October 31, 2005
Oil company profits
Why aren't the big oil companies reinvesting their huge profits?
Consider the following data, taken from the Exxon-Mobil 2004 annual report. The company earned $26.1 billion in 2004 and reported capital and exploration expenditures of $14.9 billion. Looking casually at the two numbers, this might sound exactly like what we'd expect to find, namely, a company plowing a good deal of its profits back into the investments necessary to help increase future global oil and gasoline production. But when you look at the numbers more closely, it appears to be a surprisingly low level of investment spending.
For one thing, oil companies face a significant degree of depletion of existing oil fields and depreciation on previous capital investments, meaning huge investments are required just to maintain the status quo. Standard accounting conventions recognize this by subtracting depreciation and depletion as an operating expense, with the presumption being that the investment that would be necessary in order to maintain current production would be counted as a regular business expense rather than something one needs to pay for out of profits. In addition, Exxon sold off $2.8 billion in investments in 2004, which we would need to subtract if we wanted to calculate the net productive assets that the company added during 2004. Exxon also charged off $1.1 billion in dry-hole exploration as a cost before calculating profits, meaning that these funds didn't come out of the $26.1 billion profit, either. Finally, the notes to the annual report indicate that Exxon followed the accounting convention of including in capital expenditures a proportion of capital spending by interests in which Exxon holds equity, which again require no funds directly out of profits.
One way to keep track of all this is to look at the "Summary Statement of Cash Flows" in the annual report. We can calculate the cash Exxon had available to spend by starting with the $26.1 billion net income earned in 2004 and adding the $9.8 billion that Exxon imputed to depreciation and depletion expense, plus $4.7 billion in other items such as an increase in accounts payable (which, because the funds are net yet disbursed, means such items also add to cash in hand). These three magnitudes come to $40.6 billion, Exxon's calculation of the net cash provided by operating activities.
Exxon reported its 2004 actual cash expenditures for additions to property, plant, and equipment to be $12.0 billion, which, if we subtract the $2.8 billion sales of assets, implies $9.2 billion in net capital additions. This is actually less than the $9.8 billion depreciation and depletion figure, which one might interpret as meaning that virtually none of the tremendous 2004 profits were used to acquire net new assets. So what did Exxon do with all the rest of the money? Seven billion went to dividends, $9 billion to net stock buybacks, and an incredible $12.5 billion was just hoarded as cash.
Nor was Exxon alone in this behavior. For example, ChevronTexaco had 2004 net income of $13.3 billion, which it used to accumulate $5 billion in cash and buy back $2.1 billion of its stock.
How are companies that behave in this way going to succeed in increasing oil production? The answer is, they aren't. The graph at the right, taken from the Oil Drum, displays production over the last 3-1/2 years for the top 10 publicly traded oil companies. Half of these giants have seen their production fall over this period.
And prices and profits have continued to surge in 2005. The table below summarizes how much profits and capital spending went up in the first three quarters of this year compared to the corresponding quarters last year for three of the companies that reported big profit gains this week. Only a modest fraction of the increase in profits for these companies is showing up so far as additional investment.
|Royal Dutch Shell||7.0||49.9||1.4||13.8|
So what's the story? Maybe the oil companies are hoarding the cash in preparation for big investments just down the road. But we really could have used those investments several years ago, not several years from now. Or perhaps companies see enough danger of an oil price collapse that they are unwilling to make investments that would only pay if oil prices remain high. But if that's the explanation, it's unclear why they don't take the sure profit and hedge that's available from using futures prices. Alternatively, some might say that the only remaining plays at this point are in the control of governments, not oil companies, with the incipient decline in production by the international majors another milestone on the path to peak oil.
I must confess that I find it puzzling why it would make sense in the current situation to hoard cash and buy back shares. If anyone has a good explanation, I'd be very interested to hear.
Posted by James Hamilton at October 31, 2005 10:47 AMdigg this | reddit
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"I must confess that I find it puzzling why it would make sense in the current situation to hoard cash and buy back shares. If anyone has a good explanation, I'd be very interested to hear."
While I don't think it's necessarily true, I think you at least ought to mention the theory at The Oil Drum, since you used their chart. (That being that oil companies know the peak is here or near and that the remaining places to invest in additional production are quite dangerous).
Posted by: M1EK at October 31, 2005 12:13 PM
They could be trying to damp the volatility of their stock prices. Lots of companies have more cash on hand and underinvest in R&D than they should, because they want to have that "AAA" credit rating or that "conservatively managed" reputation. Ultimately, it this is unproductive for the stockholders, but I've heard enough of the "we're safe, we're sitting on such a large pile of cash" stories from management that I have to believe it plays well with some constituency.
Posted by: Anand H at October 31, 2005 12:17 PM
With every politician criticising oil company profits and every other one proposing windfall profit taxes or price-gouging laws, the mystery is why any long term investment occurs, and if it does why the management isn't ousted by the shareholders.
Posted by: Don Lloyd at October 31, 2005 12:30 PM
The buy-back in shares is a simple application of economics. When the public market places a value on your stock that is less than full value, management has an obligation to redeem shares from those willing to sell.
The second issue is that the escalation of oil prices is a relatively recent factor. As a shareholder, a year ago I was speculating that oil might be able to hold $40 per barrel in 2005. I think profits this year were as much a surprise to the oil companies as to the public.
Drilling expense is also curtailed by capacity. There wern't a few thousand (modern) rigs setting around waiting for work at the beginning of this year.
It seems you are examining elephants, and expecting ballerinas.
Posted by: Bill Ellis at October 31, 2005 12:33 PM
Maybe investments in oil production are not profitable, because of competition from state-run oil companies in OPEC, Russia and other places where American oil companies can't invest. Companies could invest more but it would not increase their production enough to cover their expenses.
In other words, all the good fields are off limits to capitalist firms, and it doesn't make economic sense at this point to plow more money into the bad fields.
Posted by: Hal at October 31, 2005 12:52 PM
The hedging theory won't work in practice. A typical oil project takes anywhere from 4-10 years from discovery to first production, and then produces for years or decades. The futures market only trades out 6 years, so unless you're very lucky or very good, you won't even be able hedge your first year's production, until the project is well under way. It might be possible to do something for a longer term over-the-counter, but historically the bid/ask spreads (the difference between what the seller wants and what the buyer is willing to pay) on such thinly traded markets have been prohibitive.
Posted by: Geoff at October 31, 2005 12:54 PM
I'm in the school that says they are waiting better investment opportunities. ANWR, offshore Pacific, offshore Florida, offshore Atlantic, Rockies are all to be opened up for exploration. New pipelines are being discussed (Kinder Morgan, for example). Greenfield refineries or at least heavy sour crude processing upgrades.
Timing is everything.
Posted by: Joseph Somsel at October 31, 2005 01:44 PM
Exxon et al are in possession of an ever diminishing resource the price of which will ever continue to go up as long as there is no alternative. They are in position to charge ever more per barrel. Successful R&D is the last thing they want to see.
Posted by: ken melvin at October 31, 2005 01:50 PM
I think there is a certain degree of decadence or exhaustion in many institutions including quite a few in the economic sector. Oil companies might be comfortable with the oligopolic balance.
- Future prices are hard to predict. Even the first wave of conservation seems to have dampened prices. I believe the comanies and Opec want forty plus per barrel and believe they can keep their production at current margins for the medium run.
