Tuesday, June 10, 2008

What I Don't Get

I don't understand the oil profits situation. Perhaps someone can set me straight.

Suppose a barrel of oil cost fifty dollars and it produced twenty gallons of gasoline.

Suppose further that gas at the pump cost a dollar a gallon.

Finally, suppose the oil company made a profit of ten cents per gallon of gasoline sold, or ten percent, leaving the underlying passed-on cost of oil at ninety cents a gallon. I know this doesn't include transportation, retail markup, etc, but let's keep it real simple.

Now, double the cost of a barrel of oil to one hundred dollars. It still produces twenty gallons of gas. The oil company raises the price at the pump to reflect the increased cost of oil per gallon of gasoline from ninety cents to $1.80, adding their profit of ten cents, and the new pump price is $1.90 a gallon.

Although the oil company's profit falls as a percentage of the cost of a gallon of gasoline, it remains ten cents per gallon. There is no increase in refining cost, and the increase in the price of oil is passed through to the consumer.

There are no windfall profits generated in this scenario, the ROI of the oil business remains the same.

What is the mechanism by which higher crude results in a Niagara of profits for oil companies?

No comments: