If you ever watch a defender of big oil on television, they will almost always point out something about the profit margin of most oil companies. That is that their profit margin is much smaller than most other industries. For instance, here is one such comment to another post where I attacked the oil companies.
BP made a net profit of $22.626 billion after tax. This is a net profit of 4.7%. You claim this is a result of oligopoly.
Citigroup made a net profit of $20.355 billion after tax. This is a net profit of 24.03%. Citigroup is one of 5,000 financial institutions - yet their
rate of return was more than 5 times that of BP. Seems to me that being in an oligopoly is really stupid...
People like you just wanna bash "Big Oil" because you are mad about gas prices. If you really understood economics, you would realize that having an oligopoly in an internationally traded, fungible commodity THAT YOU MUST BUY FROM A CARTEL is practically useless.
This argument is technically true and also totally misleading and nonsensical. Why in the world would anyone compare the profit margin of big oil to say computers. If I am buying a Dell, it is likely for specific reasons related only to a Dell. How many people does anyone know that buy their gasoline from one company only? I don't know anyone that is particular to Amoco over Mobile. Most folks wind up at the gas station that is closest to where they live or work or the one closest when they are running out of gasoline. That's because unlike computers gasoline is a commodity.
A commodity is anything for which there is demand, but which is supplied without qualitative differentiation across a market. In other words, copper is copper. Rice is rice. Stereos, on the other hand, come in many varieties of quality. And, the better a stereo is, the more it will cost. Whereas, the price of copper is universal, and fluctuates daily based on global supply and demand.
In other words, there is no substantive difference between the product you buy at Mobil and the one you buy at Amoco. Since there is no difference in product, the only potential difference is in price. Given that, how does the so called small profit margin look now? I have heard big oil's profit margin put somewhere between 4.5%-8.5% depending on the source and the time. Is that significantly less than Dell's which approach 20% at times? Of course, my Dell computer is unique and unlike any other computer anywhere. Dell can afford to charge because they can differentiate in their product.
Oil companies have no such luxury and yet they can still afford to make between 4.5 cents and 8.5 cents on every dollar of revenues. This argument that oil companies really don't have it so well becomes duplicitous in another way. If this business is so tough, why have the oil companies stuck out so long without trying to diversify their business? After all, profit margin on a commodity should be less, much less, than on any other product. That makes such a business not necessarily frutiful in the long term. Not so for big oil. They have been making breathtaking profits for nearly their entire existence, almost one hundred years, and never have they attempted to move into any other business that isn't strictly a commodity.
All those that proclaim that big oil has it tough because of their relatively razor thin margins should also ask, why flushed with cash, they made no attempt to move into any other business, EVER.
That brings me back to my original argument, big oil is an oligopoly or better yet a CARTEL. That's how an industry can make a commodity and continue to be profitable for such a long term, and never have to move from that industry.
31 comments:
Anyone investing in the markets for retirement should understand the differences in profit margins. investing in computers and pharma tend to be riskier but have bigger possible upside. Oil investment is much more stable but the upside is limited.
Profit margins are return on total investment. Big oil is a group of investors and if the investors don't get reasonable returns there will be no money to get the gas to the station.
As to why a company specializes that is just a straw man
Return on investment is NOT like an investment in the stock market. The more a product is differentiated the more profit margin there is.
No one is saying that big oil shouldn't make a profit. All I said is it is totally misleading to give the whoa is me argument that their profit margin is small. Their profit margin isn't small. How in the world does an entire industry get between four and eight percent profit margin on a product that is strictly a commodity? It wouldn't if the industry were functioning as a market. Of course, this industry is no market but rather an oligopoly.
As to the allusion to big oil not diversifying being a "staw man" argument, well unless you explain why it is a straw man argument your point is meaningless.
I agree with Bill. Why should a company whose expertise is in energy production take the risk of moving into another unrelated field? Would their stockholders accept a lower dividend while the company expanded into fast food or autos? If they lost huge amounts of money on these new ventures, would that somehow make things better?
