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Sunday, June 22, 2008

Big Oil is Corrupt: The Economic Argument

How does an industry get away with hardly innovating for nearly a century? It certainly is NOT an industry that is playing in any sort of market that I support. In fact, they are not competing at all and form a cartel characterized by the economic term, oligopoly.

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). The word is derived from the Greek for a few over
many. Because there are few participants in this type of market, each oligopolist is aware of the actions of the others. The decisions of one firm influence, and are influenced by the decisions of other firms. Strategic planning by oligopolists always involves taking into account the likely responses of the other market participants. This causes oligopolistic markets and industries to be at the highest risk for collusion.

So how does a supposed market allow for the major players not to have to innovate? First, all real markets have one common thread, competition. The concept of competition is one of the bedrocks of capitalism. In any market, the goal is to beat everyone else in it. That's why companies are always innovating because that's the best way to beat your competition. In real markets, there are such things as product differentiation and price differentiation. As such, this so called market is still peddling roughly the exact same product nearly a century after being created.

Yet, for nearly their entire existence none of the players have ever tried to differentiate in price or in product. Even though any market would demand that each of the players differentiates by price or by product, in big oil, a handful of companies continue to each get fabulously wealthy even though none differentiate by either. How does that happen?

It happens because none of the companies are trying to be all that different from each other.

It's a corrupt system when each of the players rig the market so that all dynamics of competition are removed. They know they can get away with it because their market has huge barriers to entry.

In economics and especially in the theory of competition, barriers to entry are obstacles in the path of a firm which wants to enter a given market.The term refers to hindrances that an individual may face while trying to gain entrance into a profession or trade. It also, more commonly, refers to hindrances that a firm may face (or even a country) while trying to enter a market, industry or trade grouping.
Barriers to entry restrict how competitive a market is.

Since they all know that it will be near impossible for anyone to challenge the cabal they have created, they have free reign to corrupt it as they please. They control it after all. All innovation and competition is discouraged in their so called market.

In fact, this is NOT what is supposed to happen in Capitalism. A few companies aren't supposed to take a market over and nearly outlaw competition. Markets are supposed to drive the companies in it not the other way around. Since it isn't the way are market is supposed (and in fact corrupted by the players), I can't understand why anyone would defend them.

That's what I don't get about so called Conservatives. They are defending a group of companies that is totally anti Capitalist. In my opinion, there is nothing capitalistic about what big oil is doing. Forcefully, sqaushing all innovation and competition. That is not the sort of behavior that any capitalist would ever defend. So, if you really believe in markets and competition you should be appalled by what big oil has done.


Anonymous said...

"nearly outlaw competition?" interesting turn of a phrase--meaning absolutely nothing. anyone is free to enter the market--except, apparently, those who would develop parts of the United States which liberals have deemed off limits.

it is liberals, not conservatives, or the oil companies who need lessons in free-market capitalism.

Anonymous said...

Do copper producers differentiate their product? Do wheat producers differentiate their prices? Has the government created legal barriers to market entry in the oil industry? The answer is no.
Are the largest global oil producers state-owned entities? Are they responsible to their own people? Is corruption the absence of responsible government? The answer is yes.
End the ethanol subsides, the gasoline blend requirements, the prohibitions on US drilling, and the high corporate taxes, and maybe we could make Saudi Arabia irrelevant.

mike volpe said...

First of all, whatever problems the politicians have created that doesn't excuse what the oil companies have done.

Now, to Ashley's points, first of all, I don't anything about the copper industry or wheat. That said, commodities, like gasoline from oil, aren't differentiated much, however that also makes being a commodity producer a not so fruitful endeavor. I have never seen any other commodity allow for such a few companies to make so much money.

Yet, big oil can stay big oil and keep their market a profitable commodity for a small group of players.

No, big oil did nothing to create this enormous barrier to entry. Instead, they are exploiting the dynamic to turn a market into a cabal.

Unknown said...