- Cash means they can buy up more dynamic producers. Let them take the risk and prove the project. This can be a safer way to invest. And if a company has lost the culture of wildcatting it is probably best. It also lets little guys go through the various regulatory and environmental issues that hurt corporate PR.
- Do little and wait for increasing Republican incentives. Republican philosophy is currently as anti capitalist as Democrat. The difference being that the Republican ideal is feudal. Established wealth must be nurtured and protected. The purpose of government is to redistribute wealth. We have a president who got rich because a city condemned land (the courts ruled at one third value) and built him a baseball park, a vice president and secretary of defence who used government connections to become corporate executives. The vision is in pure form here:
Active economic production doesn't fit into this scheme. Doing little expecting to get greater government rewards is probably more profitible.
- The test of corporate leadership is stock price. A leader who prepares a company for great success a few years down the road with flat or decling stock prices is a failure. One who destroys a company but brings in higher stock prices for the next few years gets to be a genuis and is displayed on the covers of business magazines.
Posted by: janet at October 31, 2005 02:29 PM
Does anyone know the funded status of XOM's employee benefit plans? (eg, retirement pensions and retirement health care benefits) How funded are XOM's plans relative to other U.S. corporations?
I might look some of this up.
It would be nice if XOM and others considered salting away a portion of current profits for future employee security and stability-
Posted by: nate at October 31, 2005 04:40 PM
more input from me on XOM:
Posted by: nate at October 31, 2005 05:46 PM
I enjoy your weblog.
I went back and pulled historical info from the 2000 and 2004 ExxonMobil reports:
year Earnings, M$ Capex, M$ Cap Emp M$
1997 11.7 14.1 79.7
1998 8.1 15.5 80.1
1999 7.9 13.3 83.8
2000 17.7 11.2 87.5
2001 15.3 12.3 88.0
2002 11.5 14.0 88.3
2003 21.5 15.5 95.4
2004 25.3 14.9 107.4
If you take a long term average of earnings and capital investment, the amount invested looks more reasonable. Large capital projects can take many years to plan, design, get environmental permits or otherwise complete negotiations with governments, procure and construct. This years capex probably has more to do with oil prices and profits in 2002-2003 than in 2005...
Finally, there are some limits in how fast spending can be ramped up - staffing within the large companies and the large engineering/construction companies for example...
Posted by: Doug at October 31, 2005 05:58 PM
I must confess that I find it puzzling why it would make sense in the current situation to hoard cash and buy back shares. If anyone has a good explanation, I'd be very interested to hear.
First off it is always wise to pass along dividends & buy back stock if management can't do something better with the money... especially in a 'temporary' windfall like this.
Why can't they do better? I agree with Doug here: Finally, there are some limits in how fast spending can be ramped up - staffing within the large companies and the large engineering/construction companies for example... I was in Chem Engineering when I was young and the ramp ups are very slow & expensive... and none are more difficult than energy like petro-chem or nuclear. Even if they wanted to it will take years.
But I also believe the 'Peak Oil' phenomenon is real... I mean if you had all that money where would YOU put it? There isn't much low hanging fruit out there... and they know it better than we do.
Lastly there is probably a 'Schumpeter Effect' - these companies are old & bureaucratic in a mature almost outdated industry... an essential industry still but old & stodgy. They don't even know what to do with the money because they can't imagine another business model except the one they have now (and the past that got them here). Creative destruction will make this all a moot argument someday... but we are all likely to suffer as much or more than they will when this happens... they at least start with billions... most of us (me for sure) do not.
Posted by: dryfly at October 31, 2005 06:56 PM
Well, duh. They save their cash, let others take the risk of new exploration and development of alternative forms of energy, then buy them out. Geez, a child could figure that one out, guys.
Posted by: donna at October 31, 2005 07:44 PM
"Why aren't the big oil companies reinvesting their huge profits?"
As to the hugeness of their profits, relative to those of other industries:
Posted by: Jim Glass at October 31, 2005 08:00 PM
They have said they don't expect these price levels to last. They likely consider it unprofitable to invest in more production unless prices are at least sustained at these levels. We may not be at peak oil but we are certain beyond the era of cheap oil.
Posted by: Lord at October 31, 2005 08:53 PM
They are not building refineries in the US because consumption has not been growing here for 30 years. Refineries are being built in Quatar, Vietnam, China, and are in planning stages in Iraq and Iran. Refineries are being upgraded and expanded in South Korea and in Australia.
Gas to liquid plants are being built. Massive investment is being made in Canadian Tar sands and increased drilling is taken place in Libya, Russia and other countries. Saudi Arabia has ordered three billion dollar rigs from Shanghi and projects a dramatic increase in proven reserves.
In the mean time, Ford projects building 40% hybrids by 2010 and Toyota says they will go 100% to hybrids without giving a date.
Would you build a new refinery if many efforts were underway to make it unprofitable? Tar sands and coal are plentiful. Coal can be converted to diesel for around $40 per barrel, why should XOM assume a price higher that $40 in long-term captial decisions? With so many countries building refineries, why take the risk?
Posted by: Jack Miller at October 31, 2005 09:03 PM
I agree with Dryfly and Doug and others: the oil companies do invest about as much as 10 years ago, the investment projects are by nature very long and it is not possible to increase the investment volumes suddenly.
Besides - and this is most important - where they should invest? Drilling dry holes is not investment. Building refineries with a life-cycle of 50 years to handle crude that will not be there in 10 - 20 years is not a good investment. Remember, everybody (even the official energy authorities and oil companies) agrees that the peak oil will come in 20 years. It may come much earlier. R&D has the problem that the returns are diminishing. It is very difficult to beat the geology.
But from the economic theory viewpoint it is an odd question to ask why companies don't invest when they have high profits. The investment decisions are not basically made on the basis of the present profits. Rational new productive investments are made only if there are good investment opportunities. Financing them is another question.
Higher present profits usually tell the company that there is probably higher demand in the future and expansion is a good idea. This is why it often seems that profits bring investments. But this is not always the case, especially in heavy industry where investment life-cycle is long. There are lots of constraints working here. This is why the idea that higher profits would automatically generate higher investments and growth is not always working. Subsidies and lower taxes or rates will not help if the other prerequisites are not there.
Posted by: TI at November 1, 2005 12:26 AM
I strongly concur with TI and Doug. CapEx decisions made by competent management invests based on FUTURE returns. Present returns are almost irrelevant.
In the last few conference calls, Lee Raymond has pointedly expressed that a large percentage of Exxon's future profits are likely to come from Natural Gas versus oil.
China is firing up more new NatGas power plants than oil-powered.
Posted by: bk at November 1, 2005 05:16 AM
Another factor not mentioned is the sheer size of XOM and CVX. Years ago as a banker I did business with ARCO (eventually bot by BP) and with UNOCAL (being bot by CVX). They were considered majors at the time. Because of the size of the companies they only prioritized major projects. ARCO,for example,was working on the development of the North Slope project in Alaska and had a ten-year horizon until production occurred. This because of the time needed for permitting, for building the pipeline and related infrastructure,and just drilling. They don't just drill one hole,they might drill hundreds, with pipes, compressors, tanks, etc., all organized to achieve optimal production.
