the average across all of American industry — about 25 percent. And these profit indices were much lower during the recent lean years in the oil business.

What of ExxonMobil’s “obscene” $40 billion total profit last year? Isn’t it natural for the largest corporation to earn the largest profit? Anything other than that would be a major upset. Moreover, record profits year after year are the natural order of things in business, reflecting normal growth.

Gaski claims “Big Oil” only makes $0.25 per gallon of gas. He cites this fact as evidence that Big Oil isn’t engaging in price gouging.

One measly quarter per gallon of gas, especially since a gallon of gas now costs about $4.oo per gallon, seems like very little. But that $0.25 per gallon figure doesn’t tell you much in isolation. So I decided to see how oil industry profit has changed in relationship to gasoline consumption over time.

I don’t know where Gaski gets his $0.25 figure from. I assume that’s what the average profit Big Oil makes from a gallon of gas in the US, given the context of Gaski’s comments. I don’t know where I can find statistics on how much Big Oil has made in just the US, given that the companies that make up Big Oil are giant multinational corporations that have global reach. So I decided to square apples with apples as best I could.

I calculated world gasoline consumption using data from BP. They list consumption in tonnes of oil equivalent (toe), so I converted that to gallons (US) using this website. Next, I tried to find a website that lists annual profits of the oil industry the last few years. Unfortunately, I could only find this one that goes back to 2001. (If anyone knows another place to find these data, especially if it goes back earlier than 2001, I’d appreciate it).

Here is a figure illustrating worldwide gasoline consumption and oil industry profits from 2001 to 2006:
I calculated the profit in dollars per gallon consumed by just dividing the two. Here is that figure:
This assumes a couple of things. First, all of the industry profits are directly tied to gallons consumed. We know this is not true, because not all oil is converted into gasoline. Nevertheless, I ended up calculating that profit per gallon worldwide is much less than the $0.25 per gallon that Gaski reports. But the point of all of this is how these values have changed over time. I calculated the percent change in these three values relative to 2001:
As you can see, industry profits and profit per gallon consumed have increased enormously the past few years relative to gas consumption. Gas consumption was 16% higher in 2006 than it was in 2001. Industry profits, on the other hand, were 190% higher in 2006 than in 2001.

It is clear the the profits of Big Oil have grown much faster than gasoline consumption the past few years. Perhaps the profit accrued by Big Oil over the past few years do not come from gasoline sales but from other revenue streams. I doubt it, though.

Does this mean Big Oil is participating in some grand conspiracy of collusion to drive prices higher? Of course not; I think it’s pretty clear that the increase in price of gas and oil is the result of increased demand, however small, with no increase in supply given that we are at capacity supply right now. Nevertheless, the data strongly suggest that the profit pocketed by Big Oil per gallon of gasoline consumed is increasing, something that runs contrary to what was suggested by Gaski in his piece.