Big Oil's Latest PR Campaign: How Does the Math Add Up?

After spotting this Big Oil ad for about the tenth time in recent weeks, looking at the math behind the ad copy seemed like a reasonable exercise to undertake.

[For the entire ad, see this item(.pdf) at Energy API.]

Based on a study of U.S. oil company ownership conducted last year, among other things, the ad states:

Tens of millions of Americans have a stake in the U.S. oil and natural gas industry. When the industry’s earnings are strong, the real winners are middle-class Americans, people investing in their retirement security or saving for their children’s college education.

And of course they go on to rail against the ill-effects of higher taxes on energy company profits - how higher taxes would hurt not only them, but also middle-class Americans through their investments.

What is left unspoken here is that high energy prices aren't such a bad thing because the middle class benefits as shareholders.

But is that true at all for the "middle-class Americans" cited in the advertisement?

Let's find out...

For example, assume that the average "middle-class American" has a 401k retirement account or other investment accounts with a balance of $90,000, which seems reasonable after looking at the $40K to $80K income range across all age groups in this report.

Then figure that each holds an average of 70 percent in stocks and that all this money is in an S&P500 index fund with a weighting of about 13% for energy stocks (per the S&P500 sector weightings) resulting in a total energy stock value of $8,190.

Investment in energy stocks: $90K x 0.7 x 0.13 = $8,190

Using data from the DOE, it appears that retail gasoline prices have risen from about $2.80 last summer to about $3.60 today for a hefty increase of about 28 percent. So, since a typical middle class American consumes 500 gallons of gas per year and, assuming a roughly linear increase in the gas price since that time, an additional $133 has been spent on gas over the last eight months.

Increased gas cost: 333 gallons * $0.40 = $133

That seems like a lot of money for a middle class family trying to make ends meet. Now, how much of this has been offset by rising prices for energy stocks?

Well, things were pretty volatile last summer, but it's fair to say that the giant energy ETF (XLE) was at about $70 when gasoline prices started rising. At around $82 now, that's a hefty gain of 17 percent which, when applied to the typical middle-class American's investment portfolio, would yield a whopping gain of well over $1,000.

Increased stock value: $8,190 x 0.17 = $1392

Hey, maybe Big Oil companies aren't that bad after all!

Of course this doesn't consider those middle class individuals who have no 401k account at all or who are now too scared to death to invest in anything but FDIC insured CDs now yielding about two or three percent per year.

Comments

[jjason]

Tim, IMO the oil industry ad is misleading. It assumes that investments in oil will always be profitable. Not true all the time.

As you know, some folks are successful when they buy low and sell high. I see, lately that refining companies have dropped in price. If oil drops to say $90.00/bbl then those who bought oil at $120bbl will have lost money.

In the meantime, OPEC does very well...or should I say the oil barrons do very well....and us consumers pay for it.

I think that if oil futures trading were made illegal then the costs associated with speculation in oil futures would be eliminated. I think this would help reduce prices.

Also, increased tax breaks for solar, wind, ethanol and clean coal fired electricity would help too. The tax breaks should be for US manufacturing firms, utility companies, retailers and the consumers who use/sell alternative energy sources.

Finally, there is conservation and life style changes. I have already set up a solar hot water heating system. It is quite low tech. No moving parts. It involves two eight gallon plastic bags that you can buy at any store that sells camping gear. These bags get quite hot but will not work in the winter in PA. But I look at it as a start.

I know Congressman Paul Kanjorski. I will let him know that I approve a windfall profits tax. I am angry at OPEC, Big Oil executives and speculators....and I am happy to see that there are more people who are doing something about it.

[Mmarrkk]

"if oil futures trading were made illegal"...do you know who is buying the oil futures contracts? Take a guess. Its the commodity index funds, the oil ETF's, etc. These are not speculators. These are investment funds looking for an alternative to equities and bonds. So they have begun investing in commodities contracts...the futures contracts. These are long term buy/hold investments, not speculators. Actually, the speculators are buying "short" contracts on the commodities. So, don't believe everything you hear, especially the likes from serial liars like politicians...particularly anyone with the last name Clinton. those folks never have been introduced to the truth.

If you don't believe this issue, do a bit of research and see who is really buying the oil futures contracts. Its called rotation; stocks are sucking, bonds are sucking, real estate sucks, so people buy commodities. Oil, gas, gold, etc.