Frankly, I don't see why it is unfair for them or any other business to earn an 8% return on investment, regardless of what they are selling. That seems like a reasonable profit considering the huge investments that must be made to get the oil to market. Lets not forget, those dollars are worth a lot less than they used to be which could also explain why the profits seem to be higher. Now, why is milk as expensive as gas? It is a commodity and is far easier to produce than gasoline!
They shouldn't however in nearly one hundred years if they were in market they would move over naturally. Is GE still only in light bulbs? Is Motorola still merely in car radios? No, and yet that was their specialty one hundred years ago when big oil was in oil.
For some reason those two companies, along with every company around as long as big oil, naturally evolve their product line. Big Oil feels no such necessity to evolve their product line. If their business was a market, they would have to.
I think most of the oil companies have diversified into chemicals, visit www.exxonmobilechemical.com to see a list of other products. I am sure these are all offshoots from their core oil business, but it does show some diversification. If we would actually allow the oil companies to go after the reserves we have, we would have over a hundred years of supply, so I don't see the hurry to get out of the oil business.
The Dems are always saying we need new technology and that drilling won't solve the problem. Unfortunately, their new tech doesn't exist yet and if it did, it would take 20 years minimum to replace the entire fleet of autos on the road. I know it will be years before I can afford a new car again!
I am in the boat business, we still have quite a few old boats on the water that were built 50 years ago. Most boats can not use the new technology as it can't produce the horsepower required to get a boat to planing speed. Many large sportfishing boats have twin engines that each produce well over 1,000 hp. It will be a looong time before we have hydrogen fuel cells that can replace engines of that size.
It is all window dressing. The core of their business, the overwhelming portion of their revenues and profits, is gasoline made from oil. That is what it was nearly one hundred years ago, and it is no different now.
"The core of their business, the overwhelming portion of their revenues and profits, is gasoline made from oil. That is what it was nearly one hundred years ago, and it is no different now."
Mike can you please show us the stats that confirm this statement? Thank you Timb
You are setting up a straw man.
You don't recognize that oil is the commodiy and gasoling, heating oil, oil based lubricants, etc are products that are produced. Most oil companies are into chemicals, all types of lubricants, food marts, etc.
If the gasoline manufacturer moved into something else as you suggest GE did regarding the light bulb, were would you get the gas to put in your car to get to work.
I guess you would have the same attitude with respects to sugar companies that just sell a commodity.
No, what I recognize is that gasoline made out of oil is the only gasoline that the oil companies have made in nearly one hundred years. How could that be if they were competing in a market? After all, in a market, companies are forced by competition to innovate and evolve, a la, General Electric. Yet, these companies continue to make the exact same product after one hundred years. Furthermore, they are quite profitable doing it. It doesn't add up.
"No one is saying that big oil shouldn't make a profit. All I said is it is totally misleading to give the whoa is me argument that their profit margin is small."
Are you saying the profit margin is NOT small ? What is your point ? Between 4 and 6 percent does not seem extraordinary...
Not exactly, gasoline is a commodity. The only difference is price. There is no difference between what you buy at Walmart and at other retailers except it is always cheaper at Walmart. One reason is their profit margin is razor thin. The oil companies get away with healthy margins at the same time all of them at once make tons of money. You think this is on the level.
You got it wrong. The profit margin does not equal the return on equity. The return on equity for ExxonMobil is actually 35%. Do not defend ExxonMobil
I don't know who that last comment was directed at but profit margin and return on investment are two different measurements. If you think I am defending big oil, you didn't read the piece or any of my comments.
I don't think there's any conspiracy here. Yes, oil may be a commodity, but that doesn't mean the competitors are going to price themselves down to zero profit. Players may simply follow the price leader. A commodity market does not always fall into a "Bertrand trap" as Mike Volpe implies.
If two people have lemonade stands next to each other, they're not necessarily going to have a pricing war down to their respective breakeven points. One stand might observe what price the other one sets, and then set their price the same. Neither lemonade stand wants to start a price war that will obliterate profits.
If you think this situation is unfair, and that the lemonade stands are "colluding" in some basatardized sense of the word, then you can start your own lemonade stand and charge a lower price.
