Wednesday, May 10, 2006

Price gouging oil companies redux

When will this ever end? From the Business Mirror:

Oil firms’ bottomline unscathed

WHILE consumers grapple with the skyrocketing fuel prices, multinational oil firms have been raking in huge profits as shown by their income statements submitted to the Securities and Exchange Commission (SEC), a senior administration congressman disclosed Tuesday.

Liberal Party Rep. Abraham Mitra of Palawan made public the income documents submitted by Pilipinas Shell and Petron Corporation, two of the country’s biggest oil firms, “not to accuse the oil giants of price gouging or excessive profiteering, but to let the public draw its own conclusion from what the cold numbers present.”

Mitra, vice chairman of the House Committee on Appropriations, said that based on the statements furnished by the SEC, Shell’s net profit jumped by 102 percent in 2005, while Petron’s surged by almost 50 percent in the same period.

Shell reported a net income after tax of P5.672 billion last year, more than double the P2.846-billion profit it pocketed in 2004. As a result, its earnings per share doubled too, from P4.12 to P8.34.

The firm’s net sales jumped 17 percent from P126.7 billion in 2004, to P148.9 billion in 2005.

Petron, which is partly owned by the national government, saw its income after tax surge to P5.765 billion, up from the P3.886 billion profit it reported in 2004. This represents a 48-percent increase in profits.

In its income statement, Petron declared that its gross sales soared to P191.2 billion, up by 29 percent from the P147.5 billion in 2004. With this, Petron’s earning per share improved to 61 centavos from 41 centavos in 2004.
Again some basic economics (this is easier done with graphs, but then I realize some of us may not be that familiar with the use of supply-demand diagrams). A price increase occurs either because either costs go up, or demand goes up. If costs go up, producers pass on the increase in cost to the consumer; however they are not able to do so completely, because consumers cut back on their purchases. In the end their profit falls, even as prices paid by consumers increases. On the other hand, if demand goes up, then consumers are willing to pay more to get extra units of output. The firms are thereby persuaded to increase their production, but of course in the process, the market price goes up. What happens to their profit? Of course, it goes up! The increase in profit is precisely the incentive that is required to increase production and therefore satisfy the extra consumer demand. We should find it a remarkable mystery to observe firms obliging consumers' higher demand, without requiring any extra incentive to do so.

However, it is not a mystery that legislators would want their names in the news by pandering to popular mythology.

4 comments:

Amadeo said...

Worry not too much; the same thing is happening here too. Many well-intentioned pundits and politicians are in unison berating the huge profits of the US oil companies. To them, it has to be price gouging to have such unconscionable profits – in the midst of soaring crude oil prices.

The CEO of Exxon went on TV the other day and gave everybody willing to listen with an open mind some basic lessons in Economics, appertaining specifically to the oil industry. In the end, score one for big oil, and zero for the politicians and pundits.

Hard to imagine also that of the three biggest net oil exporters in the world, two are not even members of OPEC – that would be Russia and Norway. Saudi Arabia is the third country and is on number two.

Gabby said...

If costs go up, producers pass on the increase in cost to the consumer; however they are not able to do so completely, because consumers cut back on their purchases. In the end their profit falls, even as prices paid by consumers increases.

regarding this passage, the effect on total revenue depends upon the elasticity of demand. if it is inelastic, then Total Rev increases. one imagines that in the short run, gasoline is inelastic. i'm not too sure about profits tho... it depends on how the MC and ATC curves move (monopolistic competition model).

Econblogger said...

Gabby,

In the standard supply demand model with rising marginal cost, if the entire marginal cost schedule (= supply curve) rises by D, price will rise by less than D because the demand curve is downward sloping. Hence the cost increase is not fully passed onto the consumer, implying a decline in profit.

In the monopolistic competition model, profit is always zero at equilibrium.

gabby said...

oh yes, i see now. thanks. even as TR rises, TC must rise by more. thats absolutely right.