[Vervegent]

I applaud your research and mathematical efforts to dissect this ad. As a management consultant, principally to the oil and gas industry, I would like nothing more than to champion your take-away.

Unfortunately, your analysis is seriously flawed. At bottom, your analysis is premised on an assumption that oil prices and energy stock prices operate in a vacuum. They do not.

Take crude prices. Specifically, as the largest and most variable component of the transportation sector’s cost structure, oil prices affect the cost -- and margins, and hence, profitability -- of any product that depends on transportation to get the finished product to market. From food to clothing to appliance goods, etc., all of those are affected by higher energy prices.

Moreover, so much of the raw material that comprise the bulk of today’s products are made of plastics and other end-products from this nation’s petrochemical industry, an industry whose feedstock is crude oil, and for whom increased oil prices are a burden. Additionally, increased crude prices directly affect the cost to produce certain non-discretionary items, such as the increased costs for the American farmer to produce food for our tables. Again, increased crude costs affect all of those involved in those respective chains and their concomitant product pricing.

Consequently, the very real inflation the consumer sees in numerous areas can be directly linked to the huge degree that oil prices have increased. So, to analyze increased consumer expenditures by merely looking at those tied solely and directly to gasoline usage is to size up a mere portion of consumer expenditures and ignore the balance that have increased as a direct or indirect result of increased crude prices. For the typical American middle-class family, 5% inflation on “required” expenditures (“required” expenditures defined here as those that are elastic, but largely non-discretionary, such as food, clothing, home repairs, etc.) is going to erode a significant chunk of the balance of the $1259 variance you show.

Secondly, energy stocks do not operate in a vacuum either. While you examine the increase in energy stocks, you neglect, as does the API, to consider the affect that increased energy prices might have on stock prices of the 87% of non-energy companies in the S&P 500. Revisiting a statement I made earlier, increased transportation costs directly affect the margins, and hence, profitability, of those companies that must rely on crude either directly (as a petrochem feedstock) or indirectly (as the source for diesel or gasoline to move their product to market). To the extent that the total increases in one’s costs (and considering only those that are directly attributable to increased fuel prices) cannot be recouped in inflationary pricing (or from the market’s forward-looking perspective, do not appear to be able to be passed on), those companies will be downgraded in the marketplace. As a result, their stock prices will suffer.

Revisiting your analysis, for those typical middle-class American families you cite, the 87% of their S&P holdings places just shy of $55K of their portfolio at risk of a fall in value ($90K X 0.7 X 0.87 = $54.8K) And, sure enough, the performance of the S&P 500 over the past year reflects the reality of this declining by 6% since last August (and even more if one uses the high for the Summer period). If the relationship is linear, that alone translates into a loss of $3300 to your “typical” middle-class American family. Moreover, that figure already includes the $1392 gains it achieved from its’ 13% energy holdings within the S&P 500.

As an aside, in fairness, one must consider the possibility that some of these companies faltered due to poor management, strategic vision, business development efforts, or a host of other possibilities not directly related to increased fuel prices. Likewise, it is a possibility that some energy companies did not appreciate in proportion to the relative increase of the underlying commodity due to those very same areas of mismanagement. It is impossible to examine and quantify this in a cursory manner. Thirdly, none of this examines the decline of the US dollar and the very real affect it has had on purchasing power, whether it manifests itself directly in increased crude prices or indirectly in broad inflationary pressures.

At bottom, my point is that such simplistic analyses can be dangerous. Not only are they misleading, they can sometimes work to the detriment of those of us who are genuinely trying to educate the bulk of the American public regarding the ignorance that abounds concerning energy truths and the fiction promulgated by self-serving Congressional representatives and “so-called” consumer groups. In fact, I could not agree more with the ad’s concerns regarding Congressional efforts toward the ill-advised singling out of energy companies for excess taxation. Beyond that, however, this ad by the API (and, I regret to say, your well-meaning analysis) plays into the hands of those who seek to portray the industry as one who has the power to “spin” anything to their advantage, and who won’t hesitate to use it.

The raw facts make the industry’s case. They need no spin or embellishment. We just need to be better and more careful in correcting the ignorance that abounds in the mainstream public. The API is sometimes the industry’s own worst enemy.