Friday, April 28, 2006

A Little Economics

Let's all rejoice for the good fortune of Chevron:

Chevron Corp.'s first-quarter profit soared 49 percent to $4 billion, joining the procession of U.S. oil companies to report colossal earnings as lawmakers consider ways to pacify motorists agitated about rising gas prices.

The San Ramon, Calif.-based company's net income, reported Friday, translated into $1.80 per share, two cents above the average estimate among analysts polled by Thomson Financial. It compared to a profit of $2.7 billion, or $1.28 per share, in the same January-March period last year.

Revenue totaled $54.6 billion, a 31 percent increase from $41.6 billion last year.

If not for continuing production problems caused by Hurricanes Katrina and Rita last summer, Chevron said it would have made an additional $300 million - an amount that would have generated the highest quarterly profit in the company's 127-year history.

As it was, the performance marked the fourth consecutive quarter that Chevron has earned at least $3.6 billion as the company continued to capitalize on oil prices that have climbed above $70 per barrel since the first quarter ended.

Now these are the people of the Bush tribe, the guys whose back he has. Remember that the oil companies got special tax breaks and that quite recently these special tax breaks were continued?

You don't actually need a PhD in economics (though it helps) to smell something very wrong in a game which gives Chevron both its best profits ever and further tax breaks because times are hard, especially when times are not hard. For firms like Chevron anyway. The only negative they face is all those unhappy people paying them their record profits.

Then to the economics part. Profit is defined as Revenue Minus Costs. Revenue is all the money Chevron takes in from the people it sells its products to and Costs consist of all the expenses it has, roughly. Now firms like Chevron argue that their costs have gone up with the difficulty of getting hold of oil. Think of the unrest in Iraq and in Nigeria and so on. All this means, Chevron tells us, that the costs have gone up through the roof.

Poor Chevron. The only thing it can do to keep its profit from going negative is...what? Yes, it must raise the prices to increase Revenue, though raising prices is always hairy because when prices rise people want to buy less and Revenue = Price x Quantity Sold. But luckily for Chevron, gasoline use tends to show inelasticity in demand, which means that if Chevron raises the price term the quantity sold term doesn't go down enough to lower the whole product which makes Revenue. Hence, raising prices can save Chevron from bankruptcy.

Here's the problem. If we were watching real problems with the costs going up, Chevron shouldn't be recording incredibly high profits. It should be doing poorly. That it's not doing poorly means that the high prices we are seeing are not a consequence of high costs of oil, except in the sense that the oil costs gave Chevron the chance to really take advantage of the market.

Now there was clearly no reason to present that ecobabble to explain something that is quite obvious. But I thought that it might be interesting to show how it's done. I'm available for similar lessons on the major political shows. Shallowness and learnedness guaranteed.