Gasoline Price Changes - Federal Trade Commission

GASOLINE PRICE CHANGES:
2004 as in 2003. Some consumers face difficult choices when budgeting for these higher
gasoline expenditures.
Profits, however, play necessary and important roles in a well-functioning market
economy. Moreover, profit levels in the oil industry – as in other industries – have been variable
over time and among firms. This section reviews the roles that profits play in a healthy market
economy and gives a historical perspective on profitability in the oil industry.
A. Profits Play Necessary and Important Roles in a Market Economy.
Profits play two necessary and important roles in a market economy. First, profits
compensate owners of capital for the use of the funds they have invested in a firm. The level of
profits for a firm, as well as the rate of return on those investments in that firm, will be
influenced by supply and demand, in addition to regulatory conditions. Second, profits are a
reward for an investor’s willingness to bear the risk that an enterprise will not be successful and
the investment will be lost. If the enterprise instead is successful, an investor may receive a high
rate of return. High rates of return signal possible profit opportunities and thus encourage
investors to reallocate resources across the economy, investing new capital in areas of high rates
of return.
Profits play the same roles in the oil industry. The oil industry, which produces more
than 80 million barrels per day of petroleum products, is one of the largest in the world. A great
deal of investment must support the enormous infrastructure required to find and produce crude
oil, transport it to refineries, produce finished petroleum products, and distribute these products
throughout the world. Investors expect compensation for the use of their funds in supporting this
business.
Profits also compensate firms for taking risks. The oil industry faces many types of risks.
Potential changes in the macroeconomic climate, at either the national or the global level, and
general uncertainty about future prices pose investment risk for all industries, including oil.
Other risks are more specific to the oil industry. For example, production levels may be lower
than expected at an oil field, or war or terrorism, in some areas, may destroy crude production
assets or reduce their values. At downstream levels, refinery margins may fall if the price of
gasoline falls relative to the price of crude oil. New environmental requirements may increase
operating costs or require substantial new capital investments. Over the longer run, energysaving
innovations at the consumer level may reduce the demand for refined petroleum products.
That these risks did not come to pass in any particular year may make investments look very
profitable in hindsight. That does not necessarily mean, however, that firms should have
invested more based on the information about risks that firms had at the time.
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B. Profits in the Oil Industry Have Varied Over Time, Over Industry Segments,
and Among Firms.
EIA’s Financial Reporting System (FRS) tracks the financial performance of the major
FEDERAL TRADE COMMISSION, JUNE 2005