If Oil Companies Control Prices, Why Do They Ever Lose Money?

With oil prices still over $100 a barrel, one thing is certain. Oil companies are going to make big profits. But misconceptions abound about the connection between high oil prices and high profits.

After years of observing the reactions of both the public and our political leaders, it seems like they believe something like the following fictional narrative.

They can see ExxonMobil
XOM
executives sitting around a smoke-filled boardroom, saying “Well, we have the public right where we want them. It’s time to jack up the price of gasoline and gouge them while we can. Put a bulletin out to all of our gas stations and let them know. Oh, and call Chevron
CVX
and Shell and make sure they are on board.”

I know people believe this, because I have had them repeat every element of this story to me at one time or another. So they rage at the oil companies. They demand that they be held accountable. Politicians call them up to Washington and chastise them for the harm they are doing to consumers.

In reality, no part of that fictional story is realistic. The only thing that is true is that high oil prices translate to high profits for oil companies. But think about this. Why do oil companies ever lose money if they are in control of prices? Do you ever see Apple lose money selling iPhones? You see, Apple is an example of a company that actually has full control over its pricing. But that’s not how oil prices work.

Consider that in the past 10 years, major oil and gas companies suffered tremendous losses in 2014, 2015, and 2020. In fact, in 2020 the five integrated supermajors (i.e., “Big Oil”) – ExxonMobil, BP, Shell, Chevron, and Total – lost $76 billion. Oil prices plunged into negative territory in 2020. Were the oil companies feeling especially generous then?

Apple, on the other, hasn’t lost money once in the past decade. Are their executives being called to Congress to explain why an iPhone costs $800 when they are reaping huge profits? No, of course not.

If I may extend the Apple analogy a bit further, it’s just about as silly to ask why a share of Apple costs $162 or why Apple is a $2.7 trillion company as it is to wonder why oil companies are charging over $100 for a barrel of oil. Apple doesn’t control what people are willing to pay for a share of their stock. Likewise, oil prices are set on an open market by buyers and sellers.

ExxonMobil doesn’t set oil prices. They are set in the market by how much people are willing to pay, just like with Apple stock. U.S. oil companies are price takers, not price makers. Yes, speculators have an influence, just as they do with Apple stock.

Even OPEC and Russia don’t control oil prices, although they do have tremendous influence relative to ExxonMobil. If ExxonMobil decided to produce less oil to drive the price up, it just hurts ExxonMobil because OPEC and Russia can easily make that up. But if OPEC and Russia decide to produce less oil, there isn’t much the rest of the world can do to make that up.

It is true that oil companies benefit from OPEC’s and Russia’s actions to restrict production. But they are also at the mercy of those actions, when they decide to flood the market with oil (i.e., 2014 and early 2020).

One of the biggest knocks on “the frackers” — that is to say the companies that use hydraulic fracturing to produce a lot of their oil and gas — is that they don’t make money. Sure, they have a good year now and then, but then they suffer tremendous losses.

Yet, in the good years they are called to Congress, blamed for high prices, and threatened with windfall profit taxes. In reality, cause and effect are backwards. High prices drove the profits, not vice versa. Likewise, when the oil companies are being blamed for inflation, cause and effect are backwards. Just as high prices drove profits, they also drove inflation. High profits are a result, not a cause.

The final thing I would point out is that oil companies own few of the gas stations in the U.S. You may see the ExxonMobil name on a gas station, but they don’t own any gas stations in the U.S. According to the National Association of Convenience Stores (NACS), over 60% of the retail stations in the U.S. are owned by an individual or family that owns one store.

Once you understand that this reflects reality in the oil and gas industry, then the seemingly arbitrary nature of oil and gas prices — and the inconsistency of the profitability of oil companies — makes complete sense.