Over the years, new oil companies have arrived on the scene in this fashion. But commmodity prices collapse as easy as they surge, so at some point new entrants are discouraged even if there are health profit margins in the current year.
I disagree with the idea that big oil is proven to be an oligopoly by the fact that these firms have not diversified into different businesses. While the bread and butter for these companies has been oil over the years, there has been incredible innovation and technological advancement within this space. Yes, all this innovation is working towards the same end-product, but this is how these companies have in fact been competing. Not through differentiating their product or moving into new businesses, but by finding cheaper ways to extract increasingly difficult to extract oil reserves. None of these companies is sitting on their laurels using the same technology the past hundred years.
I didn't necessarily say it was a conspiracy. In fact, in an oligopoly there need not be a conspiracy. There are so few firms, the group need only wait for one to set the rate and follow. There isn't necessarily a conspiracy.
You may not be moved by the argument that their lack of diversification proves they are an oligopoly, however you are ignoring basic market dynamics in reaching your conclusion. Real markets force innovation. Not so in big oil, not ever. How are the same group of companies making the exact same product nearly a century later and all make tons of money still. If this were really a market, there would eventually be so much competition that said product would no longer be profitable, and the companies would diversify out. That hasn't happened. There is a barrier to entry here. The companies know it and thus they don't diversify because they don't have to.
Mike - I think I misunderstood your earlier posts then. I thought you were implying that there was some sort of collusion or government corruption going on.
You say in your most recent post that real markets force innovation. And my opinion is that the innovation need not necessarily take the form of an improved product. I think the innovation that has taken place in terms of oil extraction techniques is staggering -- and each oil company has had to keep pace to compete. Would you agree?
I don't know that there is any government corruption. I also don't know that there is any corruption in setting prices.
There is absolutely corruption in setting up this oligopoly which freezes out any legitimate competition. The dynamic of this so called "market" is the corruption. That's why I have advocated breaking up these companies.
It sounds like mike is just jelous and lazy. Gas is only a comodity as long as the consumer allows it to be . Don't forget most people are born with two functioning feet but are too lazy to use them even though they may be the most cost efficient and ecofriendly method. There are also these things called bycicles that people ride around on. No one forces you to use gasoline you choose to drive a car every day instead of walking. Consumers control the gas price by how much they drive vs walk or drive their suburban vs a little civic.
Why shouldn't the oil companies make alot of because they produce a butload of products. only half of a barrel(1 barrel = 42 gallons)of oil even goes to gasoline. So say oil is going for 115 a barrel that means the oil company pay 2.75 a gallon. im ok with paying them 1.25 to go through the process of shipping, refining, and dealing with complainers like mike. Oh and lets not forget that of that 1.25 uncle sam takes his share from the consumer at the pump and then again from the producer at the end of the year and the station that sales it. If you break it down the government makes more off a gallon of gas than the oil company.
Lastly, Who is stopping you from coming out with your own form of transportation that doesn't use oil based products. or if you can't do that, just cut out the middle man, go up to the sadi's buy your own barrel of oil figure out how to rifine it yourself and put it in your car, although since you cut out the oil company you no longer have tires, wipers, a stereo,anything plastic, a bumber , paint, ... if you want a complete list google oil products and see.
You complain about how much money oil companies make yet forget to mention what all they create and provide for society. without them and plastic the medical industry would no where near what it is today, we wouldn't even have aspirin.
The last comment is inexplicable. You don't know what are my driving habits, and furthermore, they are totally irrelevant.
While it is easy to say that we can adjust our habits, the reality is that there is a gas station on nearly every corner. Thus, short of not driving at all, it is unclear how en masse the American people could possibly drive a car fueled by anything else.
Of course, while all those points blow your entire comment out of the water, the whole back and forth has little to do with the point of the piece.
The point is that it is misleading to proclaim that big oil's profit margins are small by comparing them to industries where the product has differentiations.