"Not innovating for nearly a century"

You are a fricking idiot! 50 years ago we started drilling in 10' of water. Now we are drilling and developing fields in 10,000 feet of water with wells going to depths of >30,000'. The amount of technology needed to achieve this is mind boggling. These wells cost >$200MM each to drill, with developing a whole field can cost several billion dollars. You have no idea, idiot.

mike volpe said...

First of all, G-Funk, when you insult me all you do is weaken your own argument. Second of all, your idea of significant innovation is the oil companies being able to drill better. In fifty years, all they can do is drill better. That's it. Are you serious? That's it.

Do you have any idea how much money they have made in the interim and all they have accomplished is a better process for drilling. Nonsense.

Motorola started as a company making car radios and now they make products that were figments in the imagination of science fiction writers when they started. That's innovation. GE used to make light bulbs. Now, that is a tiny part of a business that is conglomerate of electronics, household appliances, financing, and even broadcasting. That is innovation.

Your idea of innovation is perfecting the art of drilling which only allows these companies to make more oil.

Unknown said...

Isn't that their job - to get oil out of the ground, provide energy to the world, and make money for their shareholders? Period

They have no responsiblity to do anything other than that (although they all invest in non-profitable alternative energy for PR reasons).

mike volpe said...

Of course their ultimate responsibility is to make as much money as possible. That is beside the point and you are totally oblivious to the point I was making.

In any real market, one uncorrupted, the product mix would have evolved and innovated itself one hundred times over as long as oil companies have been around. GE sells light bulbs as a tiny portion of their business now, even though that is their original intent.

Motorola likely doesn't even make car batteries anymore, and yet that is what their business was originally.

Microsoft, Dell, any company has evolved their product lines one hundred times in the time big oil has been around.

Yet, big oil has not only not changed their main product, but their main product is no discernable way different now from when it was nearly a century ago. HOw does that happen?

It happens because the players in the so called market have corrupted it to the point that no innovation is necessary. Their products don't need to evolve and innovate the way everyone else does.

Unknown said...

i hear you man.

i'm a young dude working in the oil industry (petroleum engineer), and i'm tired of people putting down our industry. I wore a company hat to the store last week and people were downright rude to me b/c of who i worked i know how lawyers feel.

The people that make the oilfield go are regular folks - engineers and geologist and middle managers, etc. Despite all the criticism, we keep our priorities in order:

1) Protect each others safety and protect then environment, no matter what it takes
2) Put oil in the tank
3) Do it as cheaply as possible (without comprimising safety/environmental concerns).

Excuse me for getting a little worked up...but thats why

Anonymous said...

The oil industry has seen their profits increase 400% in the last 5 years. Now I ask you, has the volume of production gone up 400% in the same 5 years? And the answer is...... A resounding HELL NO! And the justification of this according to the oil industry is "supply and demand".
Nigeria dropped production. When asked why, they said, because the market is flooded with oil.
There absolutely is manipulation of the market in the form of supply by the producers, period.

Unknown said...

Nigeria's oil production dropped because their platforms and pipelines are getting attacked just about every month by rebels - thats why their production has dropped.

The "Big 5" produce <10% of total daily worldwide production - how are they controlling prices with so little a market share?

Also, keep in mind that for the last 5 years, the majors have reinvested every single dollar they earned for future projects to try to increase production or at least flatten the decline.

mike volpe said...

First of all, I don't know what the Nigerian reference is for. I don't remember anyone talking about them.

Oil and gas are NOT the same thing. I don't believe big oil controls the market for oil. Gas, on the other hand, is a different story. Their market share of gasoline is over 60% and much of the rest is regional.

Furthermore, my argument is not really so much about price fixing but rather innovation fixing. I absolutely believe they collude on the price that gasoline will be set at, but my biggest problem is that for nearly a century their business has gone through nearly no change even though that just doesn't happen in a real market.

funthea said...

The Nigerian reference went to support to notion that there is manipulation to supply in order to command top dollar for oil.
At the time of Katrina, the oil production off the coast of Texas was cut off line. Gas prices went from $1.75 a gallon to $2.50 a gallon in short order. The oil industry said this was because of, "supply and demand". And the supply of oil had been cut short because of Texas being still off line. Once Texas was back on line prices fell to $2.05 a gallon, but not back to $1.75 a gallon. Again the oil industry said that this was still because of "supply and demand" on oil. But in that same time line, Nigeria cut production. When asked why, they said because the market was flooded with oil.

