The results are coming in and oil companies are posting lower profits this year than last year. Oil is at an all time high, so how can they have lower profits? it’s pretty simple, oil companies are subject to economic forces. It turns out that supply and demand still hold true, who would have thunk it? The conventional wisdom is that people will pay “anything” for gasoline, so any increase in oil prices are passed along to the consumers in full. If it costs an extra 85 cents per gallon to manufacture the gasoline, they’ll just tack it on the price at the pump and people will buy it. The obvious question is if people would have bought the gasoline for an extra 85 cents a gallon, why didn’t those “greedy” oil companies do it before the costs went up?
Here’s the scoop, gasoline, like any other product, is priced at the highest price it can be and still be sold in the quantities that the company needs. What that price is is determined by the combination of consumer demand and how much product the company has to sell. That’s it, the cost of manufacturing is only tangentially related to the quantity that the company has to sell, but the customers really don’t care what it costs to manufacture. The higher oil prices are cutting into the companies profits because they cannot arbitrarily raise the price to cover expenses (or for any other reason). They have to offer the gasoline at the price that consumers are willing to pay if they want to sell it. So the difference is taken out of the profits in order to keep the price where it needs to be.
The punchline here is that gasoline is just like any other product, as prices go up, people buy less of it. The oil companies can’t get around this, so when faced with rising costs, their profit goes down. They are not magic money making machines, they have to offer a product at the prices that people want in order to make money. Things have been good for them in the recent past, not so good in the more distant past (1980’s-1990’s) and now things are starting to get back to where gasoline is the lower profit margin item that it was before. I’ve written about the demand side of the equation here, one of these days I will put up a simplified version of the supply side of things…