Download EC420 Oil Profits

Oil Profits Justified-Con 1
Oil Profits are justified by the capital investments of the oil industry. Oil profits enable the
industry to find new supplies of oil. Con Side.
Alejandra Villalobos Meléndez
Wes Bassett
Jarom Renfeldt
Policies of Need and Greed, EC 420
Dr. Emerson and Dr. Rush
May 21, 2007
Oil Profits Justified-Con 2
Alejandra Villalobos
RESOLUTION: Oil Profits are justified by the capital investments of the oil industry. Oil
profits enable the industry to find new supplies of oil.
1. Economic Issues
The oil industry can be considered an oligopoly. In the United States, five companies BP, Exxon
Mobil, Chevron Texaco, Royal Dutch Shell and Conoco Phillips control 62% of the retail market
(oligopolywatch.com). This holds also true in the world market, in which these and a few more
companies and the Organization of the Petroleum Exporting Countries (OPEC) control the
petroleum market.
Exercising their oligopoly power, these companies have colluded, in the same way as
monopolies do, to cooperate in managing the market’s prices and levels of production. This is
especially true for the OPEC cartel where oil producing countries have come together to
collaborate on issues regarding oil production.
In the last few years the oil industry has recorded record high profits. Moreover, consumers have
been paying record high prices as well. This has intensified the debate between the market place
(consumers, investors, and analyst) and the industry on what are reasonable profits and their use.
Some oil companies have tried to make their large profits appear as a function of their size. For
instance, after great criticism over its profits, Exxon Mobil attempted to show profit modesty
through newspaper advertisements (O’ Hara 2005). Are profits in the oil industry justified by
their capital investments and size, as they would explain?
As the economic issues below are discussed, it will become evident that capital investment does
not justify most of the industry’s current large profits.
1. Oil profit distribution.
Most of the oil profits have been distributed through dividends and stock buybacks, not capital
investment.
2. Oil sector has been under-investing.
The oil industry is not investing neither to maintain current levels of production nor to meet
increasing demand.
3. Decreasing oil supply.
Oil industry growing revenues has been due to higher prices not to increases in production.
4. Economic growth.
Lack of investment in infrastructure and higher prices may negatively impact the U. S and world
economic growth.
Oil Profits Justified-Con 3
2. Supporting Data
Oil profit distribution. In 2004, the Washington Post wrote that profits from high oil prices
were being returned to investors through dividends and stock buybacks. It is important to keep in
mind this was prior to hurricane Katrina, when there were record high prices for gasoline that
have remained until today. This same year,
according to econbrowser.com, Exxon Mobil's
2004 Exxon uses of cash flow (billions of
annual report show that 70% of the company’s
dollars)
net cash acquired through operating activities
was distributed back to shareholders and kept
in cash. This is illustrated in the chart 2004
Exxon uses of cash flow, where $7 billion were
distributed in dividends, $9 billion in stock buy
backs and $12.5 billion in cash.
This fact is reinforced by a Petroleum
Economist study published in 2006 which
calculated that the industry returned $63 billion
in dividends and $65 billion in share buyback.
Less than half, an estimated $60 billion was spent in leasehold and exploration activities.
Oil Sector has been Under-Investing. In order to maintain the industry’s level of production,
the oil companies need to invest significantly in capital, due to depletion of existing oil fields and
depreciation on previous investments. In 2004, Exxon invested $9.2 billion in capital additions.
On the other hand, capital depreciation was $9.8 billion. This example shows that capital
investment is smaller than the Exxon's capital depreciation. The chart below shows small
changes on capital investment especially compared with changes in profits for Exxon, Shell and
BP (Econbrowser 2005). The Washington Post
Change in profits and capital expenditures
(2004) explained that the International Energy
between first three quarters of 2004 and first 3
Agency (IEA) estimated that $200 billion a year in
quarters of 2005
investment by oil companies is necessary to keep up
Company
Δ
with demand. However, the investment is 15% to
Δ capex
profits
Δ profits
Δ capex
17% short.
($
($
(percent)
(percent)
billions)
billions)
Two years later, The Wall Street Journal (2006)
analyzed another report by the IEA that showed that
Exxon8.5
50.3
1.7
16.7
investment was up 70% or $340 billion from 2000
Mobil
to 2005. Nevertheless, after adjusted for inflation,
Royal
the real increase in investment was only 5%. In
Dutch
7.0
49.9
1.4
13.8
addition, the large increase in prices and profits
Shell
were “the result of self-imposed investment
BP
4.7
32.8
0.3
3.8
restrains” (Bahree, 2006).
