Gas Prices on the Rise Part 2

Today President Bush delivered a speech calling on congress to act quickly to help stabalize energy prices. Bill O'Reilly, the staunch conservative on Fox News, starts his shows with his famous "talking points memos" and recently has spoken about gas prices, speculators, and oil companies around the world. It is sad to see that such an intelligent man with influence as wide and vast as he has is so ignorant of economics. His talking dirty about the oil companies and the Middle East, makes people feel better and thus they watch him more. It is for ratings in my opinion. He is just too smart to really get this one wrong.

In the last post I discussed the supply issue which is the most important issue in that it effects the market price for oil. I briefly mentioned the also important aspect of the demand for oil in the last blog. Keep in mind that oil is not sold to countries separately at different prices but is in fact sold on a world market at one price. Thus our slowing economy does not mean that the demand is lessening. Just as our economy and standard of living rose dramatically during the 1950's, the mid to late 80's, again in the mid to late 90's and now recently in the past 4 years, we have now seen uimaginable growth in other countries around the world. China and India have seen much of that same type of growth recently. Actually they are finally using energy sources in large amounts for the first time in their nation's histories. With rising standards of living in countries that have over one-third the world's population, is it really a surprise that prices have risen without the same increase in supply? Demand rises due to wealth. That is a good thing my friends. The government does not have control of demand but can easily pass laws that affect the supply of oil which is exactly what they have done while beholding to the liberal anti-capitalist environmental wacko movement. Lets now move to a well believed fallacy in the world of corporation profits.

Many of you are angered to hear that oil companies are profiting at our expense. With gas prices through the roof, these oil companies are making bank! Lets examine this for a minute. The profits of oil companies are up big time but so is every other company that deals with markets of energy prices. The question is how much has their profit margins risen? Profit Margin is the percentage of total revenue that is kept in a form of profits to be either kept, paid to stockholders, or reinvested. In other words are they themselves charging more or is the rise in Price dictated by the market raising the price of oil? Oil Companies profit margin (that is the percentage of the dollar we pay that goes to them in profits) has not risen but in fact lowered slightly to an average that is slightly below $.09 a dollar. Yes, less than 10% of the price we pay goes to oil companies in profits. Their revenues are high but their profits are a low percentage of those revenues. It is easy for someone who does not understand the different between profits and profit margin to be angered easily when politicians can come out and condemn big oil for their record profits.

Allow me to end with this today. Oil companies are much like drug companies in that they must have high profits for two things. They must pay their investors a higher amount in dividends to convince the investors to continue risking their money on such an unstable market. An even larger expense is the necessity for this section of the economy to reinvest a higher percentage of those profits into future oil exploration and drilling. In fact most of the oil companies reinvested more money than they had in profits to find new oil this past year. Did you hear me? They have reinvested more than the "obscene" profits we have seen them make. They are not just sitting on those profits but are spending it on finding new energy resources. Just as drug companies must make a high profit margin to invest money into more and better drugs so does a company that has such high fixed and variable costs of operation. Google what is required to open up a new avenue of oil. Sometimes companies have to drill miles into the ground then sideways for miles then back down again. Needless to say this equitment and operation can cost billions not millions of dollars.

In the next blog I will discuss the impact speculators have on the market of oil. This is an often misunderstood concept and I will attempt to discuss it in layman terms.