Debunking the Debunkers

There are a few things I have learned over the years regarding the relationship between the public and oil companies. The public seems to have an especially strong distaste for oil companies, and especially Big Oil. They don’t seem to care that the profit margins are much higher at Microsoft or Citibank, because they don’t have to shell out money directly to them on a regular basis. If they are paying higher prices than they think they should be, and oil company earnings are good, then they think they must be getting ripped off.

This mentality is pervasive, despite the fact that finding, extracting, and refining oil is risky, both physically and financially, and requires huge sums of capital. When is the last time someone was seriously injured programming software? Does it require a multibillion dollar capital investment to sign someone up for a credit card at 18% interest? But, I bet if you polled the public, a substantial portion would say they don’t care if oil companies make any money at all. They just want their cheap gas. Of course politicians know this and they pander to their constituents, promising to punish oil companies and to bring prices back down.

Oil Industry “Windfall”
Source: Facts on Fuel

To be fair, not everyone is complaining. From

First the oil companies scour the freaking globe, going to the most gosh-forsaken dangerous places on earth to find the stuff. Then they pump it. Then they ship the stuff in huge, complicated ships halfway across the world. Then in giant, expensive plants they refine the stuff through amazingly complicated processes and turn in into gasoline. Then they distribute it to rural Nebraska and Vermont and all over the USA. The price is less than a gallon of bottled water, and it’s gone up less than inflation, and we take it for granted and we’ve squandered it with our Suburbans and Tahoes and Navigators. (1)

That brings me to a new report from Consumers Union , a non-profit publisher of Consumer Reports, explaining how you are being ripped off by oil companies. The report is “Debunking Oil Company Myths and Deception: The $100 Billion Consumer Rip-Off” (2). The report gets into some areas not addressed in an earlier attack piece by FTCR, which I previously addressed. Therefore, it is worth a bit of time to address the allegations made by Consumers Union. I will hit the highlights, most of which are contained in a news release here.

Addressing Some Claims

Claim 1: The U.S. oil industry made $100 billion in windfall profits since the late 1990s, largely by eliminating refining capacity that paved the way to drive up prices at the pump.

Fact: The oil industry is cyclical, and is not always as profitable as it is now. So, what is the baseline for defining a windfall profit? Should it be based on a time in which the industry was at the bottom of the cycle? Refineries are shut down when they are not profitable – not to restrict capacity. If there is a refinery that is not providing a very good return, or is even a money loser, why should I be expected to continue running it? Would you run your business this way?

Consider this “windfall” analogy. Millions of homeowners are sitting on a huge amount of appreciation in their homes. What did they do to earn this windfall? Nothing, other than being in the right place when the market was appreciating. I am sure the person buying one of these houses doesn’t want to pay that much for it. But, what are their options? All of the other houses are also sitting on windfalls and are also “too much”. Consider the person in California who bought a house for $170,000 that is now worth $750,000. That is a serious windfall. Shall we cap how much they can sell their house for? After all, that price isn’t really “fair” to new homeowners. Shall we impose a steep windfall profits tax for all houses that have a certain level of capital gains, and then use that to help those who want to move into that neighborhood? Sure, they will have to pay capital gains taxes, just like oil companies pay taxes on their earnings. But why not an additional penalty, since they really did nothing to earn their windfall? The market just gave it to them.

Claim 2: Consumers are trapped between a small group of powerful, non-competing oil companies out to maximize profits and weak governmental authorities who consistently fail to strengthen or enforce the law.

Fact: The oil companies are certainly out to maximize profits. That’s what companies are supposed to do. But non-competing? How’s that? ExxonMobil, the largest company in the United States, controls 3% of the world’s oil supply and 8% of the nation’s service stations. How exactly is it that oil companies aren’t competing? No company can dictate price, because they don’t control enough of the market to do so. Oil companies have been investigated countless times for collusion, and they have always been vindicated. In order to be “non-competing”, a company either has to control the market or be in collusion. Unless Consumers Union can show either of these to be the case, they should retract this claim.

Claim 3: On Wall Street they point to their soaring return on equity and cash flow as proof of their huge profitability, while on Main Street they point to profit as a percentage of sales and ignore cash flow to claim less than stellar results.

Fact: The reason oil companies point to their profit on sales is that it is a commonly reported metric for many different industries. It allows the public to see just where Big Oil fits among other industries. The return on capital employed (ROCE) metric is often criticized as proof that the profitability of Big Oil is “too high”. What ROCE means is basically the return on your assets. That is a perfectly acceptable measure of a company’s profitability, but if you want to criticize it for being too high, you must again look at other industries. What is the ROCE for software companies? Banks? Pharmaceuticals? Since these industries don’t require a lot of capital, as is the case with oil companies, their ROCE is going to be much, much higher than that for oil companies. What ROCE does is allow one oil company to compare itself to another. Using ROCE to claim that oil companies are too profitable is meaningless unless we use the same metric to compare other industries and see where Big Oil fits into the overall picture.


I thought one theme in the report was particularly ironic. On the one hand, they admit that earnings were much lower just a few years ago. ExxonMobil, for instance, had profits of $11 billion in 2002, which was less than 6% profit on sales. Yet they complain the oil companies have underinvested in recent years in new refining capacity. So, let me pose a question for the good people at Consumers Union: Do you think it’s possible that underinvestment was due to lower profits just a few years ago? Profits drive investments. When you are making good profits, you tend to make more investments back into the business. When profits aren’t all that great, you don’t have as much money to invest in the business. Yet the supreme irony is that when profits are good, so more investments can be made back into the business, you complain about the windfall!

