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By Robert Rapier on Mar 12, 2012 with 27 responses

The Professor Who Knew Too Little

It is clear that many people have a very simplistic — but wrong — view of the energy markets. This extends to politicians who believe they can usher in a return to $2 gasoline, as well as those who underestimate the difficulty of replacing oil with renewable energy.

For the average person, gasoline prices go up because oil companies are pulling strings, meeting in secret to set prices, or withholding product from the market. To top it off, we are sending them our tax dollars as subsidies while they are wallowing in cash! That’s the view from the man on the street. Somehow, I would have expected a USC business school professor to have a more sophisticated understanding of the situation — especially if he decided to write an article about it. But I would have been wrong.

Normally, when I read something like the following, I am more prone to just shake my head over the sad state of the person’s energy IQ. But I am making an exception here in the case of Professor Ira Kalb, a marketing professor at USC’s Marshall School of Business. The professor recently wrote the following article for Business Insider:

The Only Reason Gas Is $5-A-Gallon Is Oil Companies Have Convinced Us Prices Are Out Of Their Control

The article is so full of misinformation, red herrings, conspiracy theories, and half-baked notions that it warrants a response, especially since the professor is probably passing on this misinformation to his students. If misinformation like this is not addressed, it simply helps create more generations of people who believe all sorts of energy myths. I attempted to engage the professor in the comments after the article, but his responses were about as informative as his article. As I break down the article I will also address some of our exchanges in the comments.

Marketing or High Oil Prices?

There is so much wrong with the article, I don’t know where to start. The premise of the article is that gasoline prices are flirting with $5/gallon because “oil companies must be marketing geniuses.” Bear in mind, that these same “marketing geniuses” are overseeing plummeting natural gas prices that in many cases are below break even.

Following his introduction, Professor Kalb talks about “Huge Profits” even as “the average price at the pump in the US is expected to hit $5 per gallon by summer’s peak driving season.” The source that he frequently cites for his claims is not the SEC filings of these companies, but rather he relies on the Center for American Progress to put these profits into context for readers. He cites their “energy experts”, which as I point out in the comments: “CAP’s “energy experts” consist of bureaucrats and journalists, and all are openly hostile to the oil industry. Not a single person among them has any experience actually producing energy. Why would you expect them to be able to give an informed, objective opinion about the topic?

Profits vs. Profit Margins

We can agree that oil companies are making large profits. But then I tried to explain to him in the comments why his premise that $5 gasoline is driving oil company profits was wrong. To demonstrate this, all we have to do is look at the profit margins of Tesoro and Valero, the country’s largest pure refiners. If high gas prices are driving their profits, we would expect to see that show up in their profit margins. After all, this current gasoline price spike is not the first one we have seen in the past 5 years, and therefore we should see some pretty hefty profit margins from these pure refiners. But in fact, the profit margin for Tesoro has ranged from -3.83% to +7.91% over the past five years. Their average profit margin was 0.93%. Valero’s profit margin was worse, averaging -1.39% over the past five years. Ah, but they had one great quarter in 2007, when their profit margin skyrocketed to 9.3%. Not quite as impressive as Apple’s 28.2% profit margin of last year’s Q4, but then that’s why Apple trades at double-digit PE ratio and Tesoro and Valero trade at single-digit PE ratios. It is certainly apparent that investors aren’t treating these refiners as money printing machines.

So I tried to explain to the professor that all he had to do was look at the profit margins of the refiners to understand that his basic premise is in error. Refining margins are historically very poor, which leads to poor profit margins and as we have seen, shuttered refineries. But when I and others pointed out that it was actually oil prices that were driving oil company profits, the professor respondedIf it is the price of crude, which is a cost to the oil companies, then how do you explain the profits going up so much?” I don’t have to tell most readers what a bizarre reply that is. Is Professor Kalb unaware that the oil companies that are making big profits are either integrated companies, or merely oil producers and not refiners? Does he know the difference between a refiner — for which oil is indeed a cost — and an oil company? I replied that he appeared to be very misinformed, and that a cursory look at the profit margins of refiners should tell him that it isn’t gasoline prices that were driving profits. He replied: “Why do you think my “misinformed” article talked about refineries? I don’t mention refineries at all. My post is about marketing that supports $5 per gallon gas and subsidies.”

Correlation Between Oil and Gas Prices

So Professor Kalb thinks that refineries have no bearing on his contention that brilliant marketing — and not high oil prices — is behind the rise in the price of gasoline. Perhaps he should test an alternative hypothesis by checking the correlation between gasoline prices and oil prices. In fact, a recent article in U.S. News and World Report explained the correlation:

Why have gasoline prices increased since the start of the year? The simplest explanation is that the price of crude oil has increased. Specifically, the spot price for Brent (North Sea) crude has increased $16 a barrel since January. Given that there are 42 gallons to a barrel, that works out to a 38 cent increase in the price of a gallon of oil. Spot prices for gasoline trade in New York have increased about 41 cents per gallon over the same time frame. So there you go.

The professor’s hypothesis requires us to believe that this brilliant marketing is taking place throughout the entire world (except where gasoline is subsidized) and yet these brilliant marketers can’t seem to use the same marketing techniques to support a higher natural gas price.

Who Needs Crude Oil and Gasoline?

