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Life, Liberty and the pursuit of Happiness.

That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed,

Wednesday, March 28, 2007

Just Who Is Gouging Whom?

by Alexander Green, Investment Director, The Oxford Club

The new speaker of the House, Nancy Pelosi, calls oil company profits “obscene.”

And at first blush, many would agree. Over the past 12 months, for example, ExxonMobil has made pre-tax profits of $164 billion on sales of $369.5 billion. That’s a lot.
But are big profits bad?

Hardly. Companies exist to maximize profits. Profits are what keep workers employed. They keep companies innovating, creating new products and services. They keep the economy humming and the country strong. And they allow you and I to invest and secure our financial future.

Even the school teacher who plunks some of her retirement account in an S&P 500 Index fund benefits from Exxon’s rising share price – which is a direct result of Exxon’s rising profits.

Many will argue that there is nothing wrong with profits, per se. It’s just that Exxon is gouging us at the pump. They’re making too much.

But are they? After all, Exxon can’t dictate gasoline prices. Markets determine the price of oil. It’s supply and demand that sets the price at the pump.

Some Americans are skeptical on this point, I know. So I direct them to last year’s Supreme Court decision. The court ruled unanimously that oil companies have not been colluding to set prices.

Oil prices are high today because the economies of huge nations like China and India are developing rapidly. More oil is being demanded in the world market and there are few new sources of supply.

Hurricane Katrina destroyed a lot of oil processing capacity around the Gulf of Mexico too, so there has been less oil being processed. When less oil is supplied, gasoline prices rise.

What does the average oil company make today on the sale of a gallon of gas? Ten cents.

The federal tax on gasoline, on the other hand, is nearly twice that. Then there’s state gasoline taxes. (If you live in New York, for example, you’re paying 68 cents a gallon in taxes.)

If Exxon is gouging us at ten cents a gallon, what exactly is the federal government doing to us at 18.4 cents a gallon?

Who is gouging whom?

After all, Exxon has to compete with other oil companies both here and abroad. It has to spend billions on exploration, billions more on development, and further billions on refining and transportation.

As a result, it’s hardly making money hand over fist. Earnings at Exxon rose 9% last year but fell 4% in the fourth quarter, underscoring the challenges of rising costs and lower commodity prices.

And Exxon’s profit margins are only 10.7%. Profit margins at Microsoft, on the other hand, are 26%. Perhaps we should pass a windfall profits tax on software companies.

Because that’s what Big Oil’s opponents really want: a bigger federal gasoline tax. Why? To fund the search for alternative sources of energy.

That’s a fine sentiment. But will throwing around tens of billions of dollars in federal research grants really create alternative energy sources? If that were the case, shouldn’t Uncle Sam give grants to Dell to create more powerful computers, to Boeing to build faster aircraft, and to McDonalds to make low-fat French fries that taste good.

The federal government doesn’t need to do this, of course. These companies will continue to make higher quality products at better prices on their own. Why? Because they exist to maximize profits. (Profits, incidentally, that provide much of the tax base for the U.S. government.)

Trust me, we will have alternative energy sources eventually. Many scientists believe that near incredible advances in nanotechnology will allow us to solve all our energy needs with solar power within 20 years.

But it won’t be the federal government that solves the problem. It will be the private sector – and its relentless drive for profits.

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