Oil companies, including Exxon-Mobil, Valero Energy, and Royal Dutch Shell, reported record profits last week. (See today’s article at http://www.forbes.com/). Exxon-Mobil makes the news because of its sheer size, reporting more than 37 billion in profits this last year, up slightly from the 35 billion it reported in 2005. (Its 2005 Annual Report is online, and can be found here: http://www.exxonmobil.com/Corporate/Files/Corporate/fo_2005.pdf.)
Profits of 35-40 billion dollars seems like a staggering amount to mere mortals. This is, after all, more than ten times the amount of the entire budget of the State of Nebraska for 2005-06. The entire GDP of Afghanistan is only about $27 billion, and lots of countries aren’t even producing that much. See GDP comparative statistics here: http://education.yahoo.com/reference/factbook/countrycompare/gdp/1a.html
But the reality for these companies is that they operate in a global environment that requires an immense amount of capital investment. According to the 2005 Exxon-Mobil Annual Report, the company had an average investment of nearly $117 billion during 2005. Assuming similar levels for 2006, its return on assets is indeed rich. But we must remember that this was not always so, and its is not guaranteed to continue to be so high in the future.
Lean years and fat years are typical in an environment where commodity prices fluctuate. Just ask any Iowa or Nebraska farmer, who if his or her farm was not stricken by drought, is enjoying substantial profits on corn and soybean production this year. With corn at $3.70, and assuming a 200 bushel yield, that translates into gross revenues of over $700/acre. Even with costs of production estimated generously, this translates into a healthy profit margin of multiple-hundred dollars/acre. But keep in mind, if your farm was hit by drought, the cost structure stays the same and margins shrink. Red ink is possible, too. And who knows what demand and supply will bring in the next growing season.
The same is true of big oil. Those fat years make up for lean years, and provide rewards to investors who stayed with the company. Keep in mind, net returns to Exxon-Mobil shareholders were negative in 2001-2002. (See their 2005 annual report, referenced above). In other words, you lost money owning this stock. You gained it back, and then some, if you stuck out the lean years and reached the fat ones.
Unfortunately, these basic truths are lost on some politicians. I was shocked to watch Hillary Clinton openly state that government should “take” these profits from big oil and reinvest them in alternative energy. See this link, which was found on today’s Drudge Report: http://www.youtube.com/watch?v=j1PfE9K8j0g. Comrades, this kind of statement should worry those who care about economic stability and capitalist incentives. This presidential candidate apparently likes to demagogue big oil when it is popular to do so, even though her policy suggests a danger to all profit makers.
Moreover, it also represents a danger to the employees working for them. Exxon had 83,700 employees worldwide in 2005 who also depend on these profits. (I note that this total is down nearly 15 percent from the total of 97,900 reported in 2001. That suggests the company’s productivity is probably growing.) Politicians need to remember that profits translate into a livelihood for people.
I am sure we will all see this speech highlighted and ridiculed on tonight’s ABC, CBS, and NBC news programs. (Yeah, Right!) But just in case they don't, I will ridicule it here.
Happy Friday.
EAM
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