I am generally not much for procrastination, but in this case I am guilty. It has been 3 weeks now since I participated in a conference call with API Chief Economist John Felmy. Robert Bluey, one of the participants, wrote up some comments immediately afterward at his blog. I had intended to do the same, but one thing or another has distracted me until now.
I will post some of Bluey’s comments, because all of the pertinent links are there. Just a bit of background. I did not know that there would only be a few of us participating, or I would have spent more time considering my questions. For all I knew, there would be 50 people on the call and I would get to ask maybe 1 question that I would formulate based on Felmy’s comments. So, if my questions and comments seem unscripted, don’t worry, they were. I did not know exactly what we would be discussing.
I will be the first to admit that this was not a hostile audience. I imagine this was just a test run before this message is carried to more hostile audiences; they are the ones who need to be engaged. After all, I am not the one who believes that oil companies are ripping you off. But this is what the average person believes, so it is the average person who needs to hear this message
The intent is to hold such conference calls on a regular basis, so if you have specific questions you would like asked, then post them and I will ask them next time around. (You can’t accuse me of bias if I am asking YOUR questions). So, if you have some questions on climate change, profits, ethanol (I did not ask any ethanol questions, although it was tempting to jump in and answer some questions myself), or energy issues in general, give me some of your questions. I will make a list, and I will try to get them answered.
Here are some of Robert Bluey’s comments:
Seeking to get in front of the brewing storm over rising gas prices, the American Petroleum Institute on Thursday hosted a conference call for bloggers with its chief economist, John Felmy.
Yesterday’s call was intended to counter what Felmy dubbed as “repeated attacks on the industry as having excessive profit” — a charge that just doesn’t hold up when compared to other industries. API provided a PowerPoint document (which is publicly available) to prove its point. It’s also set up a website, Energy Tomorrow, to hone its message.
Joining me on the call were Mary Katharine Ham of Townhall, Kevin Holtsberry of RedState, Robert Rapier of The Oil Drum and R-Squared Energy Blog, Geoffrey Styles of Energy Outlook and Jerry Taylor of Cato-at-Liberty.
A complete, edited transcript along with an audio recording are available on the Energy Tomorrow.
All of the pertinent links are included in Robert Bluey’s posting. I did get to ask several questions, one of which I flubbed. I asked what their policy was on gas taxes, when I meant to ask about their stance on gas taxes.
As far as the message, I agree whole-heartedly that the public needs to be engaged on these issues. I don’t know how receptive they will be from getting this message from the API, though. I have trouble myself talking to people because I work for an oil company. A lot of people immediately dismiss all arguments on that basis alone. “Of course YOU don’t think oil companies are gouging us; YOU work for an oil company.” However, as I have stated again and again, my arguments are independent of my identity. Question my motives all you want, but that doesn’t address my arguments.
The presentation is very informative, and does a nice job of addressing misconceptions. For example, who exactly is “Big Oil”? I think a lot of people envision former ExxonMobil CEO Lee Raymond, in a smoke-filled room with a bunch of his buddies plotting the destruction of the environment. In fact, pension and retirement accounts hold 41% of the shares of oil companies, and the other 59% is divided among individual shareholders, mutual funds, etc. If you have a pension or retirement account, the odds are pretty good that YOU are Big Oil (albeit just a little slice).
My biggest area of disagreement, being a guy who is quite concerned about future oil supplies, was the message that there is still plenty of oil out there. Undiscovered oil in the U.S. and Alaska was estimated at 112 billion barrels (“enough oil to power over 60 million cars for 60 years AND heat over 25 million homes for 60 years”). To put that in perspective, that is more oil than Saudi Arabia has produced in their entire oil production history.
Given that this oil is “undiscovered”, I think it would be prudent to plan as if it isn’t there; or at least not in nearly the amount forecast. This has been my criticism of cellulosic ethanol. What if it doesn’t pan out? What is the contingency plan? This is the same question we need to ask about these undiscovered reserves. What if they are never discovered, or are never economical to produce? We need to plan a future in which we are scaling down our energy consumption – not a future in which we count on “powering 60 million cars for 60 more years.”
Anyway, check out the presentation and the transcript, and if you have a question that you would like to see answered by the chief economist at the API, I will attempt to get it answered.