But this isn’t really what his article was about, as evidenced by many of the red herrings Professor Kalb brought up in the article and in his subsequent comments. The professor’s article is really just a misinformed attack on what he feels are unjust profits. I doubt that many readers actually accept that brilliant marketing has anything to do with the high price of gasoline, so let’s move on and address some of the professors other contentions:

Professor Kalb: Most companies generate large profits by creating innovative, unique, or highly-desirable, got-to-have-it brands. Apple devices and Nike shoes come to mind. The gasoline we buy at the pump is not particularly innovative. It is basically the same as the gas we have been buying since we all started driving. It looks, smells, and works the same as it always has.

So the professor’s contention here is that the profits are unjust because they did not require innovation. Yet the oil we are producing today has required significant innovation relative to how oil was produced in previous decades. The same innovative techniques have the U.S. currently awash in natural gas — and consumers benefiting from low natural gas prices as a result. The engineering challenges of building a floating city in the ocean and then drilling miles below the ocean to produce oil — which then has to be refined to increasingly higher environmental standards — are substantial. That iPhone that Professor Kalb believes is creating justifiable profits is dependent on the 1.7 gallons of oil embedded in each device. Oil is a major enabler of those iPhones and Nikes, and yes, it did require substantial innovation.

Professor Kalb: As most economists will tell you, commodities typically sell for less because there is significant price competition and no clear reason for brand loyalty. To have control over price, marketers position their products as unique with no adequate substitutes. The more uniqueness, the more control. If buyers really want or need the product, they have to pay the price because they cannot get the same product somewhere else. Uniqueness, from effective branding, gives marketers a monopoly over the mind-space of buyers. This, in turn, creates an effect similar to that of an inelastic demand curve. With oil, there is very little or no uniqueness – making the high prices at the pump and resultant profits an amazing marketing feat.

With oil, there is little or no uniqueness? OK, name a replacement for the 85 million barrels of day that the world currently consumes. I will give you a hint. At the present time, there is nothing that can actually replace oil. Nothing. I would say that makes oil pretty unique. There is no replacement, and without oil the entire world would swiftly come to a grinding halt. It may not be that way at some point in the future, but it is that way today. Thus, people are willing to pay ever increasing prices for oil. The Chinese and Indians are consuming ever more oil (an “excuse”, according to the professor), even at $100 a barrel. Why should they do this, if there is an adequate, economic replacement?

Fossil Fuel Subsidies

Professor Kalb: More amazing is the fact that the oil companies have been getting tax subsidies from the U.S. government since 1916. In spite of their gargantuan profits, the oil industry has convinced the American public that these subsidies, which currently total $4 billion a year, are necessary to keep their prices lower than they ordinarily would be. If this is not another example of marketing genius, it is hard to fathom what is.

CNN just published a story that cites a CBO report that places the sum total of all fossil fuel subsidies in 2011 at $2.5 billion. The total of all energy subsidies was $24 billion, with most going to renewable energy. I challenged the professor on his subsidy claim in the comments. I asked him to detail these subsidies so we could discuss them. It was plainly apparent that he is just repeating things he has heard, and doesn’t actually know the first thing about these subsidies. He refused multiple requests to detail them. He finally resorted to “You seem to want to argue“. I would think a professor would have done a better job of due diligence in writing an article that he was going to put out there for public consumption. But let’s quickly review (more details can be found here).

Oil Company Subsidies for Apple, Google, and Microsoft

Last year, CNN broke down the oil company subsidies. They identified the single largest subsidy as the Section 199 Manufacturer’s Tax Deduction. It is an income tax deduction, and not any sort of cash subsidy that is being paid to the oil companies. More importantly, not only is it not limited to oil companies, but oil companies have already been singled out for a reduction in the tax credit. Other industries get to take a 9% deduction for Section 199, but oil companies are restricted to 6%. So Apple and their 28% profit margin gets to deduct 9% from their U.S. based manufacturing activities, and Tesoro with their single-digit profit margin gets to deduct 6%. So the question that should be asked is “Why are we giving oil company subsidies to Apple, Google, and Microsoft?” If you want to eliminate Section 199, fine. Just do it for everyone.

The other thing to point out on these so-called subsidies is that if you take his entire $4 billion claim at face value, it is 1). A small fraction of the average annual tax bill paid by the oil industry; and 2). Worth 1.7 cents per gallon of fuel used in the U.S. So why anyone thinks that scrapping these “subsidies” has any significant bearing on either oil company profits or on the price people pay at the pump is beyond me.

Lobbying and Investing in Alternatives

Professor Kalb: The oil companies have said repeatedly that they need high profits to develop alternative energy sources and explore for more oil. They may be doing a lot of the latter but very little, if any, of the former. In fact rather than investing in alternative energy sources, the LA Times reported that the oil companies “used $38 billion, or 28% of annual net income, to repurchase their own stocks and invested in politicians to maintain the policies that led to their enormous profits over the past decade.”

Little, if any of the former? The professor continues to demonstrate his absolute ignorance about the oil industry. He may think he is referencing the LA Times, but that article references the anti-oil Center for American Progress for their information. And he selectively references the article, which also presented a snippet of the other side “California’s pension plans for public employees, for example, had about 4.4% of their investments in the oil industry between 2005 and 2009 and obtained a 17.1% return on them.”

