Keeping Oil Profits In Perspective

A great uproar has emerged over record profits by oil companies. Of course I do not approve of government subsidies and I believe that the industry does not merit some criticism, but when we rationally consider this issue, we should keep in mind the following:

1. Global supply (which have been reduced due to conflicts in the Middle East and the Gulf Spill) and demand (which has risen primarily due to economic growth in China and India) are the primary factors that drive prices.

2. While speculation is a factor, American Petroleum firms (to the best of my knowledge) are not allowed to engage in it. Furthermore, speculation is largely a response to anticipated drops in production.

3. Government taxation must be taken into account; rapacious Chicago has the highest cost of gas in the country, $4.27 versus the national average of $3.88. So, why do so few people complain about "greedy government"? And when the government institutes price controls to make gasoline "affordable," shortages always ensue.

4. Although there may environmental benefits to limiting where we can drill, this limits the growth in supply, which results in higher costs. Whether this equals a net benefit or net burden is up to each individual to decide.

5. I did the math and if we take the conservative estimate of $1.00  for a 12 ounce bottle of water, the cost of bottled water is $10.65 per gallon! Keep in mind that some firms fill their bottles with tap water, whereas the gas in your car must be: drilled (from miles beneath the earth) from a field using very costly equipment, transported hundreds or even thousands of miles, refined and then once again transported to the gas station.

6. For various reasons a company's or industry's profit margin is more relevant than the actual profit. Surprisingly, the petroleum industry was ranked 7th among profit margins. On average "greedy" oil companies" earned an 11.5% margin, whereas "progressive" railroads earned 12.6% and telecommunication equipment firms enjoyed a whopping 20.4%.

7. Rising costs provide firms the incentive, as well as the capacity to invest billions in exploring new sources of petroleum to meet rising demand.

8. Rising stock prices and dividends of petroleum firms have kept many pension and retirement plans solvent.

9. As the cost of gas rises, so do incentives to: purchase fuel efficient and environmentally friendly cars, use public transportation, choose a smaller home that is closer to work (rather than a McMansion in the distant suburbs) and  (last but not least) to develop viable alternative sources of energy.

10. History shows that just as oil costs and profits rise, so shall they fall.

The heated rhetoric of politicians and misguided state intervention may sway voters, but they do nothing to ensure the continued flow of petroleum that is vital to every segment of the American Economy; that is the job of the "evil oil companies."

Green Subsidies

The public bearing the burden of green subsidies.

I recommend that my readers check out the economist Max Schulz's article on the Obama administration's costly push for "green jobs."

The author doesn't doubt the need to address global warming, but he is skeptical of Obama's claims that government subsidized "green industries" will be a net producer of jobs.

He points out that in 2008 the government subsidized solar energy at $24.34 per megawatt-hour (mw/hr) and wind power at $23.37. Whereas natural gas generates energy at $ 0.25 mw/hr, coal at $0.44 and hydroelectricity at $0.67. Given the relatively low energy output of renewable energy sources, they currently provide 0.5% of our nation's energy needs. The economic implications of this are:

1. Barring aside exponential increases in energy output via wind and solar power, a government mandated shift towards renewable energy sources will dramatically raise the cost of production through higher energy costs.

2. Or, if the government makes the widespread use of renewable energy sources feasible through heavy subsidies, these subsidies will result in a higher tax burden of productive industries, which also will raise the cost of production.

3. Any economist will tell you that raising the cost of production will result in a loss of jobs. And the author does not believe that the loss in private sector industrial jobs will be offset by gains in heavily subsidized "green jobs."

4. The author correctly points out that locals with higher energy costs (such as California) drive out jobs to areas with lower energy costs (such as North Carolina) and even straight out of the country.

And I would like to ad that the history of government subsidies shows that:

1. Inevitably the prime determinant of which companies (in any given field) are the recipients of government subsidies are not which are the most innovation. Rather, political connections and influence via lobbying determines who receives public funds.

2. Government subsidies limit market competition and market entry for new companies. And in the case of agricultural subsidies we see that public funds are often used by large, corporate recipients to buy out their smaller competitors.

3. By reducing market competition, subsidies reduce incentives to innovate or become more cost and energy effective.

4. Government mandated social goals (minority ownership etc.) that usually accompany government subsidies further erodes the efficiency of subsidized industries.

5. In general, when private finance is not willing to provide capital for a company, we should be very skeptical of the soundness and sustainability of that company and its goods and services.

6. On the rare occasion in which a subsidy is wisely conceived and administered, it will inevitably outlive its economic and social usefulness. Just look at the farm subsidies that were introduced by FDR during the Great Depression to assist poor farmers - not only have they outlived their usefulness by over 60 years, they have continued to grow and skew towards larger agro-corporations.

So, while I see the merits of fighting environmental degradation, I am very skeptical of the power of government subsidies to produce positive economic outcomes, including the creation of jobs. Max Schulz believes that the best way to a greener and more prosperous future would be for the government to simply set goals and parameters for the private sector (such as carbon caps) and let market competition do the work. But, what can we expect from an administration that claims that birth control and bridges to nowhere are economic stimuli?

http://www.city-journal.org/2009/19_1_green-jobs.html