Lately news about the rising price of gasoline has pushed covid off front pages. We hear prices of $5 or even $6 per gallon. The global average is about $5 per gallon. We in Mississippi have it a bit better with an average price of about $4.40. How mad at Big Oil should we be?
Some back of the envelope calculations might shed light on that question. According to the U.S. Energy Information Administration, a barrel of oil contains 42 U.S. gallons and yields 20 gal. of gasoline, 12.5 gal. of diesel, 3.5 gal. of jet fuel and 8 gallons of other products such as asphalt and home heating oil. How 42 gallons of oil yields 44 gallons of product is beyond me. My number crunching will be limited to the quantities of motor fuel available from a barrel of oil.
As of June 13, the average prices of a gallon of gasoline, diesel, and jet fuel were: $5; $4.34; and $4.24. On that day oil was selling world-wide for $128.09 per barrel. Keep in mind there is considerable daily variability in all those prices. Given those prices, the revenue from the sale of products from one barrel of oil was $169.09. That means oil companies’ gross profit from the sale of fuel products was $41 per barrel.
Major oil companies’ profits in dollars for the first quarter of 2022 were handsome, to say the least. Together the top five oil companies had profits totaling $35 billion. You can probably guess who the top five are; Shell, ExxonMobil, Chevron, BP, and ConocoPhillips. Before the runup in motor fuel prices each of them had been earning between $3 and $5 billion. Their profits didn’t exceed that until about April of this year. In fact, in 2020 from January until April three of the five reported zero profit or losses.
The measure of profit most consistent with economics is return on invested capital, not absolute dollars of profit. ROIC tells us how efficiently a firm is using its resources, resources which are not available to be put to any other use. When a firm uses its resources in a particular way society loses the opportunity to benefit from them if used in some better way. That is a very real and relevant cost to society, but is invisible. A firm’s P&L statement doesn’t report opportunity costs. There is no concrete way to measure opportunity costs.
That means economists are left to come up with a reasonable proxy measure for opportunity costs. A frequently used proxy is the all-industry average ROIC. If a particular firm’s ROIC is less than the average ROIC in all industries, it is not using society’s resources in their highest and best way. In other words, the cost resources the firm uses is higher than benefits to society of consuming its products.
As of the first quarter of 2022 the ROICs of Shell, ExxonMobil, Chevron, BP and ConocoPhillips, respectively, were: 10.86%, 5.78%, 9.64%, 15.15%, and 24.78%. Shell would have earned more but it took a hit closing down its Russian operations. The five oil companies together operate more than 100 refineries world-wide each of which costs between $7 and $10 billion. Therefore, collectively those companies’ refining capital structure is between $700 billion and one trillion dollars.
In order to determine whether oil companies’ returns are excessive they must be compared to the ROICs of other firms. According to the Stern School of Business at NYU, as of January, 2022 the average ROIC for a large number of U.S, non-financial industry sectors was 10.58%. That average includes the ROICs for the advertising industry of 50% and nearly 65% for the tobacco industry. A number of high tech and electronics related industries also have aggregate ROICs well above those of the big oil companies.
If 10.58% is a reasonable estimate of the ROIC of firms that are making the highest and best use of their resources, Shell, ExxonMobil and Chevron are not earning excess profits. ConocoPhillips and BP might be open to criticism or profiteering. But even they are pikers compared to advertising and tobacco firms.
The two largest drivers of fuel prices are the price of oil and state and local taxes which together account for about 70 percent of the price of a gallon of gasoline. Except for a brief spike in 2008, the price of oil is as high as it has been in the last 25 years. Oil is a commodity so everyone pays approximately the same price for a barrel of oil. Even if the big oil companies could agree to reduce gasoline prices, we’d probably still be paying about $4 per gallon. Of course, it would be patently illegal for their CEOs to discuss gasoline prices, even if the purpose of the meeting were to lower gasoline prices.
However, if one believes Big Oil’s profits are unconscionably large, the government might impose a windfall profits tax. Or it might require oil companies to increase their investments in producing more oil domestically or in ways to reduce our dependence on carbon-based energy. In fact, ExxonMobil, Shell, Chevon and BP are all using some of their current profits to buy back their own stock which raises their share prices.
Buying back stock has no benefit for society; it only benefits shareholders and executives whose compensation is tied to firms’ stock price. I’m more inclined to fault Big Oil on that account rather than they, being responsible for current, high gasoline prices. That blame rest mostly with Mr. Putin and OPEC that has only just now agreed to increase production.
Patrick Taylor lives in Ridgeland.