Another client of mine at the time was Getty Petroleum (since acquired). They were involved in the development of one of the major North Sea fields. In order to produce,they had to have a permanent production facility sitting on the seabed, housing over 1000 people,and producing from hundreds of wells. The cost of the production platform at the time was close to $1 billion. As it was custom-designed it was not considered prudent to commit to spend that amount until they were pretty certain the oil was actually there in sufficient quantities and that it could be produced,shipped,and sold at an acceptable profit margin (this was in the 1980's when the price of crude had collapsed). So the entire project from original exploration to ultimate production took years.
Most of these companies have ongoing operations in all phases of the industry,from geophysical teams to gas stations. Because of the lead times involved I don't think one can associate this year's profits with this year's e&p expense. You need to look at the relationship over maybe a ten year period.
Smaller independents can act more quickly because they are small. A single well or group of wells might make a significant change in the company's financial condition and if located in a known producing area in the U.S. might be brought into production in 90 days just by connecting a small pipe to a nearby pipeline. That type of work is of no interest to the majors because it's insignificant relative to their existing size.
I've sat on several boards of NYSE-listed companies and I've dealt with many large oil companies. I can assure you these people are not dumb. They know a lot more about what's going on than most of us,I think.
Posted by: jim miller at November 1, 2005 05:29 AM
Nevermind that volatility surrounding the price of oil makes it extremely difficult to create any sort of well planned investment. A project make look very attractive with crude at $70, but maybe your payback period doubles two weeks later with crude at $60. If E&P projects are as lengthy and involved as people say there are (and I agree they probably are), I'd be TERRIFIED to be a finance guy who has to model a 10 year project whose profitability is based on my ability (more or less) to forecast the price of oil over the 10 year span of the project.
Posted by: John Bott at November 1, 2005 05:59 AM
An important factor is the revolution in corporate governance that has taken place in the last 20 years.
Basically senior executives of big companies are now rewarded on *stock price* (note because they use options, dividends *lower* the value of the underlying option so are less relevant) for the vast majority of their compensation.
In consequence, they look far more closely at the return on investment case for spending cash than they did historically.
Economic theory says free cash flow should be in the hands of investors (the market) who will be more efficient users of capital than managers. This is how LBOs work, and how Warren Buffet manages his constituent businesses.
So the incentive now is to pay out free Cash Flow (Cash Flow from Operations less Cash Flow from Investing). And similarly to reduce investment and increase free cash flow.
Unless a management team has a high certainty about a project, why take the risk? They can buy back shares and raise the value of their own equity.
I would second what Jim Miller said. These are very smart people. The typical Chairman/ CEO/ CFO of a major oil company has a Masters or Phd in Engineering or Geology and an MBA, 20 years+ in the industry, and they are advised by even smarter people. You also don't tend to see 'hire ins' at senior levels: they have all worked for 2-3 oil companies in their careers, at successively higher levels, in exploration, production and product roles. It's rare these days to find an industry with such depth of management expertise.
If they see a declining return on investment (eg unproductive drilling) they won't do it. It's not in their economic interest, or the interests of shareholders.
What the industry is telling you is there are not enough interesting oil field properties available to them. Prospective returns just aren't high enough.
Either that oil *is* available, but in places where politics block their investment (Russia, Venezuala, Arab OPEC, Alaska, Florida beachwaters) *or* it's just not there.
I doubt they would tell us, even if they knew ;-).
Posted by: John at November 1, 2005 06:48 AM
Add to that:
oil companies, having been burned in the 80s (when these CEOs/ CFOs were just beginning their careers), may not believe that high oil prices will be sustained.
These expectations (of lower oil prices) paradoxically give some possibility that oil prices may surprise on the upside (because given the time lags, underinvestment has an affect on production *10 years* out). Any industry with large time lags is vulnerable to price volatility for precisely this reason.
Posted by: John at November 1, 2005 06:50 AM
Perhaps it makes sense to look at investment over a longer period, say, a decade or so. It's difficult to know what one year of investment means -- if it means anything at all -- particularly since it is possible the industry has invested heavily in the last decade. If anyone has numbers over a longer time, that would be useful to see.
Posted by: Nick at November 1, 2005 07:24 AM
The pattern in the oil industry for many decades,
way predating the 70s OPEC shocks, has been for prices to spike up discontinuously and then drift down. They seem to be drifting down right now. Of course they are cautious.
Posted by: Barkley Rosser at November 1, 2005 07:36 AM
Financial analysts look at other things as well,not just the data from the op.
I think most critical is the evolution of a company's proven reserves. If they can't replace the reserves they produce they'll eventually disappear. Here's a link to XOM's figures on reserve replacement which shows they've been able to replace production and increase their reserves:
One can conclude from the data that XOM is investing as reserves continue increasing over time.
People also look at "finding costs",the total cost to replace those reserves. This is an indicator how efficient a company is,compared with others.
Another critical factor is "ebitda"-Earnings Before Interest Taxes Depreciation and Amortization (including Depletion for an oil company). That number ignores all the noise created by the non-cash charges and valuation allowances of depreciation,depletion, amortization. Those non-cash items can be very misleading especially for an oil producer which has to follow some pretty exotic accounting rules for estimating future production,oil prices, costs,etc. when calculating those charges.
Posted by: jim miller at November 1, 2005 09:06 AM
On Friday, August 5 the Wall Street Journal ran a piece about Exxon Mobil's choice of company president Rex Tillerson to become the new CEO effective January 1, 2006. The next to last paragraph (page A5) quoted Tillerson from an April 2005 interview: "You give me a choice of producing more barrels or making more money, I'm going to make more money every time."
This seems like a clear and revealing statement to me, and a clear indication that, as with the California energy crisis, the oil business suffers from a distinct lack of competition. It is an oligopoly, not a competitive market place and we should adjust our model of their behavior accordingly. If you are not an investor, the oil companies are not your friends.
Posted by: Tim at November 1, 2005 09:10 AM
Can you name a for-profit industry where the company is your friend if you're not an investor?
Posted by: jim miller at November 1, 2005 09:42 AM
What about the theory that the executives are buying back shares to support the price while they are selling their own?
Posted by: Stuart Staniford at November 1, 2005 10:35 AM
We have a short-run capacity limitation in exploration and development. The drilling and sysmic rigs are fully utilized, at takes some time to build new ones and assemble crews. So big oil cannot simply spend as much as it seems they should, at least not in the short-run.
And I second the comments about price uncertainty. We didn't pass through $20 a barrel until Jan. 2002. What would you have said at that time about a proposed project that cost hundreds of millions of dollars, and would be profitable only if oil were $25 or higher?
Posted by: Bill Conerly at November 1, 2005 10:48 AM
For that matter,what would you decide today if you had to approve a multi-billion dollar investment which would take 5-10 years to develop and required even higher prices to justify?
I'm unfortunately old enough to remember the runup in oil prices in the '70s. At the time everyone in the industry and in the financial area were expecting oil prices to continue rising. Instead prices peaked at 29 (I think) and went right down to $6,taking a lot of countries, companies,banks and investors along.
Is it prudent for management to continue investing heavily in today's environment? I think it's wise to hedge a bit by taking some money off the table and paying dividends and buying back stock.
Posted by: jim miller at November 1, 2005 11:07 AM
As of today, 11/01 the market capitalization of XOM is $354 billion, average trading volume is 20 million shares. There are 6.4 billion shares outstading.
Management,directors,and employees own slightly more than 300 million shares,slightly less than 5% and this includes options not yet vested and shares which cannot be sold.