My point wasn't that they aren't allowed to make so much. My point is that they make as much as they do because they are an oligopoly. That corrupts the market. It is pure nonsense that they have created so much for society. They have taken a necessary resource and turned that market into a corrupt market.
Look to the speculators playing the supply and demand card to find the pricing.
The oil companies are price TAKERS not price MAKERS. If the oil companies were makers they would have set the price at $3 and up years ago.
That's a trojan horse RW. No one is questioning that speculators make plenty of money causing the price of oil to rise dramatically. In fact, I have written about them often.
That doesn't make big oil's profit margin has been misleading in its supposed lack of size.
Furthermore, speculators' behavior doesn't excuse the behavior of big oil. They have turned their industry into a cartel. That has nothing to do with speculators.
nMike the point of my statement was not to disprove "Big Oil" being an oligopoly. My point was you don't have to use oil but if you choose to you don't have to use as much as you do. You can walk or ride a bike and therefore your driving habbits are relevent especially if your driving around in a suburban.(do you ever walk? what do you drive?)
It is easy to just say we can change our habits because we can though some may choose not too. Personally i rode a bike every where until i was twenty and had saved enough to pay cash for a car i wanted. while only having a bike. On a bike i got from school to work and then home pretty much five days a week for four years so you can't say manual transportation is not an option. Now i do understand that not everyone can do this but the vast majority of people know how to ride a bike they just are not willing to. Maybe not driving is the answer. Humans made it until the 1900's without driving a car. all you did was prove that people are lazy when you suggest not driving is a foolish idea.
Yes the is a gas station on every corner but they are there because YOU CHOSE to drive a vehicle that consumes gasoline. The electric car has been around since 1891 and guess what, the is an outlet on practically every wall of your house. Did you choose an electric car when you went to buy a car? Why not?I know i didn't because they are slow and have hardly any power. Now is it the oil company's fault i chose a vehicle that uses their profit. No its mine the consumer, i could have just plugged a car in every night, i could have kept riding a bike, i could have walked, but no i wanted a car that uses gas.
"The point is that it is misleading to proclaim that big oil's profit margins are small by comparing them to industries where the product has differentiations" That's weird because "big oil" is a company where the product has differentiations. Lets see there is propane, gasoline(3 different octane levels), diesel, and jet fuel so there is product variation and quality. More so big oil helps produce almost anything plastic or rubber which is used in plethora products. There for that point is "blown out of the water"
i guess since you thought i was trying to argue against the fact that big oil is an oligopoly before i might as well and do that now.
First what do oil companies truly sell in the context of your original blog. People say they sell oil but the service that they really sell is transportation. you cant do anything with a galon of crude oil god knows you can't just put it in your tank and go somewhere, so when it comes down to it oil company sells transportation. now, if you stop thinking of filling you vehicle up with gallon gas but instead think of it as putting miles into your tank one can start seeing how they trully have control over what the oil company charges. If you choose to drive a car that gets 30 miles to gallon vs one that gets 15 you pay $0.13 every mile vs $0.26. Take that to 100 miles $13 vs $26. Either way the oil company gets the same profit margin but with the gas gusler they get twice the profit. now should the Oil company have to lower their profit margin because joe shmoe drives a hummer? The oil company has to work twice to get hummer 100 miles so shouldnt the get paid for doing twice the work? Now think if joe and jane want to drive seperate hummers instead of riding together in the car that gets 30 miles to the gallon. they drive their 100 miles and after spending $52 they realize they can't get home because they only have $13 between the two of them. Of coarse its not their fault they can't make it home. No, it's the oil company's fault for not lowering its profit margin and for being an oligopoly .(even though as i showed you we have control over the cost of transportation) But wait if Big Oil (transportation provider) is an ologopoly that provides transportation how did they get home on a train for only thirteen dollars verses the 52 they would have had to spend to have to oil company get them home.
If you want to think of the oil comapany as an energy provider that would completely omit big oil from being an oligopoly because there are many forms of energy such as wind, solar, nuclear,etc.
If Big Oil only providing us with oil and only oil instead of the vast array of products and services then one might be able to say it is an ologopoly but they don't, they provide transportation, energy, plastic, lubricants... and in each of these industries there is a competative market.
