Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Monday, October 31, 2005

Ungodly Oil Profits?

There have been two recent items about oil profits which have provoked my interest enough to write about them.

The first, by the Emirates Economist, says

Short-run demand for petroleum is inelastic, meaning that a fall in supply translates into percentage increase in price that is greater than the decrease in quantity consumed. As a result, negative supply shocks drive up revenues and can drive profit as well. What does this prove? That despite its size Exxon and its fellow producers were not exploiting market power - otherwise they would have done on their own what a string of hurricances did instead.
He very wisely points out that

It is only because government has been able to maintain a reputation not to grab profits that oil producers invest in exploration and production.
This long-run view is crucial for economic development.
The second item, by Kip Esquire, says,
[ExxonMobil] announced profits of $9.9 billion on sales of $101 billion. For those who cannot divide, that is a profit margin of 9.9% of sales. Since when is a profit margin at a cyclical peak of 9.9% considered "staggering"?

Microsoft makes 30%, in good times and bad, with a fraction of the investment or risk [ExxonMobil] takes. ... Procter [&] Gamble makes a margin of nearly 13% of sales selling toothpaste and detergent but we are going to begrudge oil companies 7.6% on average and 10% in their best quarters?
While I agree with the tone of his posting, I think a better comparison would be the rates of return on equity, not the rate of return on sales. Rate of return on equity better captures the opportunity costs of the shareholders' financial investments; and rates of return on sales can vary dramatically across industries for reasons that have nothing to do with market power. Furthermore, there seems to be some evidence that oil profits have fallen, now that oil prices have declined.

Back in the late 1970s, I used to tell people who were affronted by the large profits of the oil companies that they had a chance to get in on the profits themselves by buying the stocks of those companies. That they chose not to do so should not be taken as grounds for punishing or taxing those who did.
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