During the first 6 months of '05 XOM spent $6.7 billion to buy back shares, or less than 2% of the market cap of the company. At the current price of $57 they would have purchased 117 million shares, about 1.7% of the total diluted shares outstanding.
The data indicate the company's repurchase activity to have been of insignificant amounts and incapable of having maintained a price which would have otherwise have fallen.
Posted by: jim miller at November 1, 2005 11:50 AM
Perhaps they can't believe the price will warrant this or they'll buy up smaller companies that will find and produce crude or both.
Posted by: CHH1 at November 1, 2005 12:15 PM
The comment that "the oil companies are not your friends" is off track. In every economic transaction there are two competing interests. However, it is seldom that the interest of either side is in the elimination of the other party. You must have customers, and it costs a lot more to get a new customer than it does to keep an old one.
It is in the best interest of both you and the oil companies that you live to drive tomorrow.
Posted by: Bill Ellis at November 1, 2005 12:18 PM
Just a follow-up to Bill and that other Tim . . .
I confess that the observation that the oil companies are not our friends is more of rhetorical flourish than an economic argument. My deeper concern is that the larger cycle of merger and acquisition within the oil industry has created a concentration of economic power that is quite easily abused. Exxon has combined with Mobil. Chevron with Texaco. BP with Amoco. Phillips with Tosco and Conoco. Valero with Premcor. The justification for allowing this degree of concentration was that each one had to get big in order to compete with the other larger players, even as an offset to the power of OPEC. However, their economic interests are very closely aligned both with OPEC and with each other. They all benefit from the perception that there is physical shortage and higher prices and encourage that belief. They make what for them are token expenditures to support political campaigns that appear to be successful in buying off our government.
In my view, and it is just one man's opinion as a casual observer of this site, the prevailing assumption here is that the oil market is a healthy competitive market. Thus the question, "Gee, why aren't oil companies investing more?" And there is a further assumption that they must have some rational reason that supports other assumptions, like maybe there is no more oil to find. What I see is something else again, it is a combination of greed and power similar to what we saw in the California energy crisis. The incentives are all for them to restrict production and restrict investment to drive prices as high as they can.
There is a balancing backlash underway from consumers and in my view, the gasoline market is likely to see flat demand for the next decade because of it. The cycle of boom and bust will still be a fact of life for energy prices as a result.
In other words, what I am talking about is not at all theoretical economics, where companies play by the rules, but applied economics where they don't. In my view, that's the real reason why Exxon Mobil is hanging back from more aggressive investment -- there is no one out there in the world who is going to eat their lunch if they don't expand and thus they can count on making more money by holding back on the barrels.
Again, the idea is that it is not hard to understand why they don't invest more, if you simply accept that blunt economic reality.
Posted by: Tim at November 1, 2005 01:02 PM
Conspiracy theory explains nearly everything in the universe. If you look for reality, it is that sellers do not set prices. Buyers set prices. As a producer I can ask any price, but I earn nothing until I come to an agreement with my customer. As a producer, the only control I have is to limit, or eliminate production when the price is too low.
If, however, you are right that there is a monopoly controlling prices, then you have a wonderful economic opportunity. Exxon closed today at $56.40 per share, and it is available to you.
Personally, my profits in the energy investments this year will pay for a lot of years of gasoline. Maybe I am evil?
Posted by: Bill Ellis at November 1, 2005 02:16 PM
Part of the uncertainty here is the nature of the beast. Commodities (including hogs) have always been difficult to produce in the right quantity. The pattern drawn out by the succeeding supply and demand curves is called a spider web. About the time a major poject is started, new supplies will be found which might convert the project from profits to losses.
My thanks to Bill. So many of the folks who complain about the price spend 100% of their earnings and own no stocks. They fill up their big tanks and drive to the suburbs to bitch nightly.
Posted by: Jack Miller at November 1, 2005 03:27 PM
Just as a final attempt at communication here. Bill seems to think that buyers set prices. There are about a dozen refining companies in the US and there are millions of regsistered vehicles. It seems pretty clear which side of the supply/demand equation has the ability to influence price. This forum, I believe, is one dedicated to discussing economics, not a contest as to whose portfolio has performed best. I am not alleging conspiracy. There is no need for collusion or smoke-filled rooms here. Every major oil company executive on the planet knows who his friends are. Just about every oil field is a joint-venture for more than one reason. Yes, they diversify their risk, but they also happen to get very good information on production rates that way. Capitalism is a wonderful system that brings us many benefits, but I do believe there are times when the playing field is not level and all of the chips end up at one end of the table. This looks to me like one of those times. Pretending it never happens or that it never causes a political backlash just strikes me as naive. As for buying Exxon Mobil stock, I'd prefer to wait until it gets hammered by a drop in oil prices to $35 per barrel (similar to what occurred in the 1980's) and the windfall profits tax brewing in Congress has been enacted, although I do appreciate the recommendation.
Posted by: Tim at November 1, 2005 05:42 PM
As a PPS repsonse to Tim's challenge up above to name a for-profit industry that is the customer's friend, I think that in general the computer industry would qualify, and over at least the past 25 years. The value for the dollar has been extraordinary and the competition (perhaps with some elbows thrown by Microsoft at times) for the most part exemplary. I'd make a case for the airlines, but you did specify "for-profit".
Posted by: Tim at November 1, 2005 05:53 PM
You are on the right track when you mention airlines because that is another industry that people expect to act like a public utility.
Fortuneately for consumers, high energy costs are providing an economic impetus for efficiencies (technologically driven and simple conservation) that could have happened long ago.
About those windfall profits, I talked with the principals of a small exploration company probably 2yrs ago - they were engaged in bidding wars for good geologists because the cyclical nature of the industry has led to fewer entrants. Taking profits away from oil companies does not help that situation.
Posted by: biker at November 1, 2005 07:31 PM
A document I highly recommend to anyone who wants to understand what the big oil companies are up against is
It's the report of the independent investigation that Shell's audit committee commissioned into the circumstances of Shell's overbooking and subsequent write-down of reserves. It gives an extremely frank and detailed assessment of the back and forth between various executives about the Wall St pressure they were under to book reserves as fast as they were using them up, the difficulties they were having actually doing that operationally, and how they crossed the line into booking things that were speculative which they then could not manifest in time and got to the point where they ended up having no choice but to come clean.
It gave me a real feeling of an inside look at the executive suite of an oil company.
Posted by: Stuart Staniford at November 1, 2005 10:33 PM
The problem with EBITDA is this: it doesn't reflect the costs of renewing the company. Depreciation is (in the long run) exactly what it costs to renew the physical assets of the company to keep producing.
Warren Buffet (his collected essays) has a scathing piece on this very point.
During the telecoms bubble, 'EBITDA multiples' where how the companies were valued, a period when they raised trillions in debt and equity from investors. The real reason was that the conventional PE (price earnings) ratio using reported profits was far too high, or non-existent, for most of these companies (think of the goodwill amortisation after Time Warner merged with AOL). When it all started to unwind we discovered that EBITDA was just a number, and the companies were actually spending far more money than their operations could generate. Hence for example the near collapse of Cable & Wireless.
Earnings may be a bit prosaic, but there is much to be said for valuing a company out of profits that can legally be paid back to shareholders ie earnings.
In the case of oil companies, you are right to point out that analysts don't focus on PE, because of the problems of depletion accounting (a company which is producing a lot and generating lots of cash flow, might reduce its earnings by doing so).
