At odds with O’Reilly on oil

I agree with my friend Bill O’Reilly often, but not on the subject of gasoline prices.  So, if you’ve been listening to Bill opine about oil on the O’Reilly Factor lately, then from an extremely small-time participant in the oil & gas business (as an investor and lawyer) here in the heart of oil & gas country, these are my points of contention:

1)  Except for oil and natural gas located offshore and on federal lands like the Arctic National Wildlife Reserve (ANWR) in Alaska, America’s oil/gas is NOT owned collectively by “we the people” as O’Reilly has said.

It’s the personal private property of individual Americans like me and my oil/gas legal clients.  If we want to, we can:

A) Leave it in the ground until prices rise,

B) Fill tiki torches with it on our property and watch each evening as all the pretty little flames burn,

C) Fill our own SUVs’ gas tanks with it and burn it up four-wheeling on our property just for the fun of it, or

D) Put it in barrels and sell it to the highest bidders, whether they’re in the U.S. or China.

Whatever we decide to do with it is really none of anyone else’s business.  It’s no different than if we produce wheat rather than oil/gas.  And, an oil company like Exxon is just a bunch of us individuals (shareholders) pooling money to produce or purchase oil/gas, here and elsewhere, and once the company produces or purchases that oil/gas, under current U.S. law, its property rights are no different than mine — the company can stockpile it, use it up, and sell it, any way and anywhere it wants.  O’Reilly may find that unpatriotic, but that’s the way it is.

2)  O’Reilly is correct that the U.S. government could impose export restrictions and taxes on domestically-produced oil/gas, but exports of domestic production are really NOT the problem (Lou Dobbs has been off the mark on this as well).

We actually don’t produce enough oil/gas domestically on a daily basis to even meet our daily needs — if we did, we’d already be “energy independent,” and we’re nowhere close to that.  We use up the vast majority of our domestic production right here at home, and we still have to import a lot more to meet our daily needs.  Yes, we export some petroleum products elsewhere, but they’re generally refined products like JP (jet) fuel which are only made (in exportable quantities) in a handful of places, including here.  It generally would not be very cost-effective, for example, for Exxon to buy Kansas oil, truck it to the coast, and then ship it off to China.  If there are higher bidders for oil in China than there are here, then it’s far more cost-effective for Exxon to instead divert its ships full of oil, purchased in the Middle East, intended for here, to China instead of ever bringing it here in the first place (because logistically-speaking, the Middle East is already halfway to China).  That’s the global market that Lou Dobbs has been talking about, and that’s how we get an oil supply crunch and rising prices here even in a mild winter when plenty of oil’s being produced worldwide.

3)  More domestic production would help.

Contrary to what O’Reilly has said, I think increased domestic production would likely stay here and be used here.  Yes, Exxon (and its competitors) might then just divert even more shipments of Middle Eastern oil from here to China, but in a global market, anytime you add to the overall supply, the price of a commodity comes down. China’s already getting the oil that it wants at the current price.  If, for example, Exxon wanted to sell China more, it’d likely have to drop the price.  At that point, the higher bidders may well be here, in which case the ships head back here (I’m oversimplifying somewhat, but that’s the essence of it).

4)  The profit margins on the sale of oil are not high.

O’Reilly is correct that the major oil companies’ total profits are at record highs, but that’s because of the tremendous volume of oil being sold worldwide.  The profit per barrel of oil is a smaller percentage of the barrel price than the profit per unit on a lot of other products — just do a little Internet research and compare the profit margin on oil to the profit margin on contact-lens solution, i.e. salt water!

5)  Economically-speaking, both collusion and competition can result in uniform pricing, e.g. among four gas stations on the four corners of an intersection. 

Yes, if they all get together and decide to charge $5, it’ll be $5 everywhere, and that’s collusion.  But, that’s not the only way to get uniform pricing.  Even if they don’t collude, they’ll likely still all end up charging the lowest price that any one of the four of them is willing to accept for a gallon of gas.  They have to — the product is totally fungible, i.e. practically nobody cares which brand it is, so nobody has any reason other than price (and maybe a little convenience — i.e. easy ingress and egress en route to wherever they’re headed) to buy it from one seller over the others.

6)  I have to back up the President on his assertion that the major oil companies do have to use the money that they’re taking in at the pump today to purchase the oil that’s going to end up (after refining) in the pump six months from now.

They currently anticipate that it’s going to get more expensive because instability in the Middle East is going to disrupt the supply of oil coming out of there.  So, they’re charging more today, in part, in anticipation of having to spend more tomorrow to secure the supplies that they need in order to meet all of their customers’ demand, both here and in China, later this year (i.e. to make sure there’s something in the pump when you go there this fall).

7)  Instead of imposing an export tax on oil, here’s what we can do about high gasoline prices that’s more likely to be effective:

A) Permit more domestic production.

B) Cut taxes on gasoline, temporarily at least.

C) Cut domestic demand by conserving, which will have a price-suppressing effect, and

D) Individual Americans upset about the rising price of gasoline can invest in oil stocks.

Now, there’s actually a lot of psychology behind gasoline prices, and if you’re interested in that, you may want to check out this piece I wrote on that topic year ago, the last time O’Reilly and I were at odds about it:

Behavioral Finance and Oil Prices

by Dr. Brian Russell 

2/23/2011

I get to talk and write a lot about psychology and law, but the M.B.A. part of my training often gets left out of my media work, so allow me to take this opportunity to write about something a little different from the norm.  As you probably know, there’s a lot of unrest in the Middle East.  That’s no surprise, I know.  And what’s also no surprise is that the unrest in the region is going to have an impact at your local gas pump.

