Oil sure is spendy.  A good question is why?  The bad news is after you read this explanation, the price will still be high.  Petroleum comes out of the ground.  We search for oil the way a blind man searches for light.  Geologists know the signs there is oil concealed in the ground, but nothing is certain.  Discovery takes a huge capital expenditure and there may not be anything there.  Investors, even at the giant corporation level are slow to risk big bucks when nothing may come of it. The reason for mentioning all this is to make the point that oil price can change hugely and the supply level won't change for a while.  Government regulation lengthens this delay.  Litigation and regulation takes a long time to review.  We have a delay natural to the market and delay produced by various public policies.  The 'natural delay' would probably be about 18 months in a free market.  Oil developers report that new deep sea production can be on line in about 18 months to 2 years.  Despite political pronouncement that new production would take ten years to start impacting price, that is wrong.  Two years.  It's government delay which can add decades.  Behold the fact that because of environmental restriction, no new oil refineries have been built in the United States since 1977.  There's a bottleneck of delay in the making. The long run in oil production is probably about 2 years, if the government weren't molesting the market.  There is no way for the market to be agile the way private markets usually are, because the government is adding extra restraint.  What infuriates me is the big government fans have a handy villain to distract the voter.  Some carry on about 'obscene oil profits.'  Not so.  Oil companies earn a return that is only ordinary considering the huge capital expenditure just to start bringing the oil in in the first place.  The way to tinker with the books to make the profit look high is ignore the big money spent looking for oil in the first place.  When the oil well comes in, the cost per unit is less.  But wells run dry eventually.  If the oil companies haven't been making the money to keep looking for fresh supply, oil supply shrinks and the price skyrockets. There is something else.  Prices fluctuate in the short term.  If you suddenly need to fill the gas tank in your car, you don't have much impact on price, but imagine what would happen if everyone showed up at the same time to fill the tank....  Suddenly the available supply would not be enough.  There would be a shortfall.  This has been the direction of public policy in the United States for some time.  What is surprising is that it has taken so long to really clobber us. Whats more, the US is still the dominant economy in the world.  The US economy does more and better than all the rest, so when the US has a problem so does everyone.   Now the economics of it.  Given that oil is capital intensive.  The oil prospector has to buy billions worth of equipment and spend considerable time lining up sites to explore and recover the petroleum.  Supply will be subject to interruption; it will come in fits and spurts (Should I say gushers?).  Speculators in the futures market help to smooth this out by bidding on delivery of product at some date in the future.  Other speculators bid in the future market to supply that product.  Together, speculators set a price for future delivery of product, and the actual producers know they can sell what they deliver.  So the producer goes and spends huge amount of investors' money to bring in new oil wells. Now you fill your tank.  You got the place where you live, and you don't want to move.  I am like you, and there are millions more like us.  We need to get to work. In the short run, we can't do much to change this situation.  We drive to work.  In the short run, millions of people cannot change their circumstance and their demand for oil product remains inflexible even though price goes up.  Economists call this 'price inelasticity of demand in the short run.'  Price changes but the quantity demanded (and used) is mostly unchanged. In the longer run, we can change plans for vacation, change jobs, move closer to work, get a motorcycle, ride the bus, walk... We can take steps to change our oil consumption.  Also in the longer run, the oil companies will spend the money required to sink new wells and bring in new production, build new refineries and bring fresh supplies of oil to market.  But wait!  This is entangled in government delay and restriction.  Economists use graphs to introduce the concepts of markets supply and demand.    Demand in the market varies with price. The more something costs, the less the market wants to buy. That concept is pretty easy to understand.  The graph looks like this. Supply likewise varies with price, but in the opposite direction.  The more the price a product (or service) is, the more is provided.  That graph look like this. Let's overlay the two graphs.  There is a point at which the graph line of demand intersects the graph line supply.  Economists call this the 'market clearing quantity and price'.  Obviously, this is a simple presentation of the economic concept, but it is enough theory to explain how government regulation can mess this up. About 30 years ago, the American government decided to limit the amount of oil product available to the American market.  Despite extensive tinkering, the private energy sector was far more agile than the American government, and was able to supply the growing American demand despite the bureaucratic impedimenta.  It is no surprise that after twelve years of business friendly Republican control of the American Congress, it took less than two years of government friendly Democratic Party control of the Congress to break the supply system. Oil supplies were subjected to extra restriction instead of being opened up.   Graphically, the situation in the normal market compared to the government restricted market looks like this.  Supply expansion has hit a limit, and the awakening economies of China and India came on the scene. Strangely, the US Congress demanded oil companies explain themselves instead of insisting they explore for oil.  The result is shown on the graph as a vertical line in the supply 'curve.'  No matter what the price is, once demand reaches the limit point, no amount of additional price increase will increase the supply.  We are right at that point right now.  Price is a normal signal to suppliers to increase supply, but that signal has been shorted out by regulation, the graph shows sickly red tape haze. This fuzzy area will result in a price bubble forming. A sign high oil prices are fabricated by non-market forces will be a bursting and reforming of the price bubble. The bubble may reform several times until the market finally figures out that the normal price signal to the market has been shorted out by government edict. We have this weird situation where the normal market signal for oil product suppliers to increase supply has been shorted out.  The price rise should have told the oil companies to increase supply, but instead, their hands were tied.  The villains in government were so arrogant as to summon the oil company executives in for a grilling on the causes of a government made problem. Top

