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Oil groups in big profit shock

Created:

29 April 2008

Updated:

13 May 2008

Written by:

Jonathan Eley

PETROL FIRMS MAKING £3M EVERY HOUR. This is the headline in today's 'Evening Standard', and you can be pretty sure there'll be something similar on the 'Daily Mail' or the 'Express' tomorrow morning. "Fury of motorists as Shell and BP reveal record profits", it added. Sarah Teather, a Lib-Dem MP, laments that "some of the world's wealthiest companies are experiencing a profit surge at a time when household budgets are under tremendous pressure".

Maybe Ms Teather is unaware that Vince Cable, the Lib-Dems' shadow chancellor, used to be an economist at Shell. Never mind. All this stuff about oil groups' "obscene" profits is utter piffle. There are some very good reasons why oil companies make such large profits. Many of these things should be obvious, but judging from political and media reaction every three months, it seems they're not. So here are seven hard facts about oil companies and their profits:

1. Oil companies are very big. This might appear as a statement of the blindingly obvious, but nevertheless. BP is worth £115bn. That's five times as much as Tesco and 63 times as much as Persimmon, the smallest member of the FTSE 100. Big companies tend to make big profits in the same way that a fat bloke makes a big splash when he jumps in a swimming pool.

2. Oil prices are very high. Lest we forget, oil companies effectively lost their pricing power in the 1960s. Oil prices vary according to supply and demand, with the former heavily influenced by a cartel of producing nations, led by our friends, the Saudis. High prices mean high profits. And low prices, such as at the end of the 1990s when oil was $10 a barrel, mean small profits, or even losses. - but they didn't make the front pages.

3. Oil companies pay a lot of tax. A lot of it isn't paid in this country, but in the locations where their production is. And a lot of it is paid not in dollars, but effectively in barrels. Many countries favour production sharing agreements, where oil companies hand over a portion of their output to the host country instead of paying tax.

4. Oil companies spend a lot of money looking for more oil. No tabloid journalist ever looks this far. But they should. BP's cash flow statement for 2007 shows that it raked in $24.7bn from operations. But it invested $14.8bn in developing those operations - creating and sustaining jobs around the world.

5. Oil companies pay dividends to your pension fund. You might not think you are heavily invested in oil. But the sheer size of BP and Shell makes them difficult for any pension fund to avoid. Ms Teather should bear in mind that 36 per cent of the parliamentary pension fund, or around £100m, is invested in UK equities. And that fund will be getting a share of the £8.6bn-worth of dividends paid out by BP and Shell last year.

6. Three-quarters of the pump price for fuel is tax. And therefore nothing to do with oil companies. UK fuel retailing is among the most competitive in Europe. That's why BP and Shell are constantly trying to flog coffee and pastries as well as selling unleaded.

7. High oil prices hurt oil companies, too. Bizarre as this may sound, it's true. Soaring oil prices increase input costs for the refining, marketing and petrochemicals businesses that are part of BP and Shell. In some regimes, they increase the host country quota under production-sharing agreements. And in others, like Norway, they lead directly to higher tax bills. In the very long term, high oil prices encourage economising and technological innovation, which may reduce the oil demand.

You'll never read much about this in the mainstream press, but it doesn't mean it isn't true. If you're worried about the impact of petrol prices on your household budget, then use less fuel and reinvest the savings in oil shares. That way, at least you'll benefit from rising oil prices!