I have addressed these claims in Tis the Season for Oil Company Misinformation. First off, ExxonMobil may make $30 billion a year, but they invest $25-$30 billion a year back into their business. Their 2011 capital budget was $34 billion (but you don’t get that from the Center for American Progress). I can guarantee you that Apple doesn’t have to spend that kind of capital. Second, a 2009 study from the University of Texas (Key Investments in Greenhouse Gas Mitigation Technologies by Energy Firms, Other Industry and the Federal Government: An Update) said that the U.S. oil industry had invested over $6.7 billion in renewable energy over the previous nine years (almost a quarter of all investments in renewable energy by industry and governments).

Finally, with respect to the lobbying, over the past 14 years the pharmaceutical industry spent twice as much money as the oil industry on lobbying, and the insurance industry, electric utilities, business associations, agriculture, and computer and Internet industry all spent more money on lobbying than did the oil industry. So where is the outrage that Apple is lobbying to support their 28% profit margins? But do you wonder why the oil industry even has to lobby? To combat the kind of misinformation that Professor Kalb is spreading.

In the section How do they do it?, he writes:

Professor Kalb: They do their convincing by sending press releases to the news media, which distribute their messages for free via news programs and articles – warning us that prices at the pump are going up to $5 a gallon.

His support there is a link to an article in which industry analysts are predicting higher prices. Apparently, he either does not know the difference between an industry analyst and representatives from the industry, or he thinks the analysts are basing their projections on press releases from the companies. Yet here we have ExxonMobil’s CEO saying he doesn’t believe gasoline is headed to $5 a gallon. I guess he did not get the memo from the secret cabal.

U.S. Oil Companies Are OPEC’s Puppet-Masters?

Professor Kalb: In the press releases, they convince the public that the high prices are the result of supply and demand forces that are out of their control. However, OPEC (an oil cartel) controls the supply and pricing of crude oil so invoking supply and demand, while a clever strategy, is a bit disingenuous.

Wow! So does he think then that U.S. oil companies control OPEC? Bear in mind that in this article, his focus has been U.S. oil companies. And yet here he thinks it is disingenuous to cite supply and demand? OPEC does restrict supply. Unless you believe ExxonMobil can call them up and ask them to pump more crude, then what is disingenuous about citing supply as an issue? Does he actually think this is within the control of U.S. oil companies?

Excuses: Rising Demand, Instability

How else do they do it?

Professor Kalb: Providing believable reasons. They use world events as reasons (cynics might call them excuses) for supply and demand changes and higher oil prices. Typical examples include the following:

  • China, India, and other large global users bidding up the price of oil
  • Instability in the Middle East threatening supply
  • Refinery outages, which seem to occur at the worst possible times
  • Seasonal demand factors from heating, air conditioning, and increased driving
  • Industrial demand factors from a healthy economy

I can’t emphasize just how amazed I am that this is coming from a professor at a business school at a major university. These things may be a complete mystery to the professor, but they aren’t to everyone. First, we actually have data to show just how rapidly demand has risen in India and China. In the past decade, oil consumption in China was up 90%, and it was up nearly 50% in India. I would say those are believable reasons. But excuses? It is as if the professor is totally disconnected from the idea that growing global demand — for which we have actual data — might be a real reason for upward pressure on oil prices. Second, given the importance of the Middle East to global oil supplies, why wouldn’t instability there impact prices? Do you remember the Arab oil embargo of 1973? That should tell you what happens when a large fraction of the world’s oil supply is suddenly unavailable. That is a risk, and that risk is part of the price premium.

Refinery outages “seem” to occur at the worst possible times? You are a professor, why don’t you use your skills to actually track when they occur. I will give you a hint. Refineries have been running at 80-90% utilization rates. But they undergo maintenance in the spring — during the transition to summer gasoline but before summer driving season — and then again in the fall after summer driving season. That is when you will see annual refinery utilization dip. When would you suggest that refineries do their maintenance? Since they “seem” to occur at the worst possible times, can you suggest the best possible time?

As far as the last two points, it is a fact that demand goes up in the summer, and demand goes up when the economy is growing. So you think it is an excuse that prices rise when demand goes up? You teach at a business school for crying out loud!

Conclusion: Not Everything is About Marketing

It is clear that Professor Kalb has zero knowledge of the oil industry outside of the spin he picked up from the Center for Selective Information. And because of his sources, the professor is horribly misinformed, and yet determined to share that misinformation with others. So let’s now summarize a few of the professor’s misconceptions:

  • $5 gasoline is due to great marketing which extends to oil companies around the world, but is nonexistent when it comes to natural gas
  • High gasoline prices are driving oil company profits
  • Profit margins from refiners are irrelevant in the discussion
  • Oil companies are not innovating
  • Oil is not unique
  • Oil companies are not investing in alternative energy
  • Oil companies are not exploring for oil
  • Oil companies are not investing back into their business
  • Oil company analysts get their information from oil company press releases
  • Supply and demand is not a factor, since OPEC controls supply
  • Growing demand in India and China is an excuse
  • Refinery outages occur at suspicious times

The professor seems to be entirely unaware that:

