Big Oil Has Record Costs for Last 2 Quarters

Congress talks about new subsidies

People—and by “people” I mean politicians and journalists, primarily—like to use numbers to tell a story. Frequently the story is a fiction informed by fact, and the numbers are thrown in there to make the fiction seem, well “non.” The story du jour is about Big Oil’s record profits, and what the government should “do about it.” While it is true that profits are up, the cost of doing business is also up, and no one is talking about that. It’s important to bear all this in mind while our politicians send hate mail to these corporate executives.

In the last quarter, Exxon-Mobil’s profits (for example) were up $2.6 Billion or about 6% compared to the quarter before. Meanwhile costs were up by about $6 Billion, which is approximately a 10% increase in expenses. This has occurred for each of the last two quarters.

I certainly don’t want to make the point that XOM or any other major corporation (oil producing or otherwise) is a paragon of virtue, but I want to make the point that just throwing around a company’s profits is not a good basis for making a decision or for railing against their “windfall profits.”

Let me explain. Say I come to you with a business plan that could earn you $102, and all you have to do is invest $100. You’d never do it! Even without discussing the risk involved, it’s not worth it to give up your $100 just to get an extra $2. On the other hand, if I promised you a $3 payout for investing $1, you’d sign up every day and twice on Sundays. What’s the difference? In both cases you make a $2 profit, right?

The difference is the risk and opportunity cost you take on. Risk is pretty easy to understand, but opportunity cost is a little less. Basically what opportunity cost means is what else could that money have been doing for you. If you could have had it in a bank account where it would have earned you more interest, clearly that would have been better. Even if it hadn’t earned you as much interest (as most banks don’t pay much these days), you might still choose the bank option because it’s less risky.

The question that you, as the owner of some money, need to answer is “how much do I need to get paid to be willing to invest my money with you?”

What about Exxon-Mobil and their ilk? Their bean-counters have figured out approximately what the risks are, and given those risks, decided that XOM needs to be about 39% profitable, before taxes and operational costs are taken out. This means that for every dollar invested, they need to get back $1.39. This figure is much more than just a finger-in-the-air exercise, it takes into account the worst-case scenario, the most likely scenario and many others as well. It baked these all together with some very complex mathematics and came up with a profit margin that will cover them in almost all circumstances, yet without pricing their oil so high that no one will buy it.

Am I saying that we should be more sympathetic to Big Oil? No, I only say that any changes to US policies should be based on a sound argument, not one that makes for a good sound byte.

That's my $43 billion.