Purchasers of oil from the Middle East (e.g. oil companies that supply theU.S.) fear that the supply of oil getting out of the Middle East will be reduced by the unrest, making future purchases of oil more expensive for them.  Consequently, they’re scrambling to lock in enough supply to meet their customers’ needs in the coming weeks and months, and in a sense, creating a self-fulfilling prophecy — by trying to “outbid” one another today for access to tomorrow’s (and next week’s, next month’s, etc.) oil, they’re driving today’s price upward.

Now, so far, the supply of oil coming out of the Middle East has been disrupted only slightly, yet prices at the pump here in America are rising significantly.  Some, like my friend Bill O’Reilly, have opined that this suggests some kind of conspiracy by a group of shadowy “speculators” to exploit the American consumer.  I agree with O’Reilly often, but not on this.

If those who make money selling oil to consumers were getting it for the same price today that they were paying last week, yet telling consumers that the price at the pump had to be raised because of supply disruptions, at least O’Reilly would be accurate in claiming that consumers were being deceived.  But I’m not seeing that.  Even though supplies haven’t been disrupted much — yet — the price of a barrel of oil coming out of the Middle East has risen sharply, and a fairly proportional increase appears to be happening at the pump, so it looks to me like the increased cost of supply is pretty much just being passed on to consumers.

Yes, the price increases that we’re currently seeing are attributable more to fears of supply disruptions than to actual supply disruptions, but the fears appear to me to be real.  O’Reilly characterized such upward price movements as “artificial.”  I don’t know what he means by that.  Fears affect the prices that both companies and consumers are willing to pay for things.  Sometimes those fears are exaggerated, even irrational, yet they influence prices profoundly.  There’s a whole discipline called “behavioral finance” that’s dedicated to predicting such effects by combining the studies of psychology and economics.

Often, when fears elevate the price of a commodity and then turn out to have been overblown, there’s a reverse reaction whereby there’s excess supply of that commodity and a corresponding drop in its price.  That may very well happen here.  If supplies do get tight, and prices continue to rise, companies and consumers who bought at today’s prices might look like geniuses.  On the other hand, if supplies stabilize, and prices drop back to where they were a month ago, the same purchasers might lose their shirts.

That’s the nature of markets in which human beings do the purchasing, and that’s why behavioral finance is fascinating (at least to Ph.D./M.B.A. types like me).  Accurately assessing how much of an upward price swing is based on justified fear and how much of it is based on irrational fear can help one to predict who will be the “geniuses” and who will be the “shirtless” and to invest (or not) accordingly.  That’s “speculating,” and there’s nothing nefarious about it.

Now, just for fun, let’s say that O’Reilly was right and that oil companies were taking advantage of the news coming out of the Middle East to raise prices at the pump without really paying any more for their supplies.  I hate to tell you this, but that’d be ok, too.  The oil companies’ supplies of oil are the private property of those companies’ shareholders — who probably include your pension fund, your neighbors, maybe even yourself — and it’s their management’s job to get the highest possible prices for those supplies at the pump.  They can try to sell their oil for whatever price they want, and they don’t owe you or me or O’Reilly a justification or even an explanation of why they’re charging what they’re charging.

Our immediate recourse as consumers — and what keeps the price down most of the time — is our right to drive a little farther down the street and buy gas at the next company’s station.  I know, some people would say that the major oil companies are all getting together and setting the same price.  Ok, maybe, but I don’t think so.  I think it’s more likely that they’re all paying very close to the same price for supply, and they all have very close to the same costs of getting that supply to your pump, so they all end up charging very close to the same price.  If one company built a substantially-larger profit margin into its price than its competitors did, everyone would just buy from the competitors.

But guess who can get together and manipulate oil prices?  Us.  That’s right, whenever someone complains about the price of oil, we consumers do have ways to bring it down over time.  One is to increase the supply of oil available to the oil companies, and ultimately to us, by telling our politicians to permit more oil to be extracted closer to home, which also reduces our energy dependence on Middle Eastern nations who aren’t interested in our economic well-being under normal circumstances, let alone now.  If our President even talked convincingly about energy independence, you might be amazed by the effects that it could have on the outputs of oil-exporting countries around the world — if they feared that we were going full-steam-ahead with massive exploration and drilling projects, specifically so that we could buy less from them starting a few years from now, they’d probably increase their output to keep the price at a point where it wouldn’t make sense for us to go through with our plans.  See?  Behavioral finance can work for us as well as against us (and as good as “energy independence” sounds, think about this – as long as foreign oil stays relatively affordable, in the strategic long run, it may not be such a bad thing for us to be depleting Middle Eastern nations’ resources at a much faster rate than we’re depleting ours).

Another thing we can do as consumers and voters is tell our politicians to cut the substantial taxes contained in the price of every gallon of gas that we buy.  Depending on where you live, 10% or more of what you pay for gas probably has nothing whatsoever to do with the Middle East or the oil companies and everything to do with federal and state taxes.  Another approach we can take is to decrease the demand for the oil companies’ product by actually using less of it — conserving, car-pooling, etc., etc., etc.  Think about it — if you sold oil for a living, wouldn’t you keep raising the price of it until your customers finally started buying significantly less of it?  And along those lines, there’s actually something else we can do — become oil company owners if we’re not owners already.  That’s right, by investing in their stocks.  That way, if their revenues truly are rising favorably-disproportionately to their costs, then while we’re helping to generate their revenues at the pump, we can also share in their profits.

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