When analyzing investment projects, oil companies assume that the price of oil per barrel will be
around twenty to twenty five dollars. As a result, many of these projects are categorized as non
profitable (Blum, 2004).
Oil Profits Justified-Con 4
Decreasing Oil Supply & Increasing Oil Demand.
In 2005, upstream investment increased by 31% or $277 billion. On the other hand, this increase
in spending was not reflected in the increase of oil and gas reserves. Oil and gas production
worldwide rose by 1% and reserves increased by 2%. In addition, the reserves-replacement rate
continued to decline to 143% of production compared to 177% in 2000. (Petroleum Economist,
2006). These figures indicate a very constrained supply of oil which puts pressure for oil
products price to increase.
This upward pressure on prices is further magnified by increasing demand. In 2004, after an IEA
meeting, the Wall Street Journal reported that the world oil demand was expected to grow 50%
by the year 2030. It also added that, we were experiencing the “biggest potential disconnects
between supply and demand in the 150 year history of the oil business”. Moreover, The Global
Insight explained that every percentage point increase means about 500,000 more barrels of oil a
day (Bahree, 2004).
Two years after this analysis, the trend was expected to remain in the years ahead. Investment
projects in the petroleum industry take many years to complete. Therefore the lack of current and
previous year’s investment, the decreasing supply and fast growing demand will keep pressuring
oil prices up. An IEA economist explained in an interview by the Wall Street Journal that oil
demand will at best remain just above oil supply through the end of this decade even “if all the
projects [industry’s investment] see the light of day” (Bahree, 2006).
Economic Growth
The economic issues explored above, brings us to how economic growth in the U.S. and the
world will be impacted by these factors. “We’ll pay through lower economic growth” Daniel
Yergin, chairman of Cambridge Energy Research Associates warns (Bahree, 2004). The
production of oil and energy requires oil and energy. As the supply of oil fails to maintain
current levels or decreases, demand is expected to only increase. This in turn, makes energy
more costly and this cost spills on any good and service in the economy (Kaufmann, 2006).
Unfortunately, the current lack of investment on oil production, research and production of other
sources of energy makes it more challenging to sustain economic growth. Modern life will be
affected by industrial economies being forced to use lower quality of energy (Kaufman, 2006).
Oil being a non-renewable source of energy makes it inevitable for economies to transition to
renewable sources of energy. The world economy’s ability to smoothly transition to these
sources can ease the threat to sustain positive economic growth. “So if society does too much
now to stimulate alternative energies, as opposed to later, there will be some loss of economic
efficiency. But if society does too little now, as opposed to later, the effects could be disastrous”
(Kaufman, 2006).
Therefore, it is critical that the oil industry uses its resources, including profits, to invest in
projects that lead to increase production and more importantly to research and implementation of
production of renewable energy. Nevertheless, it is clear their failure to do so. And though
profits could potentially enable the industry to invest in capital and to find new supplies of oil,
currently it is not the case.
Oil Profits Justified-Con 5
Wes Bassett
Political Issues (Con Side)
Because of recent soaring costs at the pump and historic profits for oil companies, a major issue
today is the concern to understand the connection of oil companies’ profits, their investment in
finding new supplies/alternatives, and the political implications of their activities. The key
political implications which surround this issue are tax benefits for large oil companies which are
given in an effort to boost supply, Hurricane Katrina used by oil companies to profit from raised
crude and gas prices, environmental implications (alternative fuels, drilling), and conflict
conditions through out the world.
