With oil prices still above $100 a barrel, one thing is certain. The oil companies are going to make big profits. But misconceptions abound about the link between high oil prices and high profits.
After years of watching the reactions of the public and our political leaders, it seems they believe something like the following fictional account.
They can see ExxonMobil
I know people believe that, because I’ve had them repeat every bit of that story at one time or another. So they go after the oil companies. They demand accountability. Politicians call them in Washington and chastise them for the harm they do to consumers.
However, no part of this fictional story is realistic. The only thing that is true is that high oil prices mean high profits for oil companies. But think about this. Why do oil companies lose money if they control prices? Have you ever seen Apple lose money selling iPhones? You see, Apple is an example of a company that actually has complete control over its pricing. But that’s not how oil prices work.
Consider that over the past 10 years, major oil and gas companies suffered huge losses in 2014, 2015 and 2020. In fact, in 2020, the five integrated supermajors (i.e. “Big Oil ”) – ExxonMobil, BP, Shell, Chevron, and Total – lost $76 billion. Oil prices plunged into negative territory in 2020. Did oil companies then feel particularly generous?
Apple, on the other hand, hasn’t lost money once in the past decade. Are their executives being called to Congress to explain why an iPhone costs $800 when they are raking in huge profits? No of course not.
If I can take the Apple analogy one step further, it’s about as silly to ask why a share of Apple costs $162 or why Apple is a $2.7 trillion company as to ask why oil companies charge over $100 for a barrel of oil. Apple doesn’t control what people are willing to pay for a share of their stock. Similarly, oil prices are set in a free market by buyers and sellers.
ExxonMobil does not set oil prices. They are set in the market by how much people are willing to pay, just like with Apple shares. US oil companies are price takers, not price makers. Yes, speculators have influence, just like they do with Apple stocks.
Even OPEC and Russia do not control oil prices, although they have enormous influence compared to ExxonMobil. If ExxonMobil decided to produce less oil to drive up prices, it would hurt ExxonMobil because OPEC and Russia can easily catch up with that. But if OPEC and Russia decide to produce less oil, the rest of the world won’t be able to do much to compensate.
It is true that the oil companies take advantage of the actions of OPEC and Russia to restrict production. But they are also at the mercy of these actions when they decide to flood the market with oil (i.e. in 2014 and early 2020).
One of the biggest annoyances for “frackers” — that is, companies that use hydraulic fracturing to produce much of their oil and gas — is that they don’t make any money . Sure, they have a good year once in a while, but then they suffer huge losses.
Yet, in good years, they get summoned to Congress, blamed for high prices and threatened with windfall taxes. In reality, cause and effect are reversed. High prices boosted earnings, not the other way around. Similarly, when oil companies are blamed for inflation, cause and effect are reversed. Just as high prices boosted profits, they also boosted inflation. High profits are an effect, not a cause.
The last thing I want to point out is that oil companies own few gas stations in the United States. You may see the name ExxonMobil on a gas station, but they don’t own any gas stations in the United States. According to the National Association of Convenience Stores (NACS), more than 60% retail stations in the United States are owned by an individual or family that owns a store. They make their own pricing decisions, based on a number of factors.
Once you understand that this reflects the reality of the oil and gas industry, the seemingly arbitrary nature of oil and gas prices – and the inconsistency of oil company profitability – makes sense.