The price of oil

Many people from across the political spectrum are up in arms over the recently announced profits of the oil industry. We expect this from the Democrats but even Republicans have joined the cry:

The frustration is so great that even top Republicans like Senate Majority Leader Bill Frist, R-Tenn., are demanding answers from Big Oil.

“We need to make sure that there's no abuse in the current system,” he said. “We need to make sure there's full transparency, and if there's any price gouging, we need to cut it out.”

When I first heard of these seemingly incredible profits, my first reaction was along the lines of what we're hearing from politicians. But then I started thinking about it some more. You see, what we have here is a global market and, in general, the market is best left to regulate itself. There is likely more to this than the sound bites would indicate.

Once again, Neal Boortz comes to the rescue and puts it all into better perspective, explaining the difference between profit and profit margin:

Now ... for those of you who went to government schools, let's expand on the explanation. Let's say that the total gross revenues for a company for one year equal $1,000,000. That's a million bucks. This company spends $930,000 to bring in that million. The difference between the one million and the $930,000 is $70,000. That's your profit. Divide the $70,000 by the one million and you get 0.07, or 7%. That's your profit margin. Now let's say that the very next year the company sells twice as much product the second year and brings in two million bucks. Let's also say that the cost of making those products doubles as well .. to $1,860,000. How much money did you have left over? Those of you who went to government schools get out your calculators .. the rest of you can figure it out in your head. You have $140,000 left over. That's your profit.

Wait! Your profits have doubled! How dare you? What are you doing, price gouging? These are excess profits -- windfall profits -- and the government ought to step in immediately and take them away from you, you greedy capitalist pig!

Hold on ... before we get carried away with our little price gouging rant here, let's grab those calculators again. Divide the $140,000 in profits by the $2,000,000 in gross receipts and what do we have? Why, it seems the answer is once again 0.07, or 7%! The profits have doubled, but the profit margin remains exactly the same!

He goes on to address a suggestion that the junior Senator from New York has made:

Hillary's brilliant idea of seizing profits does not come as a surprise to many. After all, Hillary was identified by her college professors as a budding young socialist many years before she achieved fame as Bill's "wife." Hillary's idea is for the oil companies to hand over about $20 billion a year to the government to be used for "research" and to subsidize consumers. The subsidies, of course, would become just another government entitlement that Democratic politicians would use to buy votes. The research? Well, sad to say there are actually people out there who think that the government can do a better job conducting research to insure our future energy needs than can the private sector. The impact of state education is widely felt.

Let's explore Hillary's profit-seizure idea a bit more. Another source of funds for oil companies to use for exploration and the development of additional energy resources would be the money that comes from investors. These investors purchase shares of stock in oil companies because they believe that their investments will appreciate in value and, in some cases, will pay dividends. If the government bows to the paranoia and anti-capitalist ignorance of the state-educated masses and seizes those profits, what then will be the reason to invest in these oil companies?

While price gouging does occur, for the most part high prices as a result of scarcity are not gouging but the natural operation of the free market in the efficient and effective allocation of resources. If prices for scarce resources are held artificially low, you then run into a shortage of said resources.

Maybe we should have some sort of investigation. However, like Neal, I'm going to assume that what we're dealing with here is simply the law of supply and demand and not any deliberate attempt at price gouging unless and until it is proven otherwise.