One current issue in the political environment surrounding oil companies’ profits is the
enormous tax and royalty relief given to oil companies by the U.S. government; this is known as
the HR6 which involves the nation’s top oil companies who contribute $61.6 million to the
republican party as a soft money effort to impose a “hands off” approach to oil legislation. The
apparent goal of the HR6 bill is to encourage oil companies to invest in oil exploration and
alternative fuels technology. The protocol for oil drilling and exploration is that oil companies
must pay the government royalties for drilling in their waters and on their land. Recently, large
oil companies have forgone their royalty payment obligations and received additional tax relief
in an effort to reinvest in oil exploration. It is estimated that the major oil companies will receive
31.6 billion dollars in tax and royalty relief. (www.kicktheoilhabit.org)
The top oil companies (10 dominate 81.4 percent of the industry) claim that tax relief efforts are
essential for further oil exploration to meet the demand of U.S. which consumes 25% of the
world’s oil reserves and developing countries like China and India (Slocum) . As demand
increases, the U.S. government implements “hands off” policies the world’s top oil companies
(Exxon Mobil, Conoco Phillips, Chevron Texaco, Valero, Shell and BP) which enables them to
fix gas prices for the benefit of maximizing profit rather than promoting technology for
exploration (Mokhiber). This follows the historic notion that limiting an industry to an oligopoly
does not only limit innovation but it curbs innovation. According to Tyson Slocum in his
article,” Hot Profits and Global Warming: How Oil Companies Hurt Consumers and the
Environment”, oil companies use behind the scene business tactics such as price gouging by
limiting production in order to boost their profit margin rather than boost innovation. By keeping
oil refineries in tight production, oil companies are able to boost there profit margins by 158
percent between 1999 and 2005 creating an unfair market condition.
A strategy used by oil companies to curb oil production to decrease the supply and increase
profits is to force small oil refineries out of business. Between 1995-2004, 97 percent of 929,000
barrels of oil per day of capacity has been shut down were owned by smaller, independent
refiners. (Slocum) According to www.reason.org, an oil refinery has not been built in the U.S.
since 1976.
Instead of oil companies using their massive profits and tax relief to invest in exploration,
statistics show that the world’s top oil companies are investing their profits in stock buy backs
Oil Profits Justified-Con 6
and dividends payments for their investors rather than investing in to research and ending
America’s dependence on oil.
(Slocum)
To further illustrate big oil company price manipulation; in June and January of 2006 and July
and August of 2004, the CFTC charged the Shell oil company with a civil penalty for using
unfair strategies which include market manipulation as well as disclosing false information to
government investigators. Also in September of 2003, BP agreed to pay NYMEX 2.5 million
dollars to settle accusations of market manipulation and unfair crude oil trading methods
(Slocum).
A critical issue in the manipulation of oil markets is how oil companies used hurricane Katrina to
unfairly raise gas prices. In August of 2005, hurricane Katrina ravaged the Gulf of Mexico which
damaged oil refineries and caused surges in crude oil and gasoline prices. Consequently, oil
companies found this disaster as an opportunity to maximize profits. Following the hurricane
Katrina, Royal Dutch Shell profits grew 68 percent, to $9.03 billion, BP announced profits at 34
percent above 2004 levels, and Conoco Phillips saw revenue jump 43 percent. (Noe) As Hillary
Clinton said, “You have a hurricane, and all of a sudden you see prices going up like that. That
has . . . everything to do with people trying to make money off the backs of this tragedy.”
Another consideration of oil companies’ capital investment choices is their investment into
alternative and renewable energy sources rather than promoting a culture of oil dependence. It is
essential that oil companies invest in sustainable technology because oil exploration is
destructive to the environment and it involves expensive technology to further deplete our
resources. Oil exploration also increases the possibility for environmental contamination as scene
in the eroding condition of the Alaska pipeline and it increases the risk of ocean contamination
like the Exxon Valdez spill in 1989
Profits are also not justified in oil companies investment in oil exploration because they are
investing in resources with an ever approaching ceiling whereas research into sustainable energy
would be a more profitable investment given that it is becoming more and more expensive to
engage in deep sea drilling which demands more technology to tap into the world’s scarce oil
reserves.
Oil Profits Justified-Con 7
According to author Tyson Slocum, average fuel economy in autos has not increased in 25 years.
This is largely because oil and U.S. auto companies continue to exploit gas guzzling SUVs
which drive up fuel profits. Consequently, U.S. consumers are turning to Honda and Toyota as
leaders of sustainable technology because they can no longer afford the prices at the pump which
exceed the 3 dollar mark. .
Another important political issue associated with the oil profits is the effect of oil revenues on oil
dependant developing countries. In countries like Sudan and Azerbaijan, it is likely that these
revenues will be used to exclude governments’ obligations to the humanity of their citizens.
Essentially, these governments do not have to invest in there country’s human capital because
they are not relying on taxes from individuals and businesses. Consequently, these countries’
citizens are exploited.
These oil revenues also encourage corruption, violent conflict, and internal repression which
arise in countries like Sudan and Azerbaijan. In the case of Sudan, the government used oil
profits to continue a north/south war with Darfur which further promotes separatism and ethnic
cleansing. (Shankleman)
The issue of oil revenues is a dense web of corruption, misuse of vital funds, and violent conflict
which are overlooked by oil companies in an effort to maximize profit. The world would greatly
benefit by responsible oil companies who invest in sustainable energy sources to limit
dependence on oil rich countries and minimize world conflict.