Anyone who believes that the oil industry doesn't engage in collusion is best advise to put down that crack pipe. And while your at it perhaps you should stop listening to that oil industry spokesman, Rush Limbaugh, who clearly has his lips firmly planted around the collective proverbial penis of the oil industry.

Anonymous said...

It's kind of hard to innovate when envronmentalists won't let you build a new refinery. Retrofitting an existing one would be harder than building a new one. Plus, while it is out of service, there would be less product and people(like you) would say they are fixing prices. Of course if there was cheaper gas being made somewhere else, it would be shipped here and sold. Since that isn't happening, I guess demand is up. For every dollar Exxon makes, they pay $3.50 in taxes.
Your premise, by the way, is not proof, just your opinion.

mike volpe said...

So, your idea of innovating is building refineries to make it easier to make oil into gas. This is the so called innovation that you think the oil companies should go through in one hundred years. Are you serious?

So, in other words, in your opinion, innovation is being able to make the exact same product just a bit better in one hundred years. That isn't the sort of innovation a company that isn't corrupting an industry would have over generations. That is the sort of innovation such a company would have in ten years, not one hundred years.

Anonymous said...

What innovation are you looking for? Should they have been making something else? Car makers make cars, appliances makers make washers and dryers. Why should refiners make something else? Why aren't you complaining about sugar refiners colluding since granulated sugar hasn't improved in a hundred years. You still haven't proved ANYTHING about corruption. This is STILL your opinion. You say they should innovate but don't say what or how. You offer no factual evidence of collusion but claim they are because of a lack of innovation.

mike volpe said...

Are you actually saying that cars are roughly the same now as they were 80 years ago? Are you saying washers and dryers are the same?

What exactly is different now about the product big oil makes now from the one they made 80 years ago? Nothing, that's what.

Of course, it's my opinion however it is based on that fact.

Every other company that has been around as long as big oil has transformed their product line so that is not the same as it was 80 years ago. Not big oil, and yet big oil is the one making more than every other industry, even though their product line is the exact same as it was 80 years ago.

So far, you have shown nothing to show that my opinion is not correct.

Anonymous said...

You're asking me to disprove a negative. You make the claim that they are corrupt without any proof of collusion other than your opinion and when I say they aren't because you have no proof, you say that proves it. That's circular logic and makes no sense. Cars are mechanical devices, so are washers and dryers yet, despite improvements in technology, they work the SAME way they did 100 years ago. Cars use combustion and washers and dryers rotate clothes in a basket. Technology can improve the PROCESS for making gas but the feedstock is the same material it was a million years ago. You don't seem to recognize the difference between building a mechanical device and refining a commodity.

mike volpe said...

It's called Big Oil is Corrupt: The Economic Argument. I didn't bring up collusion because I am attempting to prove it economically, that's why it is an economic argument.

I am not asking anyone to disprove anything. You are taking this awfully personally. Is your uncle on the board of Exxon?

My point is that these companies have been around for way too long to have such little innovation. This would never happen in a free market. Thus, my thesis is that the market has been compromised.

Anonymous said...

You make a claim and don't support it except to say if there's no innovation, it must be corrupt. Okay, By who and how? All the oil companies? For a market to be corrupt some form of collusion has to take place. Either between suppliers or consumers, somebody has to get with someone else to corrupt the market. OPEC is one such group. I'm not taking it personally, I just want to know the rest of the story.

mike volpe said...

Yes, all the oil companies. This isn't the only piece I have written about how the oil companies have, in my opinion, corrupted the market.

I still don't understand why you are taking it so personally. If my piece is as bad as you claim, why do you care so much?

Yes, in my opinion, any industry that has innovated nearly zero in nearly one hundred years and still makes obscene amounts of money is corrupt.

Is my position clear now?

Anonymous said...

Good argument people know can you tell me, is the oil industry corrupt or not?