Monday, April 17, 2006

A Short Economics Lesson From A Non-Economist

In a previous post I pointed to a comprehensive article by Lacey Putney regarding the current budget stalemate. I mentioned that it was the current topic of choice among those Virginians who tend to follow politics closely.

My observation has been that those persons appear to be vastly outnumbered by Virginians who have chosen an entirely different topic (though much closer related than they realize) as the conversation starter of choice.

Gas prices are quite high now and, as Summer approaches, are certain to go higher. I can't get through a day without listening to several people complain about the "ridiculous" profits made by the "Oil Company". I understand their frustration. Really, I do. I buy gasoline too. I drive 36 miles to work (and back, of course) each day. I too have read about Exxon/Mobil's multi-billion dollar profits of late.

But what most do not understand is that Exxon/Mobil (and Valero, and Shell, and Texaco, etc.) are HUGE corporations. Along with HUGE comes MASSIVE amounts of retail sales. One cannot look only at the dollar profit line without looking at the entire balance sheet. Anyone with a modicum of business acumen will tell you that any corporation that can manage 7% net profit has done extremely well for the year in question. That means that for every dollar Mega-Oil Corp, INC. takes into it's numerous cash registers, it can put 7 cents into the pile that it calls profit at the end of the year.

Granted, a 7% return on investment is considerably better than you will be offered down at the local BB&T on your CD. But that CD is guaranteed to pay at it's advertised rate. Mega-Oil Corp has no such guarantee that it's investment will return even the more common average of 3.5% net profit on retail sales.

Now I come to the point at which I hinted earlier, the relationship between these profits and the current budget debate. Listen closely, you are not likely to hear this elsewhere.

During the campaign Tim Kaine took every opportunity to decry the "obscene" profits made by the aforementioned evil oil companies. Even going so far as to suggest that they freeze prices. (Apparently Timmy! is a disciple of Jimmy!).

You can spend a few minutes with Google and find that most Evil Oil Companies annual reports list a category for "Marketing, Distribution, and Profit". You will also find that these categories in all cases range from 9 to 11%. Now, obviously, this number is not the actual profit earned by the company in question. It also includes all advertising costs, as well as trucking, pipeline costs, tank farm costs, and warehousing.

If we assume that advertising, distribution, and warehousing together comprise a little less than half of this number we come to a number approaching that magical 7% profit that is considered to be outstanding by the green eyshade set. But let's get more realistic and assume that this category is actually fairly evenly divided. That puts us more in line with the much more typical 3 to 5% net profit for retail businesses.

I now return your attention to those (especially Timmy!) who decry the "obscene profits" being made by our mythical Mega-Oil Corp. What Timmy! didn't tell you, and probably won't, is that the Commonwealth of Virginia is currently earning that magical 7% or better on every gallon of gasoline that Mega-Oil sells. And every gallon that Exxon/Mobil sells. And every gallon that Valero sells. And every gallon that Shell sells. And every gallon that Citgo sells. You get the picture. Candidate Timmy! calls it "obscene profits" when Mega-Oil works for and earns 3 to 5% on the sale of a gallon of gasoline, but does not tell you that Virginia "earns" almost twice as much from the same sale. Now, you tell me who recieves the "obscene" profit.


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