Oil Companies Rip off Customers

Oil consumption in the U.S. and the effect of unrestrained control

In the oil “market”, as with any free market, major oil company’s control over the raw product supply results in direct control over the price. There are many aspects of this power, some within our control, and some beyond.

OPEC, which surprisingly is largely friendly with American oil producers, dictates production quotas for most of the world’s oil producing nations. The United States is the 3rd largest oil producing nation in the world but that does not offset the fact that our domestic oil production provides only 37% of our daily oil needs.

Our thirst for oil is insatiable. The United States consumes 25% of the world’s oil which forces us to import much of our oil from other countries. Many are surprised to learn that only 15% of our oil imports come from Middle Eastern countries. Non-OPEC nations, such as Canada, Mexico, Norway, and England, supply over 34% of our oil needs.

In addition to artificially limiting the supply of crude oil, the major domestic oil players can also limit refinery capacity and further control the price of the final product. In fact, this limitation affects the final price of gasoline far more than artificial limitations in crude oil capacity.

Suffice to say, control of the oil market in two few hands results in the gross ability to abuse that power and few will argue that control has indeed slipped into too few hands. Experts agree that recent mergers have resulted in an uncompetitive market. This consolidated control allows our major oil companies to tightly direct supply and hence artificially hoist prices (but not so high that Americans will seek out alternative fuel supplies). Efficiencies resulting from these mergers should have driven prices downward but instead, prices increased almost three-fold from 2001 through 2005 and broke new records in 2011. With regards to refining processes, limited competition offers no incentive to add extra refining capacity.  Why would oil companies want to increase refinery and lower prices (and profits)?

The federal government steps in

The Federal Trade Commission (FTC) has not helped matters either. In the 2002 Conoco/Phillips merger, the major condition demanded by the FTC was that each entity had to sell a single refinery. The end result was still the largest domestic refiner controlling more than 13% of the market. There have been many other cases where FTC demands to sell off assets before approving a merger, resulted in nothing more than one of the other top five domestic oil companies buying up those assets and further solidifying their dominance, and control, within the oil market. Not coincidentally, the oil industry has contributed over $67 million to our nation’s politicians.

Partnerships further reduce competition

In addition to peculiar government intervention, partnerships by major oil companies further contribute to a lack of competition. Large projects, such as oil refineries, offshore drilling platforms, and cross-country pipelines, can cost upwards of $5 billion to construct. These extravagant costs force oil producers to partner in order to realize economic efficiencies and leverage. An unfortunate result of these partnerships is that closely held secrets and production details that normally result from a competitive market, fail to exist. In addition, these partnerships often result in “under the table” arrangements which serve to further reduce what would otherwise be a natural competitive environment.

As of 2011, the five largest oil companies in the United States, almost all of which have resulted from recent mergers, are Exxon Mobil, Chevron Texaco, Conoco Phillips, BP, and Shell. Together they control 14.2% of global oil production, almost half of all domestic oil production, more than half of the total domestic refining capacity, and nearly ¾ of the retail gas market. To top things off, they control nearly a quarter of domestic natural gas production.

Vertical integration in the industry

Compounding the problem, these five major oil companies are “vertically integrated” – they provide most of the services that naturally occur from the drilling process to the final product that is sold in retail stores. Although vertical integration provides efficiencies, this vertical integration also grants them even more power and control over the supply and price of gasoline. This control does produce remarkable dividends – in 2003 these major oil companies realized a phenomenal $60 billion in after-tax profits.

Political muscle in the oil industry

Battling against their substantial power is rather difficult as the political power of the major oil companies is quite significant. The oil industry has contributed $67 million to federal politicians (of which 79% went to Republicans). The big five spent a staggering $50 million on lobbying efforts before Congress and the White House. One of the distressing effects of this political muscle, one that has been blindly ignored by the federal government, is that the uncompetitive practices initiated by the large oil companies have forced many smaller independent refineries to close down (which further reduces supply).

The United States government is often at odds with itself when discussing the problem. The White House claims that stiff environmental rules and regulations have stifled refining capacity. This contrasts with the 2002 findings of the Federal Trade Commission (FTC) who concluded that oil companies had intentionally withheld supplies of gasoline as a tactic to drive up prices and maximize profits. As of January 2011, these findings have not been challenged nor have alternative solutions been pursued by our Federal government. For example, the Federal government conceivably could order oil companies to increase the size of their storage facilities which would offset the temporary supply disruptions and serve to keep gasoline prices stable.

