A reader’s query about energy markets

DSN asks me:

With all the talk of a
(misguided) windfall profits tax on petroleum producers, I have a related

Based on logic and observation
of input cost and profit trends in various industries, when the cost of raw
materials rise, companies in a competitive market are often not able to pass through
these cost increases and, therefore, may see a decline in profitability.
How then are oil companies able to make huge profits when oil prices rise
significantly.  Is this not a competitive market?  What is the
economic process in oil production, processing, and marketing that allows oil
companies to make record profits when the price of their raw materials is at
historically high levels?

Here’s one source, I am not sure how reliable:

…about two-thirds of Exxon Mobil’s profits come from oil
and natural-gas production outside the United States, with rising
production in Africa, the Middle East and Russia consistently
offsetting declining output in the United States, Canada and Europe.

Mobil said it pumped 7 percent more oil and natural gas than it did
during the same quarter a year earlier.

In other words, Exxon already has paid for a concession in Nigeria and when the oil price is high profits for the company go up.  In that simple model a windfall profits tax leads to less pumping in the short run and even less pumping if people view the tax as temporary.  The tax also means fewer oil concessions in the longer run.  It is also possible — if you take the bargaining solution between Exxon and Nigeria as more or less given — that in the long run the tax redistributes income from the government of Nigeria to the government of the United States.  The less Exxon earns on net, the less it will offer Nigeria for the concession in the first place.

Addendum: Lynne Kiesling comments, worth reading.


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