An industry-wide study in the late 1990s showed that oil industry profits amounted to an estimated 7.3 cents on each gallon sold.¹ More recently, ConocoPhillips reported that during the third quarter of 2005 earnings from its U.S. refining and marketing operations amounted to 9 cents per gallon, out of industry average retail price of $2.60 per gallon during the quarter.

A multitude of factors can affect an individual oil company's profit on gasoline sales. Profitability factors include the efficiency of the firm's refining, distribution and marketing system, as well as its source of raw material. In times of rising oil prices, companies that own and produce a considerable portion of the crude oil used in their refineries may benefit more than other companies that must purchase most or all of their supplies on the open market.

Crude oil generally represents the single greatest cost component of gasoline, which explains why gasoline prices rise and fall so quickly with changes in the world price of crude oil. For example, at ConocoPhillips, crude oil costs make up 85 to 90 percent of the total costs of running its refineries. As an international commodity, crude oil is bought and sold 24 hours a day, so its price is changing constantly. In the matter of a day or two, crude oil prices can move up or down by several dollars, depending upon supply and demand factors.

In general, crude oil accounts for roughly half of gasoline's price, as shown in the graphic. Other price components include refining, distribution (pipelines and tanker trucks) and marketing (service stations and convenience stores). These so-called "downstream" costs have been falling as companies have made operations more efficient. When gasoline reaches the pump, another major factor comes into play - federal, state and local taxes, which average 15 to 20 percent or more of the pump price. The federal tax is 18.4 cents per gallon, while state taxes vary from 14 cents in Wyoming to more than 44 cents per gallon in New York.

¹ Estimate was based on an average pump price between January 1997 and September 1999. The estimate was derived by dividing the net income of the gasoline-related operations of major oil companies by the total number of gallons sold by those companies. Study was conducted by the American Petroleum Institute.

Find out more out at...
Weekly Update on Gasoline Prices, a report compiled by the U.S. Energy Information Administration.
Gasoline and the American People, a report by Cambridge Energy Research Associates, an independent energy research and consulting organization.

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Why are oil company profits so large?

Profits of major oil companies reached $43.3 billion in the first half of 2005, some 42 percent higher than in the same period last year. The big percentage increase helped support the impression that oil profits are excessive, but business analysts stress that other measures should be considered in assessing a company's or industry's profit picture. Business Week magazine, for example, regularly monitors the profitability of various companies and industries by comparing their profit margins. To determine profit margin, the magazine divides net income by total revenue. In the case of oil and gas companies, total sales consist of the money they receive from selling their products, as well as revenue received from any other sources. Net income is the money left over after all costs and taxes are paid.

Over the long haul oil profits generally remain below or on a par with those of other major industries. As the chart indicates, the Business Week analysis of the data from the five-year period July 2000- July 2005, shows that the profitability of oil and natural gas companies (5.7 cents per dollar of sales)² has been just slightly above the profitability of all industries combined (5.5 cents per dollar of sales).

² Not to be confused with profit margin on each gallon of gasoline sold, as described in the first question.

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How do oil profits compare with those of other industries?

Business Week magazine regularly compares the profitability of various industries and companies on the basis of profit margin, which is calculated by dividing net income (profit) by total sales and other revenues. For example, a software company that clears $90 million in net income on product sales of $1 billion would earn a profit margin of 9 percent or 9 cents on each dollar of sales.

Traditionally, oil companies have trailed many other industries in this measure of profitability. As indicated in the graphic, the profit margin of oil and natural gas companies was slightly above that of all industry in the second quarter of 2005. However, the industry's profitability remained below the profit margins of many other industries such as banking, financial services, pharmaceuticals, insurance and computer software and services.

Find out more out at...
Oil and Gas Industry Profit Margins, compares industry profit margins against other industries in the second quarter of 2005. Compiled by the American Petroleum Institute using Business Week data.
Energy Finance, a gateway to energy industry financial and operating data compiled by the U.S. Energy Information Administration.

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Shouldn't the government regulate oil profits?

