Page 3 of
3 Crude: Barrels of fun to crack you
up By Julian Delasantellis
California do, because I got smart
guys who can always figure out how to make money."
The main thing that Lay's smart guys, as
well as the people in the oil industry who are not
building new refinery capacity, have figured out
is that the market for energy is very unique. When
demand is high and supplies are tight, you make
less money selling your product than by not
selling it. This is what Enron did
through taking offline much
of California-dedicated electricity-generating
capacity for strategically timed (in the
California summer, when air-conditioning puts
intense demand on power supplies) "maintenance".
This drove prices up and created scarcity, not
just in California, but all across the western
US's interlinked electricity power transmission
grid.
"Maintenance" is the same reason
that the oil companies annually, including this
year, give for taking refinery capacity offline in
spring, driving prices up, and setting the world's
drivers up for the fuel price increase season that
now lasts into early autumn.
This yearly
problem, and the tightness in the world's
petroleum products markets in general, could be
alleviated with new refinery construction, but, as
demonstrated above, this is not happening. Oil
refinery construction can be a difficult and
expensive process, one which probably requires the
company to go into debt by either issuing
corporate bonds or taking out lines of credit with
large commercial banks.
Much better to
take the money that would have been spent on
refinery construction and use it more judiciously,
on things like risk-free short-term dollar or euro
treasury securities (currently earning about 5.25%
annually) and increased and enhanced corporate
salaries, perks and dividends. This strategy is
certainly working; oil company profits are
skyrocketing. Early this year, ExxonMobil, the
world's largest oil company, reported the
largest-ever quarterly and yearly profits, $10.71
billion and $36.13 billion respectively, ever
reported by an American corporation.
In
classical economic theory, excessive price rises
are self-defeating for companies. For one thing,
they are supposed to tempt other competitors into
the market, lured by the profit potential of those
high prices, and eventually those high profits
would be arbitraged, taken away by other
companies, in the market. This does not happen in
the petroleum products markets.
The
"barriers of entry" for a new competitor, the
costs, time and complexity of setting up new
refinery capacity and distribution networks are
enormous, and so the oil business stays what it is
has been for many years, a comfortable little
oligarchy, with only occasional new members, like
LUKoil in Russia and China National Offshore Oil
Corporation in China. Both these now major players
in the international oil markets solved the high
initial barriers of entry problems by emerging out
of the cadavers of former state-owned entities
during the eras of communist economic management.
A more substantial reason why this
situation continues is the very unique demand
profile of petroleum products.
Economists
use the term elasticity of demand to describe how
sensitive demand for a product is to changes in
price. For a product with what is called perfect
elasticity, each percentage increase in price is
met with equal and opposite reduction in demand,
say, a 5% increase in price causes a 5% reduction
in demand. In this circumstance, excessive price
increases make no sense; what the company picks up
in the extra price it loses in reduced demand.
Because they are so essential to modern
life, petroleum products have one of the most
inelastic demand profiles of any product in the
world. It is estimated that in the US, far and
away the world's biggest consumer of oil products,
their elasticity of demand is around 10%, meaning
that for every 10% rise in price there is only a
1% reduction in demand. Only healthcare has a
demand elasticity profile anywhere near this low,
and, as more healthcare costs are shifted away
from insurance companies to actual consumers,
economists believe that even healthcare's demand
elasticity is normalizing.
Enron knew this
when it pounced on California's newly deregulated
electricity markets. Over a century ago, US
president Theodore Roosevelt knew this when he
campaigned for the breakup of the Standard Oil
trust. In essential industries with high barriers
of entry, you either impose prudent regulation, or
the companies run rampant. However, in a
capitalist world still dominated by the
neo-liberal laissez faire economic consensus,
corporate regulation has gone out of style.
Therefore, on a fairly frequent basis, you get
these news events - like the seizure of the
British sailors - that the popular media say are
the causes of rising prices, but, in reality, are
only distractions, diversions that condition
consumers to accept higher prices. The real issue
is the continuing uncompetitive nature of these
essential markets.
It Happens Every
Spring had a happy ending. Ray Milland, who
had been playing baseball secretly to earn money
to marry his fiance (faculty salaries apparently
as lucrative then as they are now), is worried
that, if his future father-in-law, the college
president, finds out, the wedding will be called
off, baseball players apparently being then seen
as rather rough individuals. Not to worry, his
future father-in-law already knew, and was totally
accepting.
He need not have worried. It's
not like baseball players were then, or are now,
inherently corrupt, dishonest and morally
bankrupt.
Like ... oil company executives?
Julian Delasantellis is a
management consultant, private investor and
educator in international business in the US state
of Washington. He can be reached at
juliandelasantellis@yahoo.com.
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