The usual measure I have seen is cash flow multiples (Cash Flow is essentially EBITDA *but* you have to adjust for working capital movements).
The problem for the oil companies now is that you have massive free cash flow, because they are making huge amounts on production from existing reserves, but not finding places to deploy that cash.
My bet is the next move (already started eg Unocal) will be to acquire other oil companies.
The other move going on is to gas. Whilst the emerging producer countries have proven they don't need Big Oil, they can subcontract directly with the likes of Schlumberger, Haliburton, etc. to develop oil resources, gas is a different matter. The gas supply chain requires that someone build a liquification terminal, invest in a fleet of tankers (or tanker leases), build a delivery terminal (two big ones being built in the UK as I write), strike longterm contracts with utilities and electricity producers. This requires a lot of expertise, capital and market smarts: which Big Oil has in spades.
Big Oil can also read the 'big picture' ie the very long range trends-- as you and others have pointed out, this is a multi-decade business. Scenario Analysis and Long Range Forecasting was, after all, invented by a guy at Shell (Peter Schwarz).
The big picture says Global Warming is real, and the Middle East is unstable. So by building up gas resources, Big Oil is hedging against the day when those eventualities come true. The same is true of the huge investments going into Canadian Oil Sands-- Total just bought resources for a huge price in that area.
They may also be hedging against Peak Oil. AFAIK, they don't believe in it yet. But Shell is investing heavily in Natural Gas Liquids (the Quatari plant): this is a very complex and expensive way to make gasoline, and suggest to me that they are hedging their bets.
Posted by: John at November 2, 2005 01:03 AM
Another thought which just occurred to me, especially re BP.
If you are shaping up for another big acquisition, you are not spending capex on an existing field. But you will still 'spend' 10s of billions of cash, buying a company.
The era of consolidation in oil companies is not yet over, I suspect. You will have seen the recent mining deals (Noranda-Falconbridge-Inco and also American Barrick)-- companies are trying to bed down their strategic position, now that they have the Free Cash Flow to do it.
Posted by: John at November 2, 2005 01:06 AM
Re XOM pension plans. there will be disclosure in the accounts.
AFAIK for current employees XOM has a (very good) defined contribution scheme (very low cost funds, even lower than Vanguard). As such, there is no legacy obligation to XOM for the people in the scheme.
The situation with already retired and previous defined benefit schemes, I don't know (see Report and Accounts).
Since XOM will always be in the position of being a bidder for companies, not a bid target, I am in the camp that says there are probably better stocks to own. If you want a major, Total is worth looking at (good reserve replacement history AFAIK).
Posted by: John at November 2, 2005 01:09 AM
Clear communication - if gas is priced to high, don't buy it. When enough people do likewise, the price will come down. If you can sell all you can produce, then it is probable the price is too low. Pretty simple stuff.
Posted by: Bill Ellis at November 2, 2005 06:20 AM
A response to this comment from Tim:
"There are about a dozen refining companies in the US and there are millions of regsistered vehicles. It seems pretty clear which side of the supply/demand equation has the ability to influence price."
There are less than a dozen car manufacturers operating in the U.S. Less than a dozen airlines flying the significant domestic routes. Less than a dozen corn flakes producers of any presence. Each of those industries have millions of buyers. But the sellers don't set the prices in those industries.
The Energy Information Administration lists about 40 different refiners that operate in the U.S. But probably only these 13 are significant:
Valero, ConocoPhillips, ExxonMobil, BP, Shell, Chevron, Citgo, Marathon-Ashland, Tesoro, Sunoco, Murphy, Motiva, Total
Still, the other 25 or so companies can impact prices in markets where they operate.
If it were possible for these 13 oil refiners to set very high prices for gasoline, then it would probably be possible for 15 or 18 to do so. So why were refining margins so low for the 20 years prior to 2003?
I'm troubled by this passage from your post:
"What I am talking about is not at all theoretical economics, where companies play by the rules, but applied economics where they don't. In my view, that's the real reason why Exxon Mobil is hanging back from more aggressive investment."
What rules would dictate that ExxonMobil should
be reinvesting more of their profits right now? It's their money - a reward for billions of dollars prior investment in oil leases and refineries. Buyers have willingly given up that money for the product ExxonMobil offerred. What rules - government or economics - would require them to reinvest it all rather than return some of it to shareholders?
Posted by: JohnDewey at November 2, 2005 09:16 AM
"But if that's the explanation, it's unclear why they don't take the sure profit and hedge that's available from using futures prices."
How much oil do you think oil companies can sell six years out without having a large market impact on the price of the oil futures? My guess (and it's only a guess - I don't follow this market) is "very little", at least compared to the amount the oil companies would need to sell in order to make a difference to their bottom line.
I say this because it seems to me that the party taking the other side of the trade - the long futures position - cannot easily hedge, so I suspect that if the oil majors started to sell oil futures in size, the price would drop quickly.
Maybe somone who knows the oil futures market could comment on this?
Posted by: Jeffrey Miller at November 2, 2005 10:33 AM
Just to add to JohnDewey's point on market share. I think a lot of people are confusing gas station market share with crude oil production market share. In reality most branded stations are owned by individuals and licencing the brand name from the oil cos. Station owners and not big oil co. sets the price you pay at the pump.
Despite XOM's size, it controls less than 15% of US refining capacity, and less than 5% of world wide crude production. Compare this with other industries and it is impossible for a reasonable person to conclude monopoly pricing power without conspiracy theory. And even then it is hard to explain why crude prices were less than $20/bbl as recent as year 2000?
Some comparsion with other industry may be educational: HP + Dell controls about 50% of US PC market; GM, Ford, and Toyota around 60% of US market; Intel and AMD more than 95% of PC CPU market. Cingular, Verizon and Sprint over 2/3 of cell phones in US.
A gallon of milk, which is produced from a renewable source (cow) and minimally processed costs about $3/gallon. A cup of Starbucks Latte made from a few coffee beans (again a renewable resource), milk and hot water costs about $3/cup. A can of soda made from a few cents of sugar, food color and water costs $0.75/can.
A gallon of unleaded gasoline made from crude lifted from 1000ft below the earth surface which is in turn 1000ft below sea surface in the gulf of mexico, from a platform that just survived 4 hurricanes this year alone (not to mention the 5 dry holes drilled before finding this one), piped 50 miles below the sea to a refinery that cost billions to build and millions a year to run, truck and delivered to a retail network that provides reliable supply 24x7, coast to coast. All that and it will cost you about the same or less than that gallon of milk or latte.
It is instructive to see that XOM was investing more than their income back in the 90's when crude prices were less than $20/bbl. I think XOM's exectutives understand the long term nature of oil investments, certainly more than the politicians and other critics in this debate.
Posted by: Anonymous at November 2, 2005 12:06 PM
Oops! the anonymous post is from me.
As for Jeffrey Miller's question, the simple answer is 1) liquidity more than 2 years out is not that great, and 2) shareholders can hedge / diversify away the risk (if they choose to) cheaper than XOM can (standard finance 101 material).
The long answer is that the crude forward market has a imbalance of sellers and buyers. Sellers, namely oil cos, have to put up billion dollar investment up front, so hedging some of future revenue makes some sense. Buyers, namely you and me (more than 70% of crude oil ended up in transportation consumption) only buy what we need when we need it. None of us is really in the position to go out and lock up gasoline prices for our consumption for any length of time. Industrial users and speculators provide liquidity for the buy side but nothing that will have the size and term that will be meaningful for a oil major like XOM.
