Oil companies and their profits

Econ 101 teaches us that as bottomlines improve and demand increases, private companies plough back their increasing profits into newer investments in upgradation and capacity expansion. By this logic, the oil companies should have been funneling back their windfall profits of recent years into exploration and refinery capacity expansion. But statistics for the top five oil companies reveal that in the last five years, while profits have soared production has remained stagnant.



Compared with 1994, these big five have been spending a much smaller proportion of profits on exploration and instead have been splurging the windfall on share buybacks that would enrich the existing shareholders without adding any value to the economy. In other words, the high oil prices may be one of the largest single transfers of wealth from the ordinary citizens to the some of the richest people in the world. It is a virtual tax imposed by the rich on everybody else. (And it is in this context that the proposal by Barack Obama to impose a windfall profit tax on oil companies can be seen.)

The NYT's arguement that the fall in global oil production is the result of reduced influence of the oil companies is misleading. Its contention that from the Caspian Sea to South America, Western oil companies are being squeezed out of resource-rich provinces and are being forced to renegotiate contracts on less-favorable terms and are fighting losing battles with assertive state-owned oil companies, is an indicator of the oil market finally showing signs of becoming competitive.

For decades, oil companies have been biggest beneficiaries of mercantilism, exploiting apprehensions on energy security and controlling massive oil assets in many developing countries with little or no accountability. This led to massive profits which enriched the shareholders of these companies. But now, led by the likes of Hugo Chavez and Co, many of the oil rich areas are asserting themselves and scrapping or re-negotiating heavily one-sided contracts with the big oil firms.

Faced with this reality of being forced to share a more justified share of their massive profits with the resource owners, thereby resulting in smaller and realistic bottomlines, the big oil firms appear to be digging their heels in and cutting back investments and maximizing their returns from the high energy prices.

As late as the 1970s, Western corporations controlled well over half of the world’s oil production. These companies — Exxon Mobil, BP, Royal Dutch Shell, Chevron, ConocoPhillips, Total of France and Eni of Italy — now produce just 13%. Today’s 10 largest holders of petroleum reserves are state-owned companies, like Russia’s Gazprom and Iran’s national oil company.

Many of these state owned firms, who have access to increasingly large quantities of oil, do not have access to the latest technologies or are hindered by bureaucratic inefficiencies to ramp up production quickly. It is imperative that they collaborate with the private oil majors to boost oil production in response to the growing demand. But this would require the oil companies to reconcile themselves to more realistic profits and forego the the exploitative profits of past decades.