Pelosi named her energy bill, the “Comprehensive American Energy Security and Taxpayer Protection Act” in a Machiavellian work of political art. Because there are so many taxes added in the bill, the thing has to originate in the House of Representatives. (That is where all revenue bills must originate).

H.R. 6899 resurrects many controversial “poison pill” provisions that would actually limit domestic energy production.

First, the bill essentially forbids development of nuclear energy.

The bill would continue the policy of preventing US companies from exploring for oil and natural gas in Alaska and in most areas off US coasts.

Second, the bill would limit energy exploration by preventing drilling within 50 miles of the coast.

Last the bill imposes $30 billion in new taxes on energy production.

Pelosi is a conniver!

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Exxon Mobil had a banner quarter in Q3 2005, earning about 9.2 billion on gross sales of nearly 100 billion. The way the newsdroids usually present the talk, the oil mammoths have increase profit 45% over Q3 2004.

The newsdroids say the oil companies took advantage of disorder caused by hurricane Katrina to gain these 'windfall' profits. They say that this is why you had to pay a big price recently for motor fuels. They say those rotten oil companies engage in profiteering, gaining windfall profits. Some say that's too much profit. They say oil companies should have their "excess" profit taxed away.

If you are one of those, remain calm, because I think you've been lied to. First off, 9 billion is only about 9% of gross sales. That means that 9% (less actually, but more on that later) of the pump price you paid during 2005 Q3 was profit for the oil companies. If you paid $3 per gallon, you were giving the oil companies 27 cents per gallon for providing you with a product you wanted to buy. What makes it seem like a lot of money is the fact that oil is a huge market. It's a lot of motor fuel, it's a lot of money.

Hey! Wait a minute, half the profit of the year before means the Q3 2004 gross profit for Exxon Mobil was under 5%

Back to the 8% margin... The actual price charged at the pump is more than the wholesale price of gasoline. No surprise that retail is higher than wholesale. Usually, the gas station markup is about 35%. The extra money is used to cover cost of delivery, sales help, electric pumping, drive-off theft, etc. The left over is the profit to the gas station operator. The effect of all of this is that a doubling of profit to "BigOil" increases the price at the pump by only a few cents.

Considering that during the Katrina mess, the oil product was delivered in more-trying-than-usual circumstances, a higher profit level is a reasonable compensation.

. . . .

There's more dry accounting, like the difference between operating profit, gross margins, and return on equity, also called profit, and other accounting stuff. This stuff can be puzzling to the un-initiated. You can bet the newsdroids have no idea what they are mouthing. You can bet they like making the oil companies sound bad, no matter what the truth is.

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A lot of people don't like the idea of fooling around with the free market... But surely, those oil companies are making so much money that something has to be wrong. Surely we need to place a windfall profits tax on the oil companies. That can't hurt, can it? After all, we'll only tax the unreasonable profit. Such profit must be an example of when government regulation is promising.