Constrast this with the money/bond market where long dated sellers, such as pension funds and retirement funds is matched by buyers such as home mortgages and public infrastructure projects. This is why the interest rate market goes out 10, 20, 30 years while commodity contract rarely go out more than 2 or 3 years.
Posted by: RoyYoung at November 2, 2005 12:48 PM
Well, I'm back again today. Thank you all for some thoughtful comments. I think it has been an interesting discussion.
Regarding the problem of a small oil company trying to find geologists, this is also a supply and demand problem isn't it? We could use more students choosing geology, so offering such programs and getting the word out would help in that regard. The small company's larger problem is actually competing for scarce resources with large companies. Somehow I am confident that Exxon Mobil has plenty of candidates for each opening.
Someone asked what has changed since the 1990's to boost refining margins. I think it comes down to two factors. One is the major wave of merger activity that has concentrated ownership. The other is the consumer preference shift toward larger, less fuel-efficient vehicles. After twenty years, demand growth finally chewed through the spare refining capacity and refinery margins began to improve. Refiners have discovered that just-in-time inventory policies keep the market on edge and tend to improve pricing. As someone well up the comment thread noted -- these are bright people who know what they're doing.
In terms of effective market concentration, I would argue that the degree of market share that translates into real pricing power varies widely from industry to industry. The widely critiqued California electricity deregulation plan limited power generators to no more than 8% of the market and those suppliers still discovered (because of the price inelasticity on both sides of the market) that taking 25% of their supply off the market was good for profits if the price that day would double. Forward power markets provided absolutlely no advanced economic signal that the market was tightening and, in a market where there is no such thing as inventory, full deregulation is asking for trouble in my view.
"Gas station owners, not major oil companies, set the price at the pump," someone wrote. Yes, that is technically the case. The method that most station owners use is to take the invoice price on the gasoline delivery they just received from the major oil company and then add a retail markup, often with an eye toward preserving a steady 10-15 cent profit after a glance at the competitor's sign across the intersection. This method hardly makes them responsible for either the prevailing general price level or the volatility of prices.
As for the idea that it's Exxon Mobil's money to spend and their oil reserves to produce, yes that's true. They can do what they want and we can all adjust to their decisions accordingly. To some extent that is simply the way the world works. However, they do not operate in a vacuum either. They produce oil from government lands and offshore exploration blocks. The operate under accounting rules, depletion rules and tax codes that they also often participate in writing. They lobby Congress and help fund political campaigns to influence our democracy. They get a very good return on this investment, as evidenced by the recent comprehensive energy bill. The House of Representatives has already passed a bill with more tax incentives to expand refining capacity, as if record earnings weren't enough. And then, when it reaches a point where the public becomes aware of all this and does complain, they whine about how unfair it is, arguing in effect that they shoud be allowed to keep accumulating ever more wealth and more power.
At some point, even within the wonderful free market, there have to be limits imposed. Otherwise, it eventually courts rebellion.
Posted by: Tim at November 2, 2005 01:23 PM
"I must confess that I find it puzzling why it would make sense in the current situation to hoard cash and buy back shares. If anyone has a good explanation, I'd be very interested to hear."
There is still a great deal of uncertainty about future pricing levels in the industry. Regarding the amount and timing of exploration, much depends upon pricing assumptions used in CAPEX/Investment models.
Five years ago there was far less uncertainty about pricing and exploration...because everyone at that time bought into future pricing assumptions that effectively discouraged aggressive exploration for the 2000-2005 timeframe.
Also, once greater concensus around future energy pricing emerges, there will still be a significant lag time between when exploration program decisions are made and when the oil and gas flows...particularly for the 'elephant field' projects.
Posted by: Jack at November 2, 2005 01:45 PM
If you're arguing that the federal government screws up markets through the federal tax laws, I'm with you all the way. I've always advocated eliminating corporate taxes altogether in order to get rid of all the stupid games.
If you're arguing that incentives for corporations, such as those in recent energy bills, screw up markets, I'll stand right beside you in protest.
If you're arguing that oil companies are paying too little for leases, I'll be happy to listen. I'm not sure how having them pay more will lower gasoline prices, though.
But if you're arguing that any of the above justifies further government intervention in the free market, then you've lost me.
Please know that I am neither an oil company employee nor, regrettably, an owner of their stock. I'm just someone who has much more faith in profit-seeking decisionmaking than in central planning and government control of investment.
Posted by: Anonymous at November 2, 2005 02:05 PM
I was the anonymous poster at 2:05 PM
Posted by: JohnDewey at November 2, 2005 02:13 PM
John - the point you make is right on target. Government interference in the free market does not work. Demonstrated from Moscow to California.
Posted by: Bill Ellis at November 2, 2005 03:05 PM
John . . .
Thanks for your post. It sounds like we are of similar minds on many aspects of the problem. I do agree that government has contributed to the mess, but think that government has to be involved in a solution. The status quo or the slippery slope we're on is simply asking for more trouble in my view. One aspect of this is government mess-up, in my view, is that oil companies have been more effective in lobbying in the public arena than has been good for the market.
If we could roll back the clock, I would say that had the SEC and FTC simply rejected the merger proposals of the 1990's the world would look quite different today. The problem with allowing them is not only that they permitted greater concentration of market share than has been healthy, but also that there is no easy mechanism for breaking them up again. Once we err on the side of these combinations, the fox is now in the henhouse.
There are other public policy areas where sensible economic measures might be taken. Higher gasoline taxes make a world more economic sense than legislated fuel efficiency standards, but the refiners combine with the auto makers to fight them at every turn. Why? Because they know that there is only so much consumers will pay in total for gasoline before economising. What goes to the government as tax will not come to them as profit.
It would also make tremendous sense to have only one grade of gasoline (or perhaps two since there are benefits to different vapor pressures in winter and summer) from coast to coast. In public, the oil companies will say this is what they would like too, but in private they lobby against it. Why? Because having "boutique" fuels in limited regions creates more limited market segments that they can dominate, adding a few more pennies for the custom formula with less chance of competition.
These kinds of measures would simplify the market and help it function more efficiently, at least as I understand the economic principles involved. They may be politically impossible, but I think that's a question about the governing efficiency of our democracy, and not strictly an economics question.
Posted by: Tim at November 2, 2005 04:17 PM
Re: difficulty in obtaining oil geologists -
Sure xom can get 'em but they gotta pay. Same with every other component of the oil production industry, but unlike offshore helicopters and refining capacity, geologists might be tougher to find in a hurry.
The problem, as it was related to me, is that there aren't geologists in the pipeline (so to speak)
I'm sure people will enter the field but it takes time and - I think this profession requires a year or two of OJT also.
Maybe a geologist will weigh in here?
Posted by: biker at November 2, 2005 08:22 PM
Deffyes has commented how few Americans are studying earth sciences (and the shift has been away from the 'hard' stuff like geology and geophysics).
You need at least a Masters degree plus at least 3-4 years of field experience to be a good oil geologist (so I am told by friends in the industry). One of the guys who works for us has an MSC in geophysics, from Cambridge (one of the best geoscience schools in the English speaking world), but after 5 years out of the field (he graduated in 1999 when the oil cos weren't hiring), he has no value to them.
