Big Oil Isn't as Profitable as Everyone Thinks

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Oil prices and profitAmericans spend a lot of money on oil -- about $632 billion a year. A lot of that money goes to paying the costs of getting the dinosaur juice out of the ground in the first place, including exploring for potential reserves, drilling test wells, drilling production wells, pumping the stuff, and transporting it. More money goes into the costs of refining oil into gasoline, and getting it to the gas stations, which take their own little slice of the pie after we fork over our $4 a gallon at the pump.

And yet, despite all those costs, big, integrated oil producers like ExxonMobil (XOM) still manage to report eye-popping profits at the end of each year -- $41 billion for Exxon last year, $25.7 billion for BP (BP) -- even the smaller ConocoPhillips (COP) managed to tuck away $12.4 billion for a rainy day.

Keep in mind that these companies all operate globally, so their profits aren't necessarily limited by how much Americans spend on oil. Still, numbers this big beg the question: Is "Big Oil" too profitable?

Are These Guys Ripping Us Off?

It's not exactly an original question. Americans have complained for years about the Big Oil conspiracy to rip off consumers -- most notably back in 2006, when the price of oil first ran up past $100 a barrel.

A more recent rant I ran across on Facebook (FB) is pretty typical of the anti-oil crowd:

"The problem with the oil industry is that we are essentially allowing the major companies to collude on the pricing of a basic resource that all people need, and that has a major impact on the cost of virtually everything else. The song and dance these companies spout doesn't add up. They say high gas prices are necessary to cover costs. Yet they seem to be able to achieve record profits quarterly. There needs to be some oversight/regulation."


What many people fail to notice, though, is the amount that Exxon (and its peers) must spend to create these profits.

In 2011, Exxon took in $433.5 billion in revenues from its oil business,. But what Exxon calls "cost of goods sold," which includes the cost of the oil it extracted as well as certain production and manufacturing expenses, ate up $304 billion of those revenues, and operating costs consumed another $75.4 billion. Factor in the $31 billion income tax check Exxon wrote to various world governments (a number equal to 75% of its profits), and a host of other, smaller costs. Even when you add in Exxon's $15.3 billion of "income from affiliates," and a $2.8 billion "gain on sale of assets," and Exxon ended up with "only" $41 billion on the bottom line.

Sure, sure. That's still a pretty big number. But it doesn't make Exxon as flush as you might think.

Does Apple Need to Be Regulated?

When you consider that $41 billion is less than 10% of the revenues that Exxon started with, it turns out that Big Oil isn't really all that profitable a business.

For example, car companies aren't often considered profit monsters. They even go bankrupt from time to time -- even though there's only about as many really big car companies in the world as there are really big oil companies. Yet somehow, Ford Motor (F) manages to earn a profit margin of better than 13% on its cars and trucks.

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What about the granddaddy of all profit machines, Apple (AAPL)? It boasts a jaw-dropping profit margin of 27%. That means that when somebody walks into an Apple Store and spends $1,000 on the latest hot Apple products, Apple can expect to end up, on average, $270 richer -- after paying all the costs of inventing, manufacturing, and shipping the gizmos to the store, software included.

Yet somehow, you never hear consumers wailing and gnashing their teeth, demanding that Apple's dominance of the smartphone market be "broken up" or otherwise "regulated."

What's It Mean to You?

So what's the solution to the high cost of oil, and the high price of gasoline, and what can we do about it? Well, we could regulate the industry, as its critics advocate. But capping prices will only reduce revenues -- while costs remain fixed. Exxon will earn lower profit margins.

Its peers -- companies like Conoco and BP, which right now net only 4.8% and 4.6% of their revenues as "bottom line" profits, might start actually losing money. That won't be very good news for anyone who has a pension plan, 401(k), or mutual fund that owns stock in these companies.

You could also try driving less, or buying a hybrid or electric car. Use less gasoline, and you reduce the demand for oil. If enough people do this, it could create a situation where there's more oil out there than people want to buy, resulting in a supply glut and lower prices ... until people in China and India buy a few more cars, create more demand, and send prices shooting right back up.

In short, yes, Virginia, this is the "new normal." Expensive gasoline really is here to stay. $4 a gallon ... if we're lucky.


Motley Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of Ford Motor, Apple, Facebook, and Exxon Mobil. The Motley Fool has bought calls on Facebook. Motley Fool newsletter services have recommended buying shares of Facebook, Ford Motor, and Apple, creating a synthetic long position in Ford Motor and creating a bull call spread position in Apple.

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