Big Oil and the Price at the Pump

05/25/2011 11:50 am ET

Well, you have to credit them for their doggedness, over at the American Petroleum Institute.

They've never seen a gas price increase that can't be explained away.

There is this strange fact about the market for gasoline, however: When the price of the key input (oil) goes up, so the does the profitability of the sellers.

This doesn't happen in competitive markets. If the price of steel goes up, for example, the auto companies suffer. It's not a profit-raising opportunity for them.

Ask American Petroleum Institute representatives about this, however, and they'll tell you that industry profits are not particularly high. Their profit-to-sale ratio, they say, is healthy but somewhere in the middle of the range for all industries.

The problem is, that ratio is irrelevant to assessing whether the industry is price gouging.

One more relevant fact is the industry's absolute level of profits -- more than a quarter of a trillion dollars for the top five oil companies since George W. Bush took office, calculates Public Citizen's Critical Mass Energy Project.

Also relevant, notes Public Citizen, is that the industry doesn't talk about profit-to-sale ratios when it is bragging up its performance. Rather, they say, return on capital is the relevant metric. And here, they are doing amazingly well. ExxonMobil reports more than a 31 percent return on average capital employed.

Push on the point, and American Petroleum Institute spokespeople will say, "Hey, we don't control profits. We sell a product at a price in the competitive marketplace and look afterwards to see if we made money and how much."

But the oil companies don't operate in a competitive market. There has been massive consolidation over the last decade, capped off by the merger of Oil Company Number One, Exxon, with Oil Company Number Two, Mobil, in 1999. There has also been major consolidation on the refining side. The top five refiners have gone from a combined 34 percent market share in 1993 to 56 percent in 2004.

You don't have to get very far in your introductory economics class to learn that this kind of consolidation will create anti-competitive conditions and the likelihood of price spikes.

There may or may not be overt anti-competitive activities that are making gas prices jump so fast. But in a concentrated market, there doesn't need to be any collusive activity. The few dominant companies have the power to price gouge on their own. The historic trend, on display right now, is for the price at the pump to rise too quickly -- so that the oil companies pass on costs to consumers before they have absorbed them -- and then to be sticky once high -- so that the companies are slow to pass on decreasing costs.

Push the point with the American Petroleum Institute, and they'll caution that the worst thing that could happen would be for the government to intervene in gas markets. (Hah! Like the government doesn't already intervene with its endless subsidies, including at least $4 billion packed into the 2005 Energy Bill.)

If you suggest a windfall profits tax, the petroleum lobby's talkers will say that you'd be taking money away from the American people, who through their pension funds own big chunks ExxonMobil, ChevronTexaco and the rest.

To which we can safely reply: Don't do us any favors by ripping us off at the gas pump to help us out as shareholders.

Moreover, the biggest potential benefit of a windfall profits tax is not just that we can curb the predatory oil industry, but that monies can be directed into renewable energy programs that will help end what even President Bush calls America's oil addiction.

And, oh, by the way, where are the Democrats in all this? More on that in my next post.