So that is at least a 9 year time lag. The problem is worse than that, because as student enrolment slipped, universities cut back on their department budgets. It takes almost 15 years to create a new professor. It is well known that the majority of hard science Phds in the US are awarded to non-Americans, post 9-11 the tightening of visa restrictions has made it far harder for these people to come to the US, study, and to gain US citizenship.
Another factor has been shortage of drilling crew. The Financial Times here had an article that a major problem has been crystal meths, the 'hillbilly crack'. Random drug testing suggests as much as a third of crew in the US are users, and of course the side effect profile makes it an extremely dangerous drug for any heavy equipment operator. (www.markarkleiman.com has some very good commentary on crystal Meths by a former undersecretary of drug policy, the Sean Connery movie Outland has some pretty graphic (science fictional) displays of the consequences of drug abuse in a mining situation).
The result is that a lot of qualified crew have been, according to the article, disqualified. Further worsening labour shortages.
Posted by: John at November 3, 2005 01:19 AM
I'm not sure I understand what problems will be solved by additional gasoline taxes. Does it make any difference to the consumer whether the extra dollars he pays goes to the oil companies or to the government? Does anyone really believe that government will make smarter decisions about investing money than private enterprise?
Exxon has been reinvesting $10 to $14 billion every year - I think for oil leases, production platforms, pipelines, refining equipment, etc. Other oil companies have been similarly reinvesting profits. As a result, I've been able to buy as much gasoine as I want every day of the year. In real dollars, that gasoline has been very cheap for most of the past 25 years. Why screw up everything by introducing more taxes?
We defintely are not in agreement on one thing. I do not want the federal government dictating that a refiner can sell just one grade of gasoline. I also do not want the federal government deciding what size televisions should be in my home, or what color shirt I should wear, or how many raisins should be included in each cup of my breakfast cereal. If I want to buy premium gasoline because I think it will make my SUV run better, and if Exxon wants to sell it to me, then I want every socialist planner inside and outside of the government to leave us alone.
Posted by: JohnDewey at November 3, 2005 03:13 AM
The argument for higher gas taxes is:
1. to encourage less consumption of a commodity which the US increasingly imports (US production of oil has been falling steadily since 1971, with Alaska providing a brief respite) and which is 'strategic' in the sense there are no real alternatives (60% of oil is consumed for transport purposes) and it is largely produced in politically unstable countries with regimes of dubious friendliness to the US (almost all the 9-11 hijackers came from the world's largest oil producer). It is arguably the case that if there were no oil in Iraq, the US and the UK would have shown no interest in invading (note I am not arguing we invaded to get hold of the oil, just that the power and strategic importance of Iraq derives from its oil revenues).
2. there are costs associated with driving that the driver does not bear ('externalities'): the costs of cluttering up the road and imposing delays on others, the costs of increased air pollution, the costs of global warming (if you believe in that latter).
To reduce these, the US government specifies what grades of gasoline can be burnt, bans lead in gasoline, etc.
Both 1 and 2 (which are really one and the same: arguments about externalities in the consumption of gasoline) are separate from *how* that tax might be spent.
For example, in the UK, which has one of the highest levels of gasoline tax in the world, we have relatively low income taxes by European standards. We trade a high gasoline tax against lower income taxes.
I would bet that a 50 cent a gallon US gasoline tax, if used to reduce the Employer Social Security contribution, would actually increase US GDP. What the consumer would lose, would be gained back by employers using more labour (because it was cheaper) and/ or paying workers more.
Most other uses of such a tax would, I suspect, lead to a slightly smaller GDP, at least until consumers had had time to buy smaller, more fuel efficient vehicles.
If the main reason for increasing gasoline taxes is 1), however, it is worth remembering that gasoline has a relatively low price elasticity of demand-- high prices don't lower consumption by a lot. UK gas prices are more than twice US gas prices (we're paying nearly 100p/ litre right now ie $1.75) but we stil burn plenty of gas, 8% of cars sold are SUV type vehicles, etc.
Posted by: John at November 3, 2005 07:41 AM
John (of 7:41 AM post),
Do I understand that you reside in the UK? Please accept my thanks to your nation for joining with us in fighting terrorism and common enemies on all fronts.
I generally bristle when non-U.S. residents attempt to advise us about inadequacies of our tax policies. I would definitely have lashed out at such advice from a Frenchman or a German. But, in my mind, your country's sacrifices alongside ours has earned you the right to critique the way we fund our government. Those shared sacrifices also allow me to forget some of the differences about tax policies that so divided us over two centuries ago.
My feelings right now about U.S. tax policy are driven by the state of the U.S. economy:
1. unemployment is low compared to last 40 years;
2. inflation is low;
3. the U.S. economy is strong, with a real 3.8% GDP growth in 3Q05.
The overall economic growth since 1982 has been very positive - as good if not better than any other industrialized nation. 1982 was, I think, when we eliminated windfall profits taxes on oil companies. We eliminated price controls on gasoline the year before that. The result was two decades of very cheap and plentiful gasoline.
Why in the world would we risk all the gains we've made the past 25 years on a bet that a gasoline tax would increase GDP? I certainly don't believe that such a tax would do so, and I doubt that many U.S. economists would either.
FYI, the U.S. automobile driver pays for the cost of all highways plus a huge subsidy to just about every mass transit project that's built or maintained. Through government mandated pollution controls that he has paid for in the price of his car, he has also reduced greatly the levels of U.S. air pollution. The U.S. Environmental Protection Agency reports that while miles traveled have increased 177% since 1970, the total amount of vehicle emissions have declined by 54%. So I would argue that the U.S. driver has born the cost to alleviate road congestion and the cost of removing over half his air pollution.
Posted by: JohnDewey at November 3, 2005 09:13 AM
Just one last note, before I feel I'm out of gas myself on this thread.
The reduction in the number of gasoline formulas I was referring to was not premium versus regular, it was that there are state-by-state differences. The gasoline sold in California is not the same as that sold in Texas. Governments already do determine what's legal and what's not. I was just talking about having "premium" or "unleaded" meaning the same thing nationwide, rather than having different market segments from state to state.
Added gasoline taxes would provide an added incentive to conserve a scarce resource. Whether we agree or not on a timetable for geologic depletion of the world's oil or not, there is no particular reason to hasten the day. Dependence on foreign sources is a larger economic and foreign policy issue, but the imports certainly add to our trade deficit, balance of payments deficit etc. and complicates our foreign policy abroad. These costs go well beyond keeping the interstate highway system from crumbling.
Anyway, that's my last contribution to this thread. Maybe we can visit more on another topic another time.
Posted by: Tim at November 3, 2005 03:15 PM
Could it be that they anticipate a windfall profits tax?
Posted by: John B. Chilton at November 3, 2005 09:19 PM
(I try not to worry too hard about what other countries think of my country's policies, we have enough silliness internally ;-).
The question is whether the costs of driving fully compensate for the harm done by driving.
It's a difficult one, because how for example do we value the costs of road deaths and injuries? How do we value an increase in the average commute time by 45 mins/day due to congestion? But there are benefits to driving as well (bigger houses further out, etc.).
The way we are leaning in the UK (where road congestion is the worst in Western Europe) is to go to congestion pricing. We already have this in central London: 7am-7pm, Monday to Friday, it costs £8 ($14) to drive into the central area. I can tell you the traffic jams are still pretty bad!
Longer term, it is proposed that the burden of taxation on cars be switched to an electronically monitored system-- so driving down the motorway at 2am won't cost you much, but doing so at 5pm (it can take 6 hours to go 15 miles on the main orbital motorway around London, the M25, on a Friday night) will cost you a bundle. The technology to do so is almost there, but there are civil liberties issues. As after the July 7th bombing, when Closed Circuit TV proved to be indispensable in investigating the bombers, there is a tradeoff there-- CCTV is ubiquitous in public spaces in the UK (as it probably is in US shopping malls).
The other argument is one about dependency upon foreign energy. Europe imports about 90% of its energy needs-- the coal fields are not economic, and oil and gas production is falling rapidly. It makes strategic sense for Europe to do everything it can to conserve energy, especially oil (because there is no easy substitute).
Japan is even more aggressive in this regard.
As the US becomes more dependent on foreign sources of energy, the US too will face this question. Deploy your military resources in far flung places to secure those oil supplies, or use less oil (or both). It's not a question of ideology, it is a question of strategic reality, and allocation of scarce resources (military, economic and political).
As to the GDP question: normally you would not expect a tax to raise GDP. In this case, depending on how you levied the tax, it might increase the GDP.
FWIW re Iraq my take is a very British one. We invaded Iraq in 1915, in the 1920s we dropped mustard gas (AKA Weapons of Mass Destruction) on the troublesome inhabitants (Churchill is on record as praising massed aerial bombing of the rebels)-- the first use of massed aerial bombardment against civilians, long before Abyssinia or Spain (Guernica).
Our goal was to secure an oil supply for the Royal Navy. The Royal Navy switched from coal to oil just before World War I. This gave it a supreme technical advantage in propulsion over the German High Seas Fleet, but it also tied us to a handful of oil producing fields in the Middle East.
Eventually we were driven out by terrorism.
Recent events have shown we have learned nothing from that experience. We will retreat from Iraq, again, defeated. No matter how the politicians dress it up, that is what is going to happen.
The next British Premier will take us out of Iraq.
Posted by: John at November 4, 2005 12:44 AM
"Why aren't the big oil companies reinvesting their huge profits?"
Maybe because they agree with BP?
The price of oil is grossly inflated and due for a tumble as fresh supplies come on stream and users switch to other forms of energy, BP warned yesterday.
Lord Browne, BP's chief executive, said crude was likely to fall from its current level of around $60 a barrel to nearer $40, and even lower in the long run.
"Our view is the price of oil is unsustainably high and will come down," he told an energy forum in Singapore...
Lord Browne said business was adapting fast to higher prices by examining other forms of energy, while consumers are cutting back on fuel use...
Lord Browne ridiculed claims that the world is running out of oil.
"The 'scare stories' of shortage and crisis may sell books and newspapers but they are not based on facts, and they shouldn't form the basis for any serious policy making," he said...
Posted by: Jim Glass at November 6, 2005 08:14 PM
I've read a little about congestion pricing. Not sure about England, but in the U.S. the central business districts of most cities are suffering a migration of businesses to the suburbs. IMO, U.S. cities would be providing one more reason for exodus if they burdened workers with an additional cost.
A Southern California transportation expert I communicate with provided an interesting insight about commuting times. Although freeway speeds around Los Angeles have slowed considerably, average commute times have hardly changed in 30 years. His explanation: commuters adapt in many ways. Some move closer to employment. Some change work hours. Some change employers. Some learn to telecommute for part of the week. But they adapt without giving up their cars or without paying higher gasoline taxes.
Posted by: JohnDewey at November 7, 2005 08:23 AM
1)Investment in oil & gas fields is constrained by lack of trained people. Few people have chosen to become petroleum engineers or geologists in recent decades.
2)Investment in refineries is constrained by the difficulty of getting regulatory approvals.
3)Oil & gas execs seem to be deathly afraid of doing capital projects that would be profitable at $50/bbl, but price falls to $30/bbl, project becomes a major loss generator.
Posted by: David Foster at November 7, 2005 07:41 PM
I'm just shocked that you think that investment in a commodity industry* should be a function of current cycle prices. I guess you think they should invest zero (fire the whole R&D department) when they are in the low part of the cycle?
It really worries me when I see you analyzing the issue like this. Not framing the discussion/issues more thoughtfully. Your posters have done a much more thoughtful job then you on this one. Maybe you are a bit too much of a macro tea-leaf reader and don't understand basic behavior of firms. Basic micro and corportate finance.
* let alone even an industry with 10 year outlooks before production starts...
Posted by: TCO at November 12, 2005 01:40 AM
TCO, I expected investment to respond to profits, and was surprised to find virtually 0% of profits for Exxon-Mobil reinvested.
Part of my interest in this question is whether the failure to reinvest profits indeed means, as your comments seem to assume, that oil companies view the current high prices as purely cyclical, i.e., they think oil prices are likely to come down significantly. If that is indeed the thinking of the oil companies, I regard that as a very interesting and somewhat surprising fact.
But I do agree with you that collectively the comments by readers above do a better job of analyzing this issue than I was able to alone, and I'm certainly thankful for their many high-quality contributions.
Posted by: JDH at November 12, 2005 06:25 AM
Having spent several years working in Strategic Planning for a major oil company, and several years more working as stategy consultant to major oil companies, I can re-iterate many of the themes already mentioned. The biggest issues why oil company investment patterns don't immediately respond to prices are as follows:
- Lessons learned. I would guess in the 1980's you'd see much more of a boom-bust look in oil investing. There was no capital discipline back then. Oil companies spent money when they had it. Rig counts soared and then plummeted in the 1980's. Enormous amounts of capital were wasted. (I believe Michael Jensen of Harvard did a study that estimated value creation/destruction including re-investment in this period and found oils among the worst offenders). Around this time, raiders like Boone Pickens came along who realized there was a huge amount of value to be had by stopping the flow of wasteful capital. Not coincidentally, faced with this threat, many management teams independently began stock buy backs. Anyway, this was all a very formative period for the industry. Most oil company managers now hold the view that the right approach is to maintain a steady control of the capital spigot throughout the commodity price cycle.
- People issues. Oil production projects are long lead time projects. Moreover, they must proceed through a variety of steps before they are "drill ready", and each of these steps requires the efforts of a somewhat uniquely skilled professional. This process may from several months to several years depending on the type of prospect. The number of "drill ready" prospects a company has in inventory at a given time is a function of the number of people it has had developing prospects in the past. You can't just decide one day to drill twice as many prospects this year - without a serious degradation in the quality of your prosepcts. This reinforces the first point about the chosen strategy of almost all oil companies maintaining a disciplined approach to spending capital throught the cycle. In any given company it is considered folly to spend capital faster than the organization can spend it well. Industry-wide, it is not possible to rapidly increase the pool of experienced geologists and petroleum engineers when the price of oil goes up.
- Rigs. There are a finite number of them at any given time. They cost 10's of millions of dollars to and take months to build, and generally no one will start building new ones until the idle ones are deployed and rig rates sky-rocket. People are going crazy building them now, but there is a lag of a year or more.
In some ways it's like the lag that occurs between when the light turns green and when you can go when you're the 20th car in line at a red light. You can't just hit the accelerator when you see the light change.
Posted by: diz at November 16, 2005 03:35 PM
i wish to invest my moneys out of cameroon
regard Hon chife angwafor
Posted by: aangwaforche at September 4, 2006 02:54 PM