What are companies doing now that earnings are good? ConocoPhillips invested 141% of their first quarter earnings back into the business. ExxonMobil invested more than 50% of their earnings back into the business. Chevron’s earnings were $4 billion, and their exploration and production budget for the first quarter was $3 billion. This can be done when earnings are good. The reason this level of investment did not occur 5 years ago is that the earnings were insufficient to support that level of investment.


1. “Defending Big Oil and buying some stock”,, April 27, 2006
2. “Debunking Oil Company Myths and Deception: The $100 Billion Consumer Rip-Off”, Consumers Union , May 3, 2006.

10 thoughts on “Debunking the Debunkers”

  1. when was the last time somebody was injured programming software?

    depending on whose numbers you use, between 50,000 and 80,000 programmers are permanently injured every year. I was injured in 1994 and was left with permanent chronic pain and a whole bunch of other hand and arm problems.

    because the accessibility tools (speech-recognition) are quite primitive and the sole speech-recognition vender has no interest in dealing with handicapped users, most of them leave the field and we lose a great deal of talent. It’s really quite an unpleasant situation

  2. Ah, I knew I should have stuck to my original wording. I had written “when was the last time somebody was killed programming software, but I thought it sounded too harsh. Sadly, people die every year to satisfy the world’s thirst for oil.


  3. Here’s an observation. In 1998, crude oil averaged $15.99 in 2005 dollars, $13.11 in nominal dollars (both figures from Forbes). Average gas price according to my memory (can’t find the figures) was around $1.25. Last week, when crude oil hit $75, average gas price topped out at around $3. So, depending on how you want to figure it (I’m an English major, not an economist, mathematician, or engineer), the price of crude increased by about a factor of five, while gas prices didn’t quite triple.

    What explains this? Could it be that oil companies are actually taking a bit of a hit, that their profits aren’t nearly as high as they otherwise might be?


  4. Clint,

    Oil companies who own oil have made money on the oil appreciation as well as on gasoline. So, I wouldn’t say they are taking a hit. Profits are pretty good. But if you look at the graph in the essay, you will see that they are not out of line with other industries.

    One point of the Consumers Union piece was to argue that based on ROCE, oil companies are very profitable. But, since they didn’t show ROCE for any other industry, they still can’t demonstrate that these numbers are out of line with other industries.

    Oil company profits are huge because the companies themselves are huge. The public has trouble getting their minds around this. They just know that oil companies are making multi-billion dollar profits, and they are paying record prices. Therefore, they believe they are being taken advantage of. No doubt, Big Oil has a public relations problem, and really needs to get out there and try to explain the facts to the public.


  5. I saw your piece on TOD, congratulations on becoming a contributor.

    I was wondering if you would post a piece on TOD about pseudoscience and how to detect it. As oil prices rise it seems like all kinds of snake oil salesmen are seeing an opportunity promising cheap energy and selling false hope.

  6. I was wondering if you would post a piece on TOD about pseudoscience and how to detect it.

    When I first started this blog, one of my intentions was to address pseudoscientific claims. But so far, the energy theme has kept me plenty busy.

    Wikipedia has a good definition of “crank” tactics, which will give you a pretty good idea of how to detect pseudoscience.

    Crank tactics and techniques

    If you aren’t familiar with a particular area, it isn’t always easy to tell. That’s how they get away with it.


  7. There are a few things I have learned over the years regarding the relationship between the public and oil companies. The public seems to have an especially strong distaste for oil companies, and especially Big Oil.


    I think part of the problem is that many people think of oil companies more as utilities companies than businesses.

    When they buy energy from an electric company, it is usually a company that is regulated by a public service commission. When most electric companies want to raise rates, the PSC gets involved to make sure they have a valid reason and that they do need to raise prices because the cost of coal or natural gas has gone up.

    I think too many people view gasoline as a necessity and think something like a PSC should regulate its cost instead of the free market and supply and demand.


    Gary Dikkers

  8. I think part of the problem is that many people think of oil companies more as utilities companies than businesses.


    This is exactly the problem. The other issue is that most people have to fuel up more frequently than they have to pay their electric bill, so they get mad more often.

    Another problem is that people don’t understand the economics of gasoline pricing. They seem to think that we look at the costs of producing the gasoline, and then mark up for profit. When we make more money, they think we have just decided to jack profits up. But the price is driven by supply and demand, not the desire to make more money.


  9. I agree with the price being a function of supply and demand. I’ve also been reading up on this issue and I’ve learned that oil companies are re-investing billions of dollars of their profit into developing cleaner, more efficient fuels. Therefore, they are doing more to help us solve the energy puzzle than our own government. In my opinion, something is wrong with that.

  10. “Shall we impose a steep windfall profits tax for all houses that have a certain level of capital gains..?”

    We probably should do something. Home appreciation is subsidized by income tax deductions. Home appreciation is a classic form of what economists call “rent” – non-earned income from happening to own a scarce asset. In this case there is a serious distortion due to the public subsidy.

    Doing something to reduce and recapture for the public some of this form of rent was one of the original purposes of local property taxes.

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