-chris
I don't know how you think that what you just said proves that big oil is NOT an oligopoly. You may be able to ride a bike to work, however unless you think our society in whole is going back one hundred years, cars are a vital part of our society.
Cars are run on gas from oil. There are a handful companies providing gas made from oil. Those companies do NOT operate in a market. They are an oligopoly. They are an oligopoly in a product that is vital to everything in our nation. Think about what you statement says. They wouldn't be so vital if behavior changed. That makes the product rather vital. Behavior has to change in order to make it less vital.
I hate to break it to you but electric cars wouldn't plug into the outlet in your wall.
There is absolutely no differentiation in gas. That statement is absurd. There is no difference between the product in the gas station at Amoco and Mobile.
If you read the point you would understand that the oil company provides transportation and in that sense it is not an ologopoly because you do have other forms of transportation. Though you may not want to change you behavior and walk somewhere. "There is absolutely no differentiation in gas. That statement is absurd. There is no difference between the product in the gas station at Amoco and Mobile." Where in my comment did i say amaco and mobile dont sell the same thing? What i did say is that there is differentiation in oil it is sold for Different forms for Different uses and and in different qualities which satisfies your definition differentiation remember rice is rice so there is no product differentiation but oil is not sold just as oil instead it is sold as gas oct 87, gas oct 90, diesel etc. Big Oil doesn't pick what gas station choose to sell but they do offer different forms of fuel. Whether a station wants to put in a gas pump or a propain pump is up to them not the oil company. as far as the oil company is concerned they do offer different products and different qualities.
"I hate to break it to you but electric cars wouldn't plug into the outlet in your wall." thank you for enliting me on this here i thought we could just drive through our front doors and plug in next to the tv. my point was you can charge a car cheaper than filling one up. oh and the chargers for the car, they do plug into a wall outlet.
Also why shouldn't behavior change. did you drive before you were sixteen, if not you behavior changed when you got a car so why shouldn't it now. You said we would have to chang behavior like it would be hard or something. i find walking instead of driving fairly simple transition in behavior, ive only tripped a few times. why do you think its so absurd to have to walk somewhere unless you are lazy and you never told what you drive by the way.
Your entire argument is theoretical, hypothetical, and technical. This isn't about what some textbook will define. This is about what is actually happening. This isn't about whether or not there are alternatives to cars in transportation. There are, however our economy would crumble without the automobile. Period. I don't care what other alternatives there are because the auto is a vital part of life. Period. fuel is necessary to keep the car moving. Gas from oil is right now the overwhelming method of making the car move. Six companies provide it. There is no difference between their product. The reason this is important is product differentiation is inherent in profit margin. Dell computers have a high profit margin because Dells are unique. Amoco and Exxon are exactly the same. They always have been and have no intention of changing because their so called market is corrupted. Period.
We should change behavior, however that is no excuse for a corrupted market. Big oil has corrupted their so called market. Nothing you say about changing behavior will change the fact that their market is corrupted.
The other side of the equation should also be considered, that is the 'extraction' of the oil. The oil companies have had their hands full with improving techniques to obtain oil from the ground at lower costs. This is where the differentiation comes from and allow one company to 'beat' the other in competition for higher margins.
"I don't care what other alternatives there are because the auto is a vital part of life."
The automobile is only vital to your life because you don't care what the alternatives are.
You argument is totally irrelevant. First, you don't know me and yet you are making all sorts of judgments about me. Second, what I do or don't know about alternatives to autos is totally irrelevant. You obviously are passionate about alternatives for energy and transportation, and I commend you, however that is totally irrelevant in this debate.
Whether or not I know about alternatives for transportation is beside the point. Cars are vital. They aren't going away and they are the transportation of choice for almost all americans. Nothing you say is going to change that. Furthermore, it is not going to change anytime soon.
As such, the oil companies have an oligopoly on the most important form of transportation in our society.
All I can say is all you folks must have a lot of time on your hands to discuss an issue over which you have absolutely no control. Drive on!
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