Let's define terms. What is a "windfall profit?" What is an "unreasonable profit?" You begin to see the problem. And you must see that trusting the government to do a good job regulating industry, any industry, is like asking them to do a good job building inexpensive, high quality roads. It won't happen. (Generally, we have very good roads, but they cost a fortune to build and maintain.)

So where do I think these record profits came from if they aren't windfall or unreasonable. Oil companies make money by drilling, 'recovering' or buying, refining, shipping, and selling petroleum product. This whole process of getting the raw material out of the ground to delivering it to your gas tank takes time, several months. So a company, say ExxonMobil, acquires the raw material and values it at whatever price they paid for it. By the time the process is finished, the price of the raw material may have gone up 20%. ExxonMobil has to explain to the shareholders the new value of the raw material in existing finished product. So ExxonMobil states that increase in value of raw materials for goods not sold as profit. Thus, because ExxonMobil was busy making the product, and the value of that product in the market was going up while ExxonMobil was busy making it, ExxonMobil gets more income on the bottom line.

There is only one more question. Economists say the market "sets" a price. That price is found through trial and error, what a mathematician might call successive approximation, which helps explain why economists all have to study Calculus, to be able to analyZzzzzzzzz....

Sorry about that. The price of anything is "set" by people freely interacting, all of them trying to discover how cheaply they can buy what they want, and discovering how high a price they can get for that they want to sell. Obviously, if you are trying to sell something for more than what people are willing to pay, you're not going to sell very much. If lots of people are trying to sell a similar item, then the buying public will be able to compare your price with the prevailing price pretty easily.

Can you think of a product more widely distributed by such a host of suppliers than oil products? Whatever the price you pay when you fill up the tank, it's a pretty sure bet that you're paying about the same price as you would at any nearby gas station. Because people are willing to pay the price, and because a number of suppliers are willing to take the price, the price is what it is. Even though the price of the product is widespread and common, it is the result of the free market. There is no indication of collusion or monopolistic pricing practices.

No "windfall" taxes are needed, or even a good idea. Things are working as the free markets say they should work.

. . . .

It's worth remembering that the real reason governments tax anyone is to show you who's boss. Taxing is used to intimidate, and show favoritism. The Democratic Party-droid hates across the board tax cuts, like the Bush cuts of 2004. (Every tax payer pays an average of $2000 less in annual taxes). General tax cuts don't scare anyone, and should make everyone realize that Democratic Party tax policy is a system of oppression.

Tax hikes against the producer of a product only get paid by every user of that product. If the oil companies get taxed, every driver will pay. And pay. And pay. And the Democratic-droid will insist that the oil companies are raising the price for more profit, not just to cover the tax increase. Power for the Democratic Party, not the people. Isn't that just sweet and wonderful, the blogger adds sarcasticly.

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Crude oil sells worldwide for about $62 per barrel. That 'distills' to about a raw material cost of $1.41 per gallon. (This is presently about $95 per barrel. That means $2.26 is the cost of raw materials per gallon of gasoline.) Gasoline still retails for around $3.24 per gallon. How on earth can the oil companies justify that sort of profit?Isn't this proof on the face of it that oil companies collude?

(Update 07/01/08: Crude is now selling for about $142 per barrel. The per gallon cost is about $3.23. The retail price of gasoline is around $4.25)

But how do the oil companies justify taking so much for themselves? I'm going to skip the part about states and federal taxation. Couldn't "Bigoil" just take a smaller profit and help us out?

One additional fact: No new oil refinery construction has been permitted in the United States since 1978. There has been no expansion of capacity allowed for nearly 30 years. This is all due to Leftist sponsored environmental restriction.

In free market economics, price allocates use. If something is real expensive, you use less of it. (Don't tell me you have no choice; I don't want to hear from slaves.) The normal result of a higher price is more product availability. But more gasoline product can't become available: The government won't permit it.

So the free market point is, gasoline got real steep in price, and you should complain. Direct your complaints about gasoline rationally, to the government. Get the feds and states to ease stupid restriction on refinery construction. Then supply will become more plentiful and the price will fall.

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With all the brouhaha about oil, remember that it is commodity. Here is a tidbit about the stuff itself.