  • Oil companies and refining companies are not the same thing
  • Apple gets “oil company subsidies”
  • Profit margins and not profits are what is important (in the comments, he writesI do not talk about profit margin in my post, I talk about profits and subsidies.”)
  • The level of taxes that oil companies pay is very high relative to other industries (he singles out ExxonMobil’s 2009 tax bill as his example of oil company taxes; if you want to see an analysis of XOM’s 2009 taxes here you go)
  • Gasoline prices are closely correlated with oil prices, which are set in global markets based on how much people are willing to pay
  • Gasoline is not priced in the same way as iPhones or Nikes

When I tried to correct some of Professor Kalb’s misconceptions, he let me know: “I have written books on marketing and many even consider me an expert on marketing. Perhaps you believe I have fooled them.” (He was more than a bit thin-skinned; look at his responses to some of the comments). He would not defend his positions, instead he often just repeated himself. He simply would not be dissuaded from his view. He demonstrated that he has zero experience with the oil industry, and yet was determined to lecture on matters in which he has next to zero knowledge. He could not seem to understand that it wasn’t his knowledge of marketing that was the problem, it was the attempt to relate it to something he didn’t understand, which then resulted in a series of erroneous claims. Marketing is what tries to convince people to pay a nickel more a gallon for Shell’s V-Power gasoline. But marketing is not what is pushing gasoline toward $5/gallon.

My advice to the professor would be to stick to what you know. This is not a marketing problem, and by attempting to turn it into one you are misinforming people about the energy industry.

Link to Original Article: The Professor Who Knew Too Little

By Robert Rapier

  1. By Trevor H on March 12, 2012 at 11:27 am

    Robert – thanks for not allowing such articles to go unchallenged. From reading Dr. Kalb’s article and subsequent comments I don’t think he even realizes how much he doesn’t know or how much of what he does know that just isn’t so. For instance, I don’t think he grasped why you were dragging refiners into the discussion.

    Here’s the comment I left on Dr. Kalb’s article if you are interested:

    Dr. Kalb – I think the most basic issue that Robert and others have with your article is summarized in your comment from March 5: “If it is the price of crude, which is a cost to the oil companies, then how do you explain the profits going up so much? “

    The price of crude in fact defines the revenue of the oil companies, not their costs. The price of crude is actually a cost to the refining companies like Tesoro and Valero which is why Robert brought them up. Selling oil is indeed very profitable right now. Selling gasoline is a terrible business to be in these days.

    For integrated companies the price of crude is either revenue or cost depending on the division you are looking at, but the production arms of integrated companies like ExxonMobil and BP are so much larger than their refining operations that the profits from selling oil dwarf the losses they make selling gasoline. And you even stated your belief that the price of oil is set by OPEC, so I’m not sure why there’s a need to invoke marketing to explain oil company profits. What profits are there that aren’t explained by high oil prices caused by restricted supply?

    Now if you want to end oil industry tax deductions and subsidies, I’m with you as long as we are ending them for everyone. I hate the corporate cronyism that permeates Washington. I’m not sure why the oil industry should be singled out though.

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    • By Robert Rapier on March 12, 2012 at 12:02 pm

      From reading Dr. Kalb’s article and subsequent comments I don’t think he even realizes how much he doesn’t know or how much of what he does know that just isn’t so.

      That was my biggest problem with his article. It is one thing to make a series of unsupported assertions, engage in dialogue, and then learn something. But he made the assertions and then got annoyed when people challenged him on them. It was the perfect combination of ignorance and hubris.

      RR

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  2. By rjn3 on March 12, 2012 at 11:31 am

    So why did you give him an “F”?  Because there isn’t a lower grade.

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  3. By Doug CARD on March 12, 2012 at 12:43 pm

    Excellent article and I am happy to finally know something in depth about this issue.  The Prof messed up big time on this and I hope he doesn’t make a habit of espousing things he knows not of.   He prolly doesn’t really care about the oil problem and thinks his expertise on marketing is the only thing he needs to know.

    So funny to hear the pols talking about how they will cut the price of gasoline if elected when it is obvious from your well researched article that they can actually do almost nothing other than  NOT invade another OPEC country. 

    The bottom line is that we have to conserve and switch to alternatives.  The only question is how soon we can make this conversion.  I hope it will be less than 25 years, but even if it takes until mid century, it is not an optional endeavor.  In ten years EV’s need to be superior to combustion for light vehicles and fuel cells or gas for big rigs.  I believe that to be possible, and I have never been wrong.

    Well… Maybe once or twice. 

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  4. By chris pedersen on March 12, 2012 at 12:51 pm

    It is concerning that a professor of this enegy IQ is teaching the next generation of business leaders.  Dr. Kalb, please stick to teaching what you know.  When you make a mistake, be humble and admit that  you were wrong.  Thanks for the article Robert. 

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  5. By armchair261 on March 12, 2012 at 12:53 pm

    The professor’s premise, and his entire house of cards, rests on the assumption that buyers of crude oil are stupid and easily fooled by concocted stories. So let’s put Dr. Kalb in a room with Valero traders and see how he fares.

    Shocking ignorance. I would expect such an uninformed discussion from Oil Watchdog or some equivalent, but not from people who make a living, supposedly, from doing objective research. 

    I believe it’s time that the API should file suit against people like Dr. Kalb, demanding them to present their case in a court of law, and suffer the consequences of their false charges.

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  6. By ben on March 12, 2012 at 12:54 pm

    My affiliate’s advisory board chairman holds a PhD from USC and knows school president, Dr. Max Nikias.  After reviewing his piece and RR’s response, he is sending along a note to Dr. Nikias (a very capable engineer) with cc: to a couple member-friends of the board of trustees.  