Oil Profits Justified-Con 8
Jarom Renfeldt
Limitations of opposing argument:
1. There are huge technical challenges to meeting the world’s current demand for oil such as
competition from national oil companies and demanding, even hostile foreign
governments.
a. “The unmistakable implication is that, as in the case of Iraq, nations that don’t
want to let in Western oil companies can become the targets of US military
aggression.” (Auken)
2. The reserve replacement ratio needs to always be over 100%, but in the next five years
most of the six oil majors will slip below that level.
a. “The stone age didn’t end because they ran out of stone. There will be oil left
when we stop using that too.” (Unknown)
b. Opening up Alaska’s Arctic National Wildlife Refuge to oil and gas drilling
would increase domestic oil production by .9 million barrels per day (Energy
Information Administration).
3. Oil could hit $200 a barrel by decade’s end, or about $6.00 for a gallon of gas. There is a
sharply rising demand from China and India.
a. India and especially China are making their own deals with other countries to
acquire oil now and in the future. There current demand is minimal in
comparison to the regular demand of the US.
4. So much of the global oil patch is now off-limits (85% accessible in 1960, only 16%
now); in practice the private oil companies are better than national companies at the
technology and innovation that get the best results.
a. The second half of this statement is difficult to quantify. How does one determine
that one is getting the “best” results? Many countries do not post their acquisition
of oil, yet they do sell what they have left over (a huge majority) on the open
market. It seems more likely that the big oil companies don’t like the competition
that a country brings to the table.
5. Offshore wells now often have to drill 10,000 feet or more to find oil, years ago 600 was
the limit. A single well can cost over $50 million, 5 times more than they did 10 years
ago.
a. Are these figures adjusted for inflation? Of course new individual wells are also
pumping out more oil then ever before using their advanced, more expensive,
technology. The investment is paying off. With the highest profits the oil
companies have ever seen, paying more for a well seems like a drop in the bucket.
6. 80% of capital goes to finding and developing resources and improving and expanding
facilities.
a. In 2006 Exxon spent considerably more of its profits to buy back its own shares
on the stock market than it did on new capital investments. The company laid out
fully $25 billion on repurchasing its own shares in a scheme to drive up stock
prices. During the same year, it spent $19.9 billion for capital investment.
Oil Profits Justified-Con 9
7. The price of gasoline is actually dictated by the global market which sets the price for
crude oil.
a. A strategy used by oil companies to curb oil production to decrease the supply
and increase profits is to force small oil refineries out of business. Between 19952004, 97 percent of 929,000 barrels of oil per day of capacity has been shut down
were owned by smaller, independent refiners (Bassett).
8. Oil supply and demand is inelastic because as rates go up, consumers don’t lower their
demand.
a. In January of 2007 crude oil prices fell to $50.74 a barrel. Oil prices had not been
this low since June of 2005. The pump prices then dropped as they should in a
normal supply and demand model (Energy Prices). But they didn’t fall far. In
response to falling rates the major oil companies immediately started shutting
down plants, and lowering the output of other plants (Dickens). They artificially
created more demand and have again raised the price of crude oil.
Oil Profits Justified-Con 10
Economics Issues References and Works Cited
Blum, J. (2004). Oil Companies Resist Investment. The Washington Post [Online] Retrieved:
May 13, 2007. Available: http://www.washingtonpost.com/ac2/wp-dyn/A197772004Nov2?
O’Hara, T. (2005). Oil Industry Seeks to Cast Huge Profits as No Big Deal. The Washington
Post [Online]. Retrieved: May 13, 2007. Available: http://www.washingtonpost.com/wpdyn/content/article/2005/10/27/AR2005102702399.html
Petroleum Economist (2006). Retrieved: May 13, 2007. Available: http://0proquest.umi.com.opac.library.csupomona:80/pdlink?did=1152937191&sid=6&Fmt=3&
cliendtld=17860&RTQ=309&VName=PQD (Pro Quest ID 1152937191).
International: Oil Sector dogged by underinvestment. OxResearch. (2006) Retrieved: May 13,
2007. Available: http://0proquest.umi.com.opac.library.csupomona.edu:80/pdlink?did=1075625071&sid=6&Fmt
=3&clientld=17860&RQT=309&VName=PQD (Pro Quest ID 1075625071).