Petroleum is organic material left over from old life forms who gave up being alive a long time ago. Petroleum was used as medicine, a source of salt (Saltwater is a "contaminant" in petroleum deposits. Contamination is a matter of perspective), and a supplement whale oil for lubrication. About 1846 someone discovered a way to refine kerosene from petroleum. Kerosene was burned to make light. At that time, not all parts of the petroleum oil could be used to make kerosene. Gasoline was an undesired by product of kerosene and was 'flared off,' to used the industry term. Gasoline was a waste product and simply burned.

Modern chemistry is much advanced since those days. Now the oil company can use more of the barrel of raw oil to make the desired product. This costs money, since there are more processing steps involved. But as long as the price people will pay will support the extra processing, people will be able to feed their finicky cars gasoline.

The terms the oil industry uses to describe the best quality raw oil is light, sweet crude. You've probably heard the term from tv. This term might suggests to you that there is heavy, sour crude, and there is. The lightness of oil describes its volatile component. The lighter the crude, the higher the volatility, and the easier it is to make high grade, refined products like gasoline. Heavy crude requires more processing (and expense) to make high grade products like gasoline.

Sweet crude is low in sulfur. Sour crude is higher in sulfur. Sulfur must be removed before the petroleum prouduct is burned, otherwise the sulfur will be burned up too. Just burning the sulfur with the petroleum product leads to sulfuric acid in the air, which leads to acid rain. Excess sulfur can be removed, but not in the United States. The US has the technology, but the problem is the expense of storage. No one wants that much sulfur, so it has to be piled up somewhere. Enviromental regulation makes it expensive to store because what if it catches fire? Acid rain.

The principle type of petroleum we refine in the US is the light, sweet variety. There are about three refineries in the US which can process heavy or sour crude, but these refineries used to process light, sweet crude.

There are very stupid environmental restrictions on construction of new refineries, so these refineries are conversions. The balance of US demand is made up by importation of refined gas, sort of government sponsored offshore outsourcing. But the foreigners are happy to sell the US al the gas it can pay for. The environmental regulations themselves show the goal is to retard economic growth in America.

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Senator Charles Schumer, says there is no competition in "Bigoil" in the United States. Schumer says we have to break up "Bigoil" in order to get competition. ExxonMobil is trundled out to show that "Bigoil" is making record profit (ExxonMobil made the mistake of making money last year and being a big company). And, according to Schumer, there is no competition for ExxonMobil in the US market. "Bigoil" is too big, and government control is required.

Oil and gas prices are high, no question, and Schumer is lying again, no question.

But is "Bigoil" is a monopoly? A monopoly is a single supplier in the market. There are something over 2000 companies supplying petroleum product in the US, most of that gasoline and heating oil. The biggest single company is ExxonMobil, which delivers about 8-9% of the total U.S. market supply. If ExxonMobil disappeared tomorrow, fewer than 10% of the cars in America would have to be parked.

Here is a partial, alphabetical list of major companies involved in drilling, production, refining, marketing, delivery, sale of petroleum in the United States:

ARCO Amerada Hess Corporation Anadarko Petroleum Corporation Apache Corporation Burlington Resources British Petroleum Amoco, now BP Cherokee Oil and Gas Chevron Corporation Citgo ConocoPhillips Devon Energy Ergon (US) ExxonMobil Frontier Oil

Getty Oil Gulf Oil Hornbeck Offshore Services Koch Industries Marathon Petroleum Company Occidental Petroleum Panda Energy International Paramount Petroleum Petroleum Geo-Services Pilot Corporation Pilot Travel Centers Ridgeway Petroleum Corporation Royal Dutch Shell

STP (motor oil company) Shamrock Oil Sinclair Oil Speedway SuperAmerica Starvin' Marvin's (no joke) Sunoco Syntroleum Tesoro Texaco. Union 76 Unocal Corporation Valero Williams Companies, Inc.

Well, this list is at 40 companies and there are many more. There are too many high-level management people in these oil companies on this list for secret collusive pricing. Somebody would blab. There would be details and facts, not cheapshot accusations.

Is this your nice "bigoil" monopoly, Chuckie?

To be fair, Schumer can't help himself. He suffers from being slithering political filth and has based his entire career in the Senate on a pile o' lies. What puzzles me is why people so readily believe his lies.

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