    One might expect Dr. Kalb to be much better informed before peddling such nonsense in the future.  It’s one thing to try to con young, unsuspecting undergrads, it’s quite another to go public with such babble and pretensions of expertise in a field quite apart from one’s training. 

    Kalb is giving the tribe a bad name and one would hope that they might reel him in (or throw him back) to avoid embarrassment.  Ah, but we can assume that he’ll scurry behind the cloak of academic freedom even if he doesn’t have a clue that such an entitlement demands a measure of responsibility let alone integrity.  He is a sad example of an educator.  Alas, such is the sorry state of affairs within the academy where it too often serves as a refuge for non-hackers finding it impossible to compete in the private sector among real professionals.  I guess it’s just much easier to resort to the smoke and mirrors of meaningless chatter.  Kalb ought to take to heart the admonition that it’s better to remain silent and have others think him a fool than to open his mouth and confirm it.   Maybe an academic colleague or two over at the Viterbi School of Engineering may take pity on the professor and offer a bit of counsel.

    “A nickel more a gallon for Shell’s V-Power,” eh.  Well, that’s about all I’d be willing to pay for Kalb’s consulting advice–with every expectation that Shell at least delivers higher octane:)   

    Ben

     

      

       

     

        

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  7. By Ira S. Kalb on March 12, 2012 at 1:45 pm

    Hi Robert,

    I guess I struck a nerve. Thanks for writing your own article.

    I also appear to be in good company with all those others that know so little- not nearly as much as you.

    Why do you think that is?

    You seem to have a penchant for details. Perhaps you need to see the forrest rather than get lost in the trees.

    Thanks again for your article. I have never before had someone create an entire post in the form of a personal attack.

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    • By Robert Rapier on March 12, 2012 at 1:58 pm

      I guess I struck a nerve.

      Welcome, Professor Kalb. By all means, stick around and see if we can’t engage on some of the details. As far as striking a nerve, indeed, but in the way you imagine. Anyone in a position of authority who spreads so much misinformation strikes a nerve, and often warrants a response. Tom Friedman did the same thing in his latest NYT column, and I have written a rebuttal to him as well which will be posted later this week. 

      I also appear to be in good company with all those others that know so little- not nearly as much as you.

      Define “good company.” I would not consider it good company to be grouped with those who don’t know the first thing about the energy business, yet are determined to tell people how it works. It is certainly true that there are a lot of people who are ignorant of the energy industry, but most of them aren’t teaching at business school and writing articles that misinform others.

      You seem to have a penchant for details. Perhaps you need to see the forrest rather than get lost in the trees.

      What is the forest? Details are important, you know. Without the trees, there is no forest. And when your trees are all based on misinformation, you create a forest which represents a false narrative. 

      Thanks again for your article. I have never before had someone create an entire post in the form of a personal attack.

      Correcting misinformation is not a personal attack. If I called you stupid, that is a personal attack. If I say you are grossly misinformed or ignorant of the energy industry — and then back it up with a series of facts — that is not a personal attack. And in fact, my hope is that you will engage and actually have some of your misconceptions cleared up. Have you yet realized that you got any of this wrong, or are you still sticking to your story?

      RR 

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    • By Matt Waters on March 12, 2012 at 6:06 pm

      I couldn’t elaborate on what Robert has already said. But it’s very sad to see a business school professor go from basic gross misconceptions (which many people do share) to gross logical fallacies.

      Your basic logical argument seems to go as follows:

      1. Gasoline is priced at 4-5 dollars and oil companies have huge profits.

      2. Large profits typically are due to good marketing or disruptive innovation.

      3. There is clearly no innovation in the oil field.

      4. Therefore, oil companies have large profits because they are very good at marketing their product compared to the alternatives, i.e. iphones vs. Android phones with similar features.

      This argument must make a number of unbacked, axiomatic assumptions, namely that large profits, if not from disruptive innovation, must be due to marketing acumen. Now let me say unbacked axioms are not necessarily a bad thing. As an engineer, I know that every kind of proof or argument must rely on some sort of axiom. For example, how do we know F=ma? Because the experiments say so. How do we know the experiments are correct? Because the measuring equipment has been calibrated. How do we know the calibrations are correct? And so on. In short, without axiomatic assumptions, we couldn’t believe anything about anything.

      However, if data come to light that disproves those axioms, then we can no longer rely on the previous proofs which used those axioms. For example, the following argument makes perfect sense to someone living in, say, 10th century France:

      1. The Sun moves around in the sky in a circular argument.

      2. Therefore, the sun revolves around the earth.

      I wouldn’t call that person in medieval France stupid or refusing to consider alternative evidence. Far from it, they are taking the most logical conclusion from what they know. However, when Copernicus finally did the astronomical calculations to show that the earth really rotates around the sun, then that person from France would be wrong to still believe the earth as the center of the universe.

      So, back to your argument. It makes sense that you would only see marketing acumen or disruptive innovation as sources of high profit margins since that is the field you have specialized in. But like Copernicus, we also have hard data to track the true source of those profit margins by looking at each step in the production chain. That’s not just for oil companies, but for Apple, Nike or any other manufacturing company.

