Froomkin: Oil Price Economics

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Your Pain, Their Gain: How High Gas Prices Impoverish The Many While Enriching The Few

The next time you're gritting your teeth as you fill your tank with $4 gas, here's something to consider: Your pain is their gain.

The last of the Big Five oil companies announced first-quarter earnings Friday, so the totals are in. Between the five of them, ExxonMobil, BP, Shell, Chevron, and ConocoPhillips made $34 billion in profits in the first three months of 2011 -- up 42 percent from a year ago. Exxon alone cleared a cool $10.7 billion profit from January through March, up 69 percent from 2010. That's $82,175 a minute.

Why the staggering increase in earnings? Precisely because you're paying $4 a gallon for gas. Gas prices shoot up when oil prices shoot up, and when oil prices shoot up for reasons that have nothing to do with how much it costs to bring it out of the ground, it's a windfall for the folks who produce it.

A barrel of oil costs an average of $30 to produce; its market price today is around $100.

Why is the price so high? Part of it is increased demand and geopolitical worries. But no less an authority on the matter than Goldman Sachs acknowledged earlier this month that speculation is at least partially responsible, driving oil prices up faster and higher than supply and demand could possibly explain. That means the people who are betting on oil prices are actually making the price of oil go up.

The American Petroleum Institute claims that the staggering earnings reflect oil and gas companies' tremendous contributions to the economy, and that their stock prices are shoring up the nation's pension funds. But it's part of the ongoing huge transfer of money from the many to the super-rich.

By and large, the oil companies' profits are not finding their way back into the communities from which they came; are not being used to create more jobs; and are not being invested in new equipment and exploration.

In the case of Exxon and ConocoPhillips, more than half of their total profits are being used to buy back their own stock.

Buying back stock usually sends stock prices up, by boosting earnings per outstanding share and increasing the demand for the stock, signaling that the company thinks its stock is undervalued.

But top executives often get significant stock options. The higher the stock price goes, the more valuable the option. Dividends, however, are not nearly as good a deal for company executives. They are taxed as income, at a top marginal rate for wealthy investors of 35%, while an  increase in the stock price is not taxed at all until the stock is sold -- and then at the capital gains tax rate, 15 percent.

“Buying back shares benefits existing shareholders, no one else. And more than anyone else, it benefits existing management,” says Henry Banta, an energy industry analyst and partner in the Washington D.C. law firm of Lobel, Novins & Lamont.

“They're basically enriching themselves,” says Daniel J. Weiss, a senior fellow at the Center for American Progress. “With this windfall, they enrich the board of directors, senior managers, and shareholders.”

And in 2007, when Exxon was using $30 billion a year from the previous oil-price bubble to buy back its shares, Bloomberg columnist David Pauly wrote: “In most cases, stock buybacks are suspect…. Managements should ignore investors' call to repurchase their shares and invest money in ways that will increase profit, not just earnings per share.”

As for dividends, a lot of shares are held by pension funds and mutual funds, but the vast majority of shares are held by a very small elite -- the super-rich. In 2007, the 35% of households owned $5,000 or more of stock. Only 22% owned $25,000 or more. The wealthiest 1 percent of households has 38% of stock; the wealthiest 5 percent has 69%; the wealthiest 10% has 81 percent. The bottom 60 percent of households owns 2.5 percent of the total stock.

There's another thing the big oil companies are doing with their profits: they're hoarding them. If precedent holds, as soon as oil prices started shooting up again, a lot of that money started going into the bank for safekeeping -- and adding yet more to the $1 trillion or so in corporate cash lying fallow and slowing the recovery.

And as it happens, a not insubstantial chunk of last quarter's profits were a direct gift -- from the taxpayers. Somewhere between $4 billion and $9 billion of the industry's annual profits comes from federal subsidies.

Democrats today are seeking to repeal subsidies of $4 billion a year. Republicans and the API are strongly resisting.

A significant amount of the money that isn't simply hoarded is used by the Big Oil lobby to buy influence in Washington. In a recent quarter where Exxon's profits were $11 billion, it spent $3 million on lobbying.