Thinking About Oil

Thinking About Oil 

Published as:  Several Factors To Be Considered Before Labeling Profits Obscene

I got to thinking about oil companies the other day when I received my copy of Fortune Magazine’s listing of the 500 largest corporations in America as ranked by revenue.  The rankings included interesting statistical data in seven categories including profits, market value and earnings per share.  The magazine further sub-divided these companies by states to see which had the most - New York had 57; the least – Alabama, Idaho & Utah with one each; and eleven states that did not have any,  including both Dakotas, Wyoming & New Mexico.

It also separated them into 51 industry groups.  Two in particular jumped out at me because of the media characterization of excessive profits made by selected companies:  Petroleum & pharmaceuticals.     

Imagine, if you will, that today your small business generated $354 in sales.  Your expenses totaled $324 leaving you with $30 for your days’ effort.  Do you think this is too much profit, too little profit, or just about the right profit? Now add nine zeros after each number and ask the same question about Exxon-Mobil.  

As Sen. Everett Dirksen once said:  “A few billion dollars here and a few billion dollars there and pretty soon you’re talking about real money”.

The petroleum refining industry section listed 12 oil companies.  Exxon-Mobil was rated # 1 with $354.6 billion in revenue and $30.5 billion in profits.  Frontier Oil was listed as 12th with $5.9 billion in revenue and $38 million in profits.  Two oil companies showed losses (Tesoro & Western Refining). Profit (or loss) is the mathematical result of subtracting all of the costs associated with generating revenue and running the company.  In Exxon-Mobil’s case, in order to generate $30 billion in profit, they had to spend $324 billion out of the $354.6 billion that they earned in sales.  By dividing profit into revenue, you get a profit margin of 8.6%. If you added together the profits of all 12 companies and divided that by the total revenue, the profit margin amounts to 8.5%.  Is this number excessive?  Would you rather invest in Chevron (9.7%) or Tesoro (-1.4%)?  And just how do you define excessive profits?  

The pharmaceutical industry also had 12 companies with combined revenue of $296 billion and profits of $45 billion for a profit margin of 15.6%.  Commercial banks, including Key Corp & Citigroup showed a collective profit margin of 11%.  PNC Financial Group led the way with 20%, yet Bank of America actually lost $2.2 billion on revenue of $134.2. How did they do that?  Microsoft had a profit margin of 30%, Oracle showed 23%, and Coca-Cola generated a whopping 34% profit margin, trouncing arch-rival PepsiCo’s 22.6%.  

It is neither legitimate nor fair to compare one industry’s averages to another.    One cannot compare Microsoft’s profit margin against that of Exxon-Mobil or Pfizer (12.2%) or of Berkshire Bank (9.6%).  To have value, they must be compared within their industry.  However, before one goes about condemning companies for unreal profits, it might be useful to consider the products and services that they provide and cut them some slack.  Which product or service would you be willing to go without for one month – your computer, gas for your car, your heart medicine, or your banks revolving credit line for your small business?  

Oil is a commodity whose price varies based upon a number of causes and effects:  global supply & demand, the value of the US dollar in petroleum markets, political instability, politics, futures based upon trading practices at mercantile exchanges around the world, and, yes, even executive hubris and greed.  Locally, gas stations can have four different prices on four corners in the same neighborhood.  The differences come, in part, from the price that each station owner has to pay his distributor for a delivery of gasoline, the efficiencies of the oil company’s supply chain, and the profitability of ancillary businesses such as auto repair and convenience store operations.

Profits encourage innovation.  Steven Jobs and Bill Gates have created enormous wealth for many people in their industry, yet they have plowed large sums of money into developing innovative products that consumers are demanding, expecting and buying in large quantities. Are their profits obscene, or did they just stumble onto a business that the world cannot live without and made a whopping success out of it?

The numbers do not always lead to a correct decision, but without understanding them, other arguments will not succeed.  It makes for interesting discussions around the business tables.

 

 

 

 

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