      If we look the value added in each step of the Apple process, we would indeed find very small profit margins for the Japanese, Korean and German suppliers of raw material and chips, small profit margins for the Chinese assembly plants and very large profit margins for Apple. Meanwhile, Android phone makers use the same raw material suppliers and the same Chinese assembly plants, but receive far lower profit margins. Apple has the high margins due to a combination of having a better product, marketing genius and intellectual property monopolies. Surely you don’t disagree with any of this, correct?

      So let’s look at the profits in the supply chain for gasoline. That’s split easily enough into downstream for the actual drillers, midstream for the refiners and then upstream for the actual retail gas distributor. Here, the profit situation is reverse: upstream has all the profits and midstream and downstream have extremely tight, commoditized margins.

      If only disruptive innovation and marketing genius explain high profits, then clearly one or both must be happening at the upstream portion of the supply chain. Retailers simply do not differentiate, at all, between different refiners and customers do not differentiate between different retailers. As expected, the lack of differentiation and high number of competitors drive down profit margins.

      But then, there is also zero differentiation and a high number of competitors at the upstream level. Except for possibly the extra cost of refining dirtier forms of crude oil, refiners have no differentiation between various suppliers of crude. And like midstream refiners, there are dozens of various state-owned corporations and oil companies all selling a virtually undifferentiated product. Even federal oil subsidies would not add to profit margins since all oil companies have access to the same subsidies and would pass it along to consumers. Furthermore, if we look at the other side for upstream production, the land and material costs, the upstream producers compete with each other in bidding for limited land and drilling material. In short, everything says the upstream producers should also be commoditized.

      Why isn’t it commoditized then? Either because they have a monopoly on the best land through some uncompetitive mechanism or because they put large cash flows up front to get very uncertain cash flows years into the future. The former instance is for state-backed petroleum organization which expropriated the land at far less than its market value. There would be far less profits from Saudi oil fields if oil companies had to bid against each other for the land.

      The latter is how deregulated US oil companies get their currently high profit margins. In other words, they are not Apple or most any other consumer company. Apple does not have to spend billions to get uncertain cash flows years later. They spend a small amount of money relative to the later operating cash flows a few months to maybe two years later. The difference in risk and cash flow timing is the reason consumer product maker generally have little profit margin unless they excel in some other area relative to the competition.

      As a business school professor, surely you understand discount rates, risk premiums, and so on, right? You understand also how some investors, according to the Efficient Market Hypothesis, will be lucky and some will fail, right? Or do you? I’m sorry this post’s length spiraled completely out of control, but can you at least see the assumptions backing your main argument and why they are completely wrong? Once you see US oil company upstream operations as really very risky investment vehicles, I think you will understand how they would have outsize profit margins when the direction of oil happens to go in their favor.

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    • By armchair261 on March 12, 2012 at 7:07 pm

      “I also appear to be in good company with all those others that know so little- not nearly as much as you.

      So, in other words, our collective understanding of the way the oil industry operates, and the manner in which oil prices are established in public markets, should be put up for vote, is that your view of objective research? Is that what you’re saying? You have more votes, therefore you’re correct? I believe evidence is actually somewhat more relevant, and you have provided none.

      A lot of people agree with you because 1) a lot of people don’t have oil industry experience; 2) uninformed people often seek simple solutions; and 3) prejudice against the oil industry is currently quite fashionable.

      Your point with this statement?

       

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  8. By tw on March 12, 2012 at 1:47 pm

    One cannot help but laugh at the blatant irony of the “Professors” position. In order to blame the price at the pump on nefarious marketing activities , he uses the exact same technique that he decries to make his point. Then he follows that by telling you he is an expert in marketing….because he actually wrote a book or two? Where did he get his references for those I wonder, Bagdad Bob?

    Hilarious.

     

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  9. By Andre Comparini on March 12, 2012 at 5:01 pm

    This may be an oversimplification, but perhaps the professor isn’t effectively communicating his standpoint and is looking at the issue from the perspective of “oil company profits are x, subsidies are y. Since x > y, there appears to be no value in the subsidies given to oil companies, who must be marketing geniuses in selling the public the idea that they need the subsidies”

    Even if this isn’t what the professor is trying to say, I think that’s an important question to be asked. With astronomical profits, are subsidies really necessary; is the public’s money better spent elsewhere? What part of the oil industry is subsidized – production, transport, or refinement?

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    • By Robert Rapier on March 12, 2012 at 5:19 pm

      Since x > y, there appears to be no value in the subsidies given to oil companies,

      That was really a small part of his article, coming across as more of a dig (and there were plenty) at the oil industry.

      With astronomical profits, are subsidies really necessary; 

      But that’s a legitimate question for any tax deduction for any profitable company, isn’t it? If Tesoro is able to deduction 6% from Section 199, but Apple — with much higher profit margins — is able to deduct 9% from Section 199, why aren’t people ranting about that? I broke the subsidies down in some detail here. For me, the subsidies were never really the issue, it is that people are singling out the oil industry for repeal of specific tax deductions while completely ignoring far more profitable industries that get the same sort of tax deductions. And there are some specific “subsidies” which if repealed would simply give foreign oil companies a competitive advantage against domestic producers. I don’t think we want to do that either.

