Should Oil Executives Be Blamed for Current Gasoline and Natural Gas Prices?
Executives from five major US based oil companies testified before the Senate Judiciary Committee yesterday. I am sure they were well prepared for the questions; they have been making similar journeys to Capitol Hill since at least 2005 when their profits soared and gasoline prices temporarily touched $3.00 per gallon in the wake of Hurricane Katrina. (See, for example On Profit and Pump Prices dated November 10, 2005.)
The executives in both hearings tried to explain that their companies do not really have an excessive profit margin since their final profit is only a small percentage of their total revenue. They also tried to explain that they do not set their prices; for a commodity with a world market like oil, the prices are set on transparent exchanges where anyone is free to buy the product at whatever price they can find a willing seller. They also claim that they have been restricted from developing oil production in high potential areas and that those restrictions have prevented them from being able to produce enough additional oil to have much effect on the supply-demand balance.
There are many bloggers and commentators in business oriented journals that listen to those arguments and are willing to give the executive a pass. On Trading Crude Oil, for example, the author wrote a post titled Senators Challenge Oil Executives that blamed “politicians and environmentalists” and told readers that they were the ones that supported both of those groups and allowed them to establish rules that kept the oil companies from finding new sources of oil.
On Energy Outlook Geoff Styles, a former oil trader and current energy and environmental strategy consultant, wrote a post called Crossing the Rubicon that discussed how he could not blame the executives for their “admirable fiscal discipline” in building an organization that has achieved “record earnings, not only relative to its own past performance, but when compared against the performance of any firm in any industry at any time”.
My own analysis is that the senators were onto something yesterday when they dismissed the executives for attempting to play the role of passive victim (beneficiary) of market forces. What the senators may not understand is just how much of a role the long term decision processes inside the oil, gas and coal industry have driven our current market situation.
As Trading Crude Oil pointed out, the average price of oil in 1998 was $11.91, less than one tenth of the current world price. There have been a lot of factors that have gone into the remarkable escalation in those prices, and the energy industry does not control them all. Industry decision makers do, however, control and understand those forces far better than consumers, politicians and environmentalists. The major energy companies employ virtual armies of traders, analysts, geologists, statisticians and marketers. It is their business to know how to take advantage of opportunities and to recognize limitations. If there was no strategy and planning involved, it would be even harder to understand their compensation levels.
You can learn a lot about this process by digging through strategy and financial documents posted on websites at the major companies. Without picking on any one company, let me tell you what I found in a document titled 2007 Financial and Operating Review published by ExxonMobil. There is a section titled Outlook for Energy, A View to 2030 that starts off with the following statement:
Our outlook is focused on the world’s rising energy needs and how we expect these needs to be met. Providing this energy is not easy or automatic. The challenges reflect the global scope of the task, as well as substantial objectives related to economic development, energy security, and the environment.
The Outlook for Energy summarizes ExxonMobil’s projections for global energy demand and supply through 2030. The outlook is developed annually, the result of an ongoing process that has been conducted for decades. The results are used to assist our business planning and to increase public understanding of the world’s energy needs and challenges.
In other words, the oil companies are not surprised by the variations in the world’s energy markets, they look ahead and try to put themselves in a strategic position to benefit. That much is okay, but what benefits them does not necessarily benefit the rest of the economy and may not even benefit their shareholders very much. That may be because the decision makers at many major oil companies are very minor shareholders in their own company. (The document that I reviewed also revealed that the total shareholdings by top executives at ExxonMobil was less than 1.5% of the outstanding shares and that there had only been one minor purchase by an insider in nearly 2 years.)
What the oil companies have done in the ten years since 1998 is to continue spending a huge sum of money marketing their products to help increase demand. They have also spent a lot of executive time working on mergers and acquisitions to consolidate and reduce expenditures on their work forces. (Note: they are now complaining that their workforces are aging and that they are having trouble finding people to do the difficult and technically demanding work of finding and producing more oil and oil products.)
Major oil companies have spent a good portion of their earnings buying back their own stock, considering that investment to be a better use of capital than drilling new wells or expanding their refinery capacity. (ExxonMobil, for example, spent $118 BILLION in the period between 2003-2007 on their stock buyback program and about $88 BILLION in capital development, only a portion of which is aimed at the production end of the business.) They have made token investments amounting to less than 1% of their total capital investments in alternative energy sources.
Note: you have to be careful when you read their advertisements and literature – many oil companies lump natural gas, coal and liquified natural gas into the “alternative energy” portion of their statements. They have also studiously avoided any mention or investment in nuclear power, the only non fossil alternative energy source that has ever replaced oil, coal or gas in generating reliable heat, electricity or motive power.
The oil companies have also been playing hardball with some of the countries that have remaining resources, trying to enforce agreements that were made at a time of much lower energy prices. Those agreements allow the companies to take most of the increased value of the oil without sharing it with the source. Of course, many graduates of American business schools think that contracts are inviolate, but the fact is that the only stable kind of business arrangement is one where both buyer and seller are reasonably satisfied.
Anyway, you get my point. Oil company executives are loving their perks, salaries, bonuses and power and think that they are succeeding in the game of life because they happen to sell a product that many of us cannot do without. They have chosen a business model where their profits depend on there being more demand than supply and they have made decisions that have limited the growth in supply in the name of operating efficiencies.
Because of the deleterious effect of high oil prices on countless other businesses, I imagine that oil company executives are having just as pleasant a time answering questions from their fellow Business Roundtable members or at the Davos conferences as they are getting in answering questions from US Senators.
Update: I removed the photo of Sturgis that originally accompanied this post as not being a good illustration of the topic discussed.
New Photo credit: Fuel – gasoline and diesel – prices at an Annapolis, Maryland station taken on May 26, 2008.