[OT] Gas companies report record profits (old energy thread)

Jacob Fugal lukfugl at gmail.com
Mon Jan 30 11:23:20 MST 2006

On 1/30/06, Doran L. Barton <fozz at iodynamics.com> wrote:
> Think of it this way: If you make 10% profit on a candybar that retails for
> $1.00 and demand for that candy bar pushes the price to $1.50, your profits
> are going to go up 50% as well. The oil companies aren't taking a bigger
> slice of the piece, their slice is just worth more money.

While your post has a lot of merit (even if it does simplify things
quite a bit), I just had to point out a mistake here that is often
made. With your hypothetical candybar retailing at $1.00 with a 10%
profit margin, your profit per candy bar is 10 cents. For *profits* to
increase by 50%, the profit per candy bar must be 15 cents. Assuming
costs remained the same, that means the actual price of the candy bar
only increased by 5 cents to $1.05. If the price were raised to $1.50
without any corresponding rise in cost, the profit per bar would be 60
cents, and 500% increase!

Let's setup a hypothetical gas price evalutation, say $3.00/gallon
median for the most recent quarter and $2.00/gallon for the previous
quarter. We'll also combine the entities of distribution and supply
into one for simplicity. Let's also assume a 25% profit margin
combined between the distibution stations and oil supplier. Finally a
50% increase in profits  from one quarter to the next is the given.
How much of the $1.00/gallon median price increase is attributable to
increased profit?

A 25% profit margin on $2.00/gallon gasoline equates to $0.50/gallon.
A 50% increase in profits means an extra $0.25/gallon. The other
$0.75/gallon is increased cost. In fact, the profit is now
$0.75/gallon out of $3.00/gallon. That's only a 25% profit margin; the
margin didn't increase at all! I'll give that up as a fluke due to the
correspondence between a 50% increase in profits matching a 50%
increase in price. If the rise in price were less than 50% (say from
$2.50/gallon to $3.00/gallon, which is closer to the actual
situation), the profit margin does in fact increase to 31%.

This analysis also excludes the fact that increased profits might in
fact be due to increased sales volume. Doran mentioned a few things
that affected supply -- natural disasters and war/politics -- but
there was also increased demand during that time. Travel was booming
despite rising gas prices as the travel industry recovers from 9/11.
Increased yet non-exhaustive demand (supply could rise to meet the
demand) means more units sold, and thus more profit even if the profit
margin doesn't change.

The point is, you can't look at rising profits and determine that
we're being gouged. The important thing to look at isn't the change in
profits, but the change in profit margins.

Jacob Fugal

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