      RR

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      • By Andre Comparini on March 12, 2012 at 5:44 pm

        That was really a small part of his article, coming across as more of a dig (and there were plenty) at the oil industry

        You’re right – I had latched on to that part of the article and made it the theme in my mind. 

        Thanks for the link to the subsidy article, it cleared up a lot for me, and I think the general public would greatly benefit from such a correction of the misinformation they have been fed.

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  10. By Russ Finley on March 12, 2012 at 11:16 pm

    People don’t want to believe that very little of what we read in the lay press is accurate. Once that realization sunk in, I lost my motivation to read them. It takes all the fun out of it, like enjoying a non-fiction book for its interesting facts and finding out part way through that you’ve been reading a historical novel. Now you don’t know which was fact and which was fiction.

    That’s why I won’t read an article that does not have a comment field below it where readers can point the BS out to other readers.

    The article taken to task above is no worse (i.e., just as bad) as many other articles you will find out there on a daily basis on other topics but because Robert is an expert on liquid fuels, he was very aware of just how inaccurate the article is. And thanks to the comment field, a lot of other people now know how inaccurate it is as well.

    The “letter to the editor” censorship system used to protect authors from critique. Those days are fast disappearing thanks to the internet comment field.

     

     

     

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  11. By Mike on March 13, 2012 at 4:02 am

    It would be great if someone would make a pie chart that showed the break down of the price of a gallon of gas, comparing when oil is $50 vs $150 a barrel. Since all the downstream costs are the same it should be clear who is making money when the price of oil goes up.

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    • By Addoeh on March 13, 2012 at 2:48 pm

      There are plenty of charts out on Google images that showcase what goes into a gallon of gas.  When the price of oil goes up, the increase in gas prices is almost all down to the price of crude.  As you will see with the charts that compare one price point with another, the percentage of the price in crude per gallon increases, while the percentages for refining, distribution, and taxes all go down.  This is mostly because refining, distribution, and taxes are usually flat rates.  For instance, federal taxes are 18.4 cents per gallon, regardless of the price of gas.  The gas station owner takes in between 2 and 5 cents per gallon, regardless of the price.

       

      https://www.google.com/search?num=100&hl=en&safe=off&q=price%20breakdown%20of%20a%20gallon%20of%20gas&um=1&ie=UTF-8&tbm=isch&source=og&sa=N&tab=wi&ei=sZRfT7r3LqmY2wXR8sj-Bw&biw=1280&bih=709&sei=3pRfT9LhEuWy0QGVvL23Bw

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      • By Mike W on March 14, 2012 at 11:41 am

        Thanks, that is close to what I am looking for. Most of the charts are expressed in percentages of a dollar, which obscures the fact that taxes are constant per gallon. 

        What I want is a chart like the one in this article, except put the crude oil on top since that would make it easy to see that the other factors are pretty much constant.

        http://patrickcdoyle.com/gas-price-breakdown/

         

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  12. By Bobby Borg on March 14, 2012 at 7:24 pm

    Hello, I know a few folks that literally started walking to work because of high gas prices a few years back. Some of my entertainment friends had to cancel complete tours. Despite all of the reasons for high prices, does anyone have any thoughts about alternative sources of energy or what the future may hold in regards to energy in general? There are so many passionate responses above, perhaps if everyone came together, some very profound and helpful solutions may be eventually be formed. Thank You so very much.

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    • By Optimist on March 15, 2012 at 2:48 pm

      Bobby: the short answer is nobody knows. It might come out of a respected research lab. It might also come out of Joe Sixpack’s garage.

      The problem is that in America, Mr. Sixpack is going to need a lobbyist, if his invention is not ethanol.

      Which is great news for the lobbying industry. Not so good for America.

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  13. By Optimist on March 15, 2012 at 2:53 pm

    Just posted this on the prof’s page:

    Guys,

    You are being way too hard on the poor professor.

     

    Think about it: We know that (1) $5/gal is just a matter of slick marketing (READ the article!) and (2) professor Ira is the marketing specialist at the Marshall School of Business. Coincidence? Unlikely.

     

    More likely the professor is coming out of the closet, so to speak, to admit his alliance with Big Oil, which gas enabled them to charge the unheard of price of $5/gal for a product that “looks, smells, and works the same as it always has”. I might add that the professor does this at considerable risk to his career, and possibly his life. We all know what Big Oil is capable of.

     

    Also, now that Big Oil no longer requires his services, seeing as their marketers have obviously internalized the Marshall School of Business Marketing Plan, the professor can now offer the same priceless material to other industries for the give-away price of $500,000 a seat (meals and housing NOT included). Increase your rates to any price you like, and suffer no lost business! And if you have doubts: remember the Marshall School of Business Marketing Plan delivered $5/gal for Big Oil!

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  14. By Mary B on March 17, 2012 at 2:58 pm

    Mr. Rapier,

    After, reading your artice today titled “The Professor Who Knew Too Little”-I just had to respond!  It was clear with with your unfortunate comments that you obviously don’t know Professor Ira Kalb!

    He has helped THOUSANDS of students, clients, and people like myself for so many years. I just wish you could have talked with them before you wrote this article .
    What is so distasteful about your comments is that they are mean spirited, combative, condescending, and untrue! What is so interesting is that this article says much more about you and your followers who commented on your blog than Professor Kalb. You say he knows so little. However, if you really knew him, you would say the opposite! It appears that you feel the need to tear down Professor Kalb to build yourself up! If you really understood what he was saying in his article, you would know that he was sending a message to help rather than hurt the oil industry! That is all he has ever done throughtout his career-to help!