Kaufmann, R. K. (2006). Planning for the Peak in World Oil Production. World Watch.
Retrieved: May 19, 2007. Available: http://0proquest.umi.com.opac.library.csupomona.edu:80/pqdweb?did=947458691&sid=15&Fm
t=4&clientld=17860&RQT=309&VName=PQD (Pro Quest ID 947458691).
Bahree, B. (2004). A Global Journal Report; Crude Calculation: Awash in a Gusher of Cash, Oil
Firms Are Reluctant Investors; A Failure to Add Capacity Could Leave World at Risk for
Future Price Shocks; Lessons From the ’73 Embargo. The Wall Street Journal [Online].
Retrieved: May 13, 2003. Available: http://0proquest.umi.com.opac.library.csupomona.edu:80/pqdlink?did=683286471&sid=4F&Fm
t=3&clientld=17860&RQT=309&VName=PQD (Pro Quest ID 683286471).
Bahree, B. (2005). OPEC Likely will Maintain Quotas; Recent Bounce in Oil Prices, ‘Balanced’
Market Signal Low Probability of Change. Wall Street Journal [Online]. Retrieved: May
13, 2007. Available: http://0proquest.umi.com.opac.library.csupomona.edu:80/pqdlink?did=939194921&sid=4&Fmt
=3&clientld=17860&RQT=309&VName=PQD (Pro Quest ID 939194921).
Bahree, B. (2006) Politics & Economics: Investment by Oil Industry Stalls; Prices Are Likely to
Rise as Inflation Erases Outlays, Energy-Agency Study Finds. Wall Street Journal
[Online]. Retrieved: May 19, 2007. Available: http://0proquest.umi.com.opac.library.csupomona.edu:80/pqdweb?did=1158306801&sid=9&Fm
t=4&clientld=17860&RQT=309&VName=PQD (Pro Quest ID 1158306801).
Oil Profits Justified-Con 11
Bahree, B. (2007) OPEC holds output steady; Ministers will wait for greater demand before
raising supply. The Wall Street Journal Asia [Online]. Retrieved: May 19, 2007.
Available: http://0proquest.umi.com.opac.library.csupomona.edu:80/pdqweb?did=1234333991&sid=10&F
mt=3&clientld=17860&RQT=309&VName=PQD (Pro Quest ID 1234333991).
Oil Company Profits. (2005). Retrieved: May 13, 2007. Available:
http://econbrowser.com/archives/2005/10/oil_company_pro.html
Hannaford, S. (2004). Big Five gasoline squeeze. Oligopoly Watch [Online]. Retrieved: May 13,
2007. Available: http://www.oligopolywatch.com/2004/06/12.html
Political Issues References
Balz, Dan. “Oil Firms Turn Katrina Into Profits, Clinton Says” Washington Post
Saturday, September 3, 2005; Page A10. www.washingtonpost.com
Shankleman, Jill, Myers Joanne. “Oil, Profits, and Peace: Does Business Have a Role in
Peacemaking?” April 12, 2007 www.cceia.org
Moore, Adrian. “Katrina Reveals Gas Price Folly” Orange County Register
September 1, 2005 www.reason.org
Slocum, Tyson. “Hot Profits and Global Warming: How Oil Companies Hurt Consumers
and the Environment” Pubic Citizen September 2006. www.citizen.org
Mokhiber, Russell, Weussman, Robert. “Time to Cap Big Oil’s Profit Gusher “
July 4, 2000. www.commondream.org
“About Oil Subsidies and Royalties The Big Picture” www.kicktheoilhabit.org
Noe, Eric. “For Oil Giants, Pricey Gas Means Big Profits” Jan 25, 2006 abcnews.go.com
Limitations of Opposing Argument References
Auken, Bill. "Big oil companies post record profits for 2006."
News & Analysis. 03 Feb 2007. World Socialist Web Site. 18 May 2007
<http://www.wsws.org/articles/2007/feb2007/oil-f03.shtml>.
Dickens, Geoffrey. "Meredith Vieira Advances Democratic Line on 'Big Oil'
Conspiracy." News Busters. 14 May 2007. Media Research Center. 18 May 2007
<http://newsbusters.org/node/12745>.
"Energy Prices." Monthly Energy Review. 25 Apr 2007. Energy Information
Administration. 18 May 2007 <http://www.eia.doe.gov/emeu/mer/prices.html>.