Additional price pressure has resulted from the government’s sustained increase in contributions to the nation’s Strategic Petroleum Reserve (SPR). The oil market follows a “just-in-time” inventory method where oil is extracted and refined as needed with a very small buffer to utilize when market demands change suddenly. President Bush pressed hard to aggressively fill the SPR to capacity (700 million barrels) with no regard to the current market conditions. More than 100,000 barrels of oil have been detached from the market and placed in the SPR. The current level of the SPR would fulfill America’s oil demand for more than 10 straight months. In administrations prior to the Bush administration (e.g. President Bill Clinton), oil was released from the reserve when market conditions worsened. Instead, the Bush administration has continued to contribute.

In 2000, Congress passed the Commodity Futures Modernization Act. This Act opened up a large loophole in the government oversight of energy trading by allowing traders to operate in unregulated over the counter (OTC) exchanges. Previously, traders had operated in the regulated New York Mercantile Exchange (NYMEX) and were required to disclose significant details of their trades to federal regulators. In contrast, over-the-counter exchanges are not required to disclose significant details of the trades. The end result – this allows companies to escape federal oversight and further manipulate oil prices.

Hurricane Katrina and the effects on gasoline prices

In 2005, Hurricane Katrina provided an interesting take on the affects of supply and demand and the effect on the price of oil. The 2005 storm caused at most, a 10% reduction in refining and/or importing, and probably much less. The result of this small reduction in supply produced an astonishing 25-35% increase in the price of gasoline. Even more astounding, the world price of oil during the same time period fell by almost 10%. Still, prices jumped overnight weeks or months before any oil affected by the storm could have possibly made it to the retail gas stations. While Americans scratched their heads in disbelief, during the time it took for the oil to works its way through the system to the retail stations, large oil companies pocketed the profits.

Many would argue that gas stations raising their prices simultaneously is “collusion” but in fact, this practice is not illegal. The simultaneous raising of gas prices is termed “conscious parallelism” – as long as the competitive gas stations simply act in concert without colluding with each other, they’ve done nothing illegal. In an industry where the oil companies regulate the market (and the government refuses to step in and regulate), the end result of these practices was a surge in industry profits and of course, much higher gasoline prices at the pump.

Oil companies explain away the problem

Meanwhile, the oil companies offer all sorts of explanations for their actions. They complain that strict requirements for cleaner burning fuel have forced them to use less efficient means of refining the crude oil. This is in stark contrast the Environmental Protection Agency (EPA) studies that indicated fuel prices would only rise 4 to 7 cents per gallon as a result of the new requirements. Additionally, Unical owns a clean-burning patent which Congress could force them to release – it’s effectively a patent monopoly on technology that could be used to clean the environment.

Oil companies will also claim that oil reserves are drying up and that no new reserves can be found. Then they will make an about face and claim that there are many reserves but they lie in protected environments. Many believe that the oil companies do indeed foresee the crude oil supplies are drying up and that’s precisely why they are manipulating the market – they are controlling the price of oil in order to build up financial resources so they may “cut and run” with the profits when their field of expertise is no longer valid.

In reality, none of this would really matter in our current market state. If additional resources in such areas as Alaska, where opened up in order to increase the supply, with the oil companies having complete control over the pricing, they would simply use the newly available resources to earn more profit.

As a seller of a commodity, the profits of oil industry participants should rank much lower than other industries. In 2005, Exxon Mobil realized a $25.4 billion dollar profit on total shareholder equity of $107.9 billion. That’s an annualized after-tax return of 31.3% – unheard of in any industry.

Oil companies also strongly oppose oil taxes. Adding a federal tax on refined products would hit consumers hard but economists believe it would hit oil refiners’ harder, reducing sales and profits. The federal revenue gained from oil taxes could be returned to consumers in various ways – tax refunds, special grants, or subsidies in other industries.

Antitrust action?

The Sherman Antitrust Act was passed in 1890 primarily in reaction to Standard Oils merger with its competitors to form Standard Oil Trust. In this case, Standard Oil would drive competitors out of business by setting prices very low to keep smaller companies from profiting or newer companies from entering the market. In today’s market we have a similar situation – except our major domestic oil companies have free reign to inflate prices at their whim.

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