    It saddens me greatly to listen to your untrue and unliked things about him as the oil companies continue to make record profits and I and my fellow nurses continue to pay a significant portion of our paychecks now on gas in order to reach/help  people such as yourselves and their families with serious health issues stay at home and out of the hospitals for as long as possible.  Paying almost $5.00 gallon now is outrageous!   

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    • By Robert Rapier on March 17, 2012 at 3:25 pm

      It was clear with with your unfortunate comments that you obviously don’t know Professor Ira Kalb!

      You are making the same mistake that Professor Kalb made in his comments back to me. He suggested that unless I know him or his motivations, then I can’t properly criticize the article. That’s hogwash, plain and simple. I am not criticizing Professor Kalb as a Professor of Marketing or as a human being. I am criticizing his decision to spread misinformation even though he clearly knowns nothing about the oil industry. It wouldn’t matter if that article had been written by Mother Teresa; it would be just as wrong even though she is a wonderful person. If someone argues that 2 + 2 = 5, or that the U.S. has 57 states, I do not need to know the person to argue that this is wrong.

      What is so distasteful about your comments is that they are mean spirited, combative, condescending, and untrue! 

      Yet you have chosen to address exactly none of them. Just like the professor did when he was here. I think our energy policy is a wreck because people believe so many untrue things. So for the people who spread these untrue things, yes, I am apt to be combative. 

      It appears that you feel the need to tear down Professor Kalb to build yourself up!

      One could make that argument pretty much any time someone rebuts the arguments of another, couldn’t they? Isn’t that what you are trying to do? Tear me down to build him up?

      It saddens me greatly to listen to your untrue and unliked things about him…

      I am sure you won’t do this, but I will extend the offer. Defend any of his statements that I have rebutted. Tell me why they are true, and hang around and listen to my response. 

      Like I said, you won’t, because people don’t like having their misconceptions challenged. Professor Kalb certainly didn’t. But if you want to learn more about energy than what Professor Kalb knows, then I can explain in detail to you why he is wrong.

      RR

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    • By Optimist on March 19, 2012 at 6:13 pm

      He has helped THOUSANDS of students, clients, and people like myself for so many years.

      That’s interesting logic, Mary: Nice guys are incapable of making mistakes? Wow! Hard to believe there are so few nice guys around, considering your logic.

      What is so distasteful about your comments is that they are mean spirited, combative, condescending, and untrue!

      You should get out more, Mary. You clearly have no idea what mean spirited, combative and condescending mean. As for untrue: feel free to prove otherwise. So far, neither you nor the nice professor have made one argument in that regard.

      If you really understood what he was saying in his article, you would know that he was sending a message to help rather than hurt the oil industry!

      In a senseless posting, this line stood out for making less sense than the rest! Please explain how the nice professor intends to help Big Oil. Or did he mean that if they hired a marketing expert (like himself) they could make even higher profits? “Call within the next 15  minutes, and you alos get a nice blogposting, free of charge…”

      Paying almost $5.00 gallon now is outrageous! 

      For now. At some point in Mr Obama’s second term $5/gal will seem like the good old days. With or without the help of the nice professor.

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  15. By Bill Graves on June 14, 2012 at 3:50 pm

    Good afternoon Robert,

    You present an interesting discussion but you have missed the point of  public rage toward BIG OIL.

    What is missing in your discussion is the history and experience of a great part of the older public.

    In the 1950′s we had EXXON, we had MOBILE, we had TEXACO, we had CONOCO, we had STANDARD OIL, we had CLIFF BRICE, we had possibly hundreds of gas and diesel producers.

    These producers took the crude from the ground though the entire process to your gas tank including the people to put the gas in your tank, air up your tires and wash your windshield.  It mattered whether one producer got the crude out of the ground at $7 a barrel or $11 per barrel as the difference showed up at the price tag.  Do you remember 5-cent a gallon price differential around town even though gas was 27-cents per gallon.  Do you remember GAS WARS

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  16. By Bill Graves on June 14, 2012 at 4:15 pm

    I apologize but I hit the Post button prematurely.

    Well those were the good days.  Since that time the many competing oil producers have merged down to a handful.  The days of the price at the pump being competitive and reflecting the cost of the entire operation from crude in the earth to gas in your tank.

    Well today BIG OIL is not competitive.  The global crude pricing has leveled the crude pricing to every producer.  BIG OIL spinning off the low profit sectors of their business so that profits from $11 crude at atmosphere to $100 selling price doesn’t have to help cover the costs of refining, distribution nor delivery.

    I believe that most of your statements do reflect the real world today.  I also believe that every merger, every refinery shutdown from being spun off reduced product supply and increased prices.  In every case the betterment of the American experience was not the motivation.  It was categorical profits plain and simple.

    What happened to Henry Ford’s desire for every American to be able to have the convenience of a car, Thomas Edison wanting every American to have access to his many inventions, even early oil companies wanting every American to be able to travel and see the USA.

    BIG OIL maticulously developed the loathsome bed they sleep in.  Now let them enjoy their riches at the expense of the lowest economic groups in America.

    Thanks for the opportunity to spill it out there

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