History serves as a helpful teacher on this question. As part of a general effort to combat high inflation in the early 1970s, President Nixon placed price controls on the oil industry and many other sectors of the American economy. Eventually the controls were lifted from other industries, but they remained in place for U.S.-produced oil as the government tried to partially protect consumers from the jump in world oil prices caused by the oil embargo of 1973-74. A so-called windfall profits tax was imposed on the industry in 1980, when again world oil prices rose dramatically as a result of supply disruptions stemming from conflicts in Iran and Iraq. The government began phasing out the tax in 1981.

Although various price and profit control programs did limit income to oil companies, it's questionable whether they benefited consumers in the long run. Between 1974 and 1980, imported oil prices averaged about 50 percent more than the price for oil produced in America. As a consequence, U.S. oil companies were discouraged from exploring for and finding supplies of oil and natural gas at home. Meanwhile, industrial and individual consumers were shielded from higher prices that might have encouraged greater energy conservation.

A report by the U.S. Energy Information Administration (EIA) that surveyed the events in the 25 years following the 1973-74 oil embargo concluded that federal price controls and allocations systems not only "failed to resolve these problems (electricity brownouts and rapidly rising prices), they seemed to aggravate them."

According to a 1990 Report of the Congressional Research Service, the windfall profits tax that was signed into law in 1980 and repealed in 1988 drained $79 billion in industry revenues during the 1980s that could have been used to invest in new oil production – leading to 1.6 billion fewer barrels of oil being produced in the U.S. from 1980-1988. The tax reduced domestic oil production as much as 6 percent, and increased oil imports as much as 16 percent.

As the graphic shows, gasoline prices since the early 1980s have risen at a slower rate than many other essential consumer items, including food, housing, educational and medical care.

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What happens to those oil profits?

Basically oil company profits are used for two purposes — to pay dividends to shareholders in the business and to pay for capital investments to find, produce, process and deliver energy products to consumers.

Shareholder Dividends: Millions of Americans own stock in oil companies either directly as shareholders, as owners of mutual fund shares or as participants in pension fund and other retirement accounts. Each year, dividends paid by oil companies put hundreds of millions of dollars into the hands of the public.

Capital Investments: By far the largest portion of oil profits goes back into the business to find and develop resources and improve and expand facilities. Consumers most often see industry capital investments in the form of new or upgraded marketing outlets, such as local convenience stores. But in reality, investments in the retail marketing business are small when compared to the massive amounts of money spent by the industry in places that few consumers ever see — such as the middle of the North Sea, the Alaskan North Slope or the deep waters of the Gulf of Mexico. In these far flung locations and in countless other places around the world, companies must search for new resources of oil and natural gas to replace the supplies that are being depleted daily by consumer demand.

Higher prices provide greater incentive to look for oil and gas in more remote, expensive locations. As the graph indicates, in response to the rising price environment of the last several years, the industry has steadily increased its capital expenditures. In the case of ConocoPhillips, the company has invested an average of $1 billion a month over the last three years (2003 to 2005 year-to-date annualized) – slightly more than its earnings over the same period.

The oil industry is termed a "capital intensive" industry because so much of its work requires the expenditure of millions and sometimes billions of dollars even for a single project. Here are some examples based on estimates for energy projects in which ConocoPhillips is participating:

• $4-5 billion to increase the capability of refineries to produce 15 percent more gasoline, diesel and heating oil by 2011.
• $1.5 billion to build new terminals to receive shipments of liquefied natural gas (LNG) from aboard to meet U.S. market needs.
• $6 billion for a pipeline to bring 1.8 billion cubic feet of natural gas to the United States from Canada’s Mackenzie Delta.
• $20 billion for a pipeline to transport natural gas from the Alaska North Slope to the Lower 48 states.

Find out more out at...
Economic State of the U.S. Petroleum Industry, a long-term view of how fluctuation in energy prices affect industry investment, employment, taxes and royalties. Prepared in 1999 by the American Petroleum Institute.

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