Robert, I hate to break in on your blog, but I would really appreciate your reaction to Nate Hagen’s latest article at the Oil Drum “”Peak Oil” – Why Smart Folks Disagree – Part II” at some point. Particularly his information from Prof. Cutler Cleveland. Thanks.
I would really appreciate your reaction to Nate Hagen’s latest article at the Oil Drum “”Peak Oil” – Why Smart Folks Disagree – Part II” at some point.
Nate and I are pretty good friends, and we e-mail each other all the time. He had asked my opinion of his post, and here was a portion of what I wrote:
Your post was good. No, it was great. I especially appreciated your points 6 and 7. I have come to the conclusion that OPEC has figured out that it is in their best interest to restrict supply. I also work for an oil company largely because of some of the reasons you laid out. I think that moving forward, this will provide great job security as oil continues to deplete. We will really be out there beating the bushes.
He had also voiced frustration about whether his efforts were getting through to people. I noted the irony that the posts I put the least effort into seem to be the most popular:
I learned a lesson with my summer gasoline post. I believe it holds the TOD record for most Diggs. Out of all the posts I ever wrote for TOD, it is probably the one I put the least effort into. I just sat down, wrote it, and submitted it. It was very easy to understand, and Joe Public understood. He is not going to understand any of my HL posts.
As far as spending your time on more rewarding pursuits, this is the decision I came to. I am in a new job, and I am sitting at work answering trolls at TOD. I know I should just ignore them, but there is something hardwired in me that causes me to address the critics. So, here I am risking the goodwill with of my employer to do something that is ultimately frustrating.
Cheers, RR
I read Nate’s article also and found many good points as well. Although I don’t necessarily agree with his conclusions.
I can give a personal example of marginal cost of production. About a month ago, a rotary drilling rig showed up here:
Cinco Ranch Oil Well
Click on “hybrid” to see the neighborhood. The well is a little over a mile from my house. There are 2 more rigs working just to the south of this one. It is humorous to me that we can drill here, but not in some parts of Alaska.
The marginal cost of the oil from this well has to be very high compared to Kuwait or Saudi Arabia. Looking at the Baker Hughes Rig count, you will see that just over 1/2 of the oil rigs in the world are working in the US (three of them in my neighborhood), but only 225 or so in the entire middle east.
The point being that oil in the U.S. peaked in 1972, yet the U.S. remains the 3rd largest producer in the world. Agressive development has made the peak look more like a plateau.
There is no reason to believe that the this type of production could not be duplicated elsewhere in the world. As the lower cost petroleum production peaks, the state owned oil companies will begin to abandon mature fields (just as the majors have exited the lower 48). Some countries will experiment with private capital and private development of previously state controlled resources as a way to preserve oil and gas royalties and taxes. At first it will be a small fraction of the reserves, but that will soon grow as private development competes more efficiently.
China went through the same experiment with collective farming. Soon their privatization experiment was outproducing the state farms.
The “concerned” will say that governments will not abandon state ownership. What is their alternative? Look at PEMEX or PDVSA bloated organizational structure. There is no way they could compete with any of the international majors. At some after they peak, their marginal costs will rise to exceed the market price and they become a drain on the treasury. Some royalty and tax is better than none, so countries will begin to experiment with privatization. I would expect that in another 30 years or so socialism will have completely died, although Hugo Chavez and a few others are giving it a try again.
I’m sympathetic to many of your ideas and feelings, but I’m not sure you’re really addressing some of people’s concerns.
In particular:
First, does it make sense to compare oil’s profit as a % of sales to industries that average 10% or so? Grocery stores, for instance, have a profit of less than 1% of sales, because they have such a large throughput. In other words, their “value added” is a small % of their sales, and so profit is as well.
2nd, oil companies themselves regard their current profit as a windfall. Why else do they keep their benchmark oil price below $40 for investment decisions? These prices weren’t anticipated or planned on, and aren’t expected to continue. As long as they do continue, oil companies may just continue to pass them on to their shareholders as a “bonus”.
I’m understand the idea that oil companies got no sympathy when they were losing money, but…I don’t think you can really defend current profits as ROI.
Does that mean I advocate windfall profits taxes? Not really – I don’t want to scare investors. But…these surely are windfall profits.
Finally, I would distinguish between oil company owners, and their management. I think it’s fair to say that Exxon in particular has shaped public policy in ways that were destructive. I think it’s fair to criticize it for that.
