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Wednesday, June 17, 2009

Building My Case to Break Up Big Oil

I have made no secret of my distaste for big oil. So, now, I will build a case why it would not only be beneficial for society to break them up, but, under Sherman Anti Trust it is perfectly legal. Here is the relevant portion.

The Sherman Antitrust Act (Sherman Act,[1] July 2, 1890, ch. 647, 26 Stat. 209, 15
§ 17) was the first United States Federal statute to limit cartels and monopolies. It falls under antitrust law.

As such, if big oil is in fact a cartel then they must be broken up. Here is the definition of a cartel.

A cartel is a formal (explicit) agreement among firms. It is a formal organization of producers that agree to coordinate prices and production.[1] Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products.

A homogeneous product, by the way, is a commodity much like gasoline. First, the biggest six oil companies in America account for about 60% of all the gasoline sales here. The rest is controlled by bit and regional players. One of the characteristics of a cartel is that it is in an oligopoly. A market controlled by a small group of players. Clearly, gasoline is controlled by six companies. More than that, there is a mammoth barrier to entry into this market. It takes billions of dollars to start a gasoline company. Furthermore, each of these six companies have already rooted themselves in every neighborhood in every city in every state. As such, any new competition is nearly impossible to create. Their enormous historical profits also mean that almost no one has the capability to take them on. You could combine the wealth of T. Boone Pickens, Donald Trump and Warren Buffet and they'd still get wiped out by the combined power of big oil.

The next piece we need is price manipulation. Everyone agrees that gasoline is derived from oil. So, we should all assume that gasoline and oil should move up and down in tandem. Furthermore, we should expect that if one company tries to overcharge the rest will undercut if we are truly dealing with a fair and free market.

Now, oil and gasoline track each other up and down but they certainly don't track each other up and down in any uniform percentage. For instance, oil bottomed out at $46 a barrell in November. By April 1, it was just over $50. That's only a 10% increase. Yet, in that exact same time frame, the price of gasoline went from $1.56 to $1.86. Why would gasoline need to increase 20% when oil only increased by ten percent?
This only gets more insidious when you see that gasoline prices are set to be exactly the same regionally and locally. In other words, the oil companies would argue that there are other factors besides strictly the price of oil that determine the price of gasoline. If that's the case, then why do they all arrive at the exact same price in the end? Has anyone ever seen a difference in price between different companies? The only time there is a difference in price is when the location of a gas station allows for more traffic. So, I must ask a question. If there are a variety of factors that determine the final price of gasoline, why do all of the companies always arrive at the exact same final price? Isn't this the definition of price collusion?
Then, there is the issue of innovation. When General Electric was started, it was started as a vehicle for the light bulb. Now, that company is a conglomerate. Motorola was originally created as a company that sold car radios. Now, it is a technology firm. Yet, big oil sells the exact same product in the exact same form as it did nearly a century ago. Where's the market innovation and evolution?
Now, we all want to be energy independent. We all want to stop relying on the Saudis for most of our energy needs. How can that happen when the companies providing our fuel for our automobiles refuse to innovate so that the fuel comes in some form, any form, besides the one derived from oil?
Here's the summary. We have six very powerful companies. All of these companies manage to make obscene amounts of money, all at the same time, in almost every environment. Even though their product is derived from a market traded commodity, the final price doesn't necessarily correspond to that commodity. Even so, the final price ALWAYS corresponds to each other. Furthermore, all of these companies have managed to continue to sell the exact same product they did nearly a century ago even though all other markets evolve much more than that in every other industry. That, to me, sounds like a cartel. It needs to be broken up.


Anonymous said...

I wouldn't hold my breath waiting for this post to be accepted by your watcher's council.

Craig Howard said...

Fine. And once you've done all that, you'll find out that it isn't the American oil companies that control the price of oil after all. But I'm sure you'll feel better.

mike volpe said...

I never said they were and I know it now.

I said they collude to fix the price of gasoline. I said that the price of gasoline doesn't move in tandem with the price of oil and yet ends up being the same for all companies involved.

You are putting words in my mouth.

Jason Gillman said...

Normally I agree on most of your premises.. not this time.

An appliance manufacturer's evolution (GE) is not the same as a base materials supplier. Would you say the same about iron mining operations evolution?

The process itself is sometimes merely improved in efficiencies, and not in product development. Bringing oil to market in sufficient quantities to provide manufacturing abilities as well as motor fuels and heating product is a bit more competitive in nature, and a little harder to understand than most might realize.

Then you throw in the summer anti fog, or other regional formulas and it confuses the casual pricing observer even more. Collusion might well happen, but I would argue in this day of "saved emails" by law, that it is less likely than years past.

Free Markets work. People were used to paying $4 a gallon.. why wouldn't the oil giants simply keep them at those levels for more profits when the market fell apart and the manufacturing demand disappeared? Its because there are stocks which have to be kept fresh.. Yes Gasoline can go bad.

Just my two cents a gallon anyhow..

mike volpe said...

This is definitely my most liberal position Jason so this doesn't surprise me.

I don't believe that this is anything near a free market.

Your entire argument is also an argument for all of these companies to hurry up and get out of the business as quickly as possible After all, a commodity shouldn't have much long term profitability. Yet, that's the exact opposite of that.

They don't go nuts on the prices. That would never happen. They price it, however, so that everyone can make a lot of money all at once. That's simply not competition.

Jason Gillman said...

I think rather than breaking up, the solution would be to enhance some way that removes barriers for more of the smaller entries into the field. Considering most of the domestic oil fields are leased from the government or private land owners, it certainly is possible.

When it comes to refineries, It would be good if the newest breakthroughs came from those start ups who could manage to bring micro refineries on line. However, it is not big oil holding them back unless they are pressuring regulators to prevent such things, which HAS happened..

In Michigan, the energy companies looking at the sheer expense of complying with the "green" mandates of our governor decided the BEST way to compete was to eliminate competition. They put themselves under a legislative umbrella with a slew of new regulations to limit small producers, yet require them to only ask permission to raise rates.

Michigan has only started to see the rate increases, which Should be doubled in 4 years. "green" energy production is very expensive.

mike volpe said...

That's much easier said than done though. It takes many billions just to start an oil company. Each of these companies already have many gas stations in just about every neighborhood. So, how does another company compete?

Removing the barriers to entry for the oil companies is very theoretical. There are real and massive barriers to entry in this entry and you aren't just going to remove them with some change in the law.

There is a reason why this industry has always had very little competition and that's because there are barriers to entry that are real and they aren't going to go away.