Nick – if value added is your yardstick then oil companies add a lot of value. What good is oil & gas in the ground? Once produced it can’t be consumed without further processing. What value does banking add? Insurance?
The other factor you are missing is risk. Oil companies can put billions into exploration and development only to drill a dry hole or the bottom falls out of the crude oil market.
You also miss the long time horizon. Windfall profits today are the result of investments made 10 years ago when oil prices were in the $10-20 range. Current production in non-OPEC countries is something like $50-60 per marginal barrel produced. If the price drops, these current investments are likely to lose money.
Grocery stores, for instance, have a profit of less than 1% of sales, because they have such a large throughput.
This is a very good question. In fact, I asked that question during the API conference call. I have posed that question myself. It went something like this. Let’s say we invest $100. Let’s say that this generates $1200 annually in sales, and that the profit on sales is $120. While it is true that we made 10% on sales, it is also true that we had a 20% return on our investment. So, I had to concede that the critics had a point in this instance.
BUT, here is the issue. Since oil companies are being singled out for the “windfall”, it really makes sense to see how this return compares to other industries. Do you believe it is going to rank up there with the returns made by software companies, pharmaceutical manufacturers, or banks? I don’t think so. You can’t compare these profit metrics in a vacuum. You have to see how they compare to other industries, and whether the companies are being singled out unfairly.
2nd, oil companies themselves regard their current profit as a windfall. Why else do they keep their benchmark oil price below $40 for investment decisions.
I have had this conversation with the chief economist for my company. She said that basically the reason the benchmarks are there is because that is historically where oil prices have been. Personally, I don’t think that’s where they will be in the future, but it is true that historically the prices have been very cyclical.
These prices weren’t anticipated or planned on, and aren’t expected to continue.
It’s the same with any commodity. You invest your money and take your chances. Sometimes returns are good, and sometimes they aren’t. It’s the same in real estate. Shall we slap windfall profits taxes on homeowners in California who have seen their homes greatly appreciate in value? Why not?
I think it’s fair to say that Exxon in particular has shaped public policy in ways that were destructive. I think it’s fair to criticize it for that.
No argument from me there.
Anyway, I really appreciated the questions. This is the kind of dialogue that I would like to see take place with every American. I find it very interesting that here in Europe, the attitude toward oil and gas is quite different. It is not nearly as hostile in the U.S., where there is a clear love/hate relationship. People love the convenience of going to the store and filling up whenever they want, but they hate to see oil companies profit from selling it.
Cheers, RR
“Do you believe it is going to rank up there with the returns made by software companies, pharmaceutical manufacturers, or banks? I don’t think so. You can’t compare these profit metrics in a vacuum. You have to see how they compare to other industries, and whether the companies are being singled out unfairly. “
Yes, but you have to compare to COMPETITIVE industries, with similar kinds of throughput. That’s why I used the grocery store example. Microsoft has a monopoly, and is a very bad benchmark. So, too, do some drug companies, especially in the US. I think if you look at the overall drug industry worldwide, you’ll find much lower net profit margins on sales than you expect.
“I have had this conversation with the chief economist for my company. She said that basically the reason the benchmarks are there is because that is historically where oil prices have been. “
So we’re in agreement that your oil company regards current profits as ahistorical and unexpected? In other words, a windfall?
“It’s the same with any commodity. You invest your money and take your chances. Sometimes returns are good, and sometimes they aren’t.”
I really don’t think that’s they way your company (or its stockholders), regards it’s investments. They expect reliably good results. That’s why they’re keeping the investment benchmark low.
“It’s the same in real estate. Shall we slap windfall profits taxes on homeowners in California who have seen their homes greatly appreciate in value? Why not?”
We, in fact, do that. They’re called property taxes, and were specifically devised, historically, to capture a portion of appreciation (rent, in economists’s lingo: unearned returns). In California they only go up when you sell your home, which in effect allows local government to capture some of the appreciation at that point – in effect, the new property taxes are figured into the investment decision by the new buyer, and reduce speculative real estate investment somewhat. I suspect oil companies would take royalty payments or income taxes any day in preference to taxes on assets.
Finally, I’m not suggesting that we slap on a tax, as I think it would scare investors and be counter-productive. But, on the other hand, I think these profits can only be described as a windfall, and it’s certainly proper to take back some of the royalty reductions which were originally intended to help out only during low oil prices, and seem to have persisted into the present owing to sheer lobbying influence.