The last word on gas prices

Okay, everyone. This is important, so putdown the torches and pitchforks and listen up before you go lynch the oil companies.

My colleague, Mr. Heath, has written a fine article on what exactly has caused high oil prices. Please read it, since I want to build on what he has said.

First, I do want to correct one thing. Mr. Heath misread the Wikipedia article on taxes at the pump. Mr. Heath said that the combined state and federal taxes can amount to as much as 33 cents. Actually, the article says "gasoline taxes in the various states range from 10 cents to 33 cents" (emphasis mine). That 33 cents is from the states alone. In fact, the combined taxes goes as high as almost 52 cents. You can see these taxes on a state to state basis on Free Republic.

So how much do the oil companies make for a gallon of gas if the government is making 40 to 52 cents? According to the American Petroleum Institute, around 19 cents. They make 7.7 cents for every dollar spent, and I am assuming $2.50 per gallon, which comes out to 19.25 cents.

So where is the rest of it going? Well, subtracting taxes, we're coming down to close to two dollars. Crude costs take $1.40 out of the price (which can be reduced if we would lift the restrictions on drilling in America), and manufacturing costs are a bit over fifty cents (which can be reduced if we would lift some of those restrictions on manufacturing, such as the laws that require oil companies to make a different formula of gasoline for each region). (Source: American Petroleum Institute)

So why the record profits? Well, it's simple. Look, if you set your profit level as a percentage (7.7% in this case, since they are making 7.7 cents a dollar), then your profit will rise, as a percentage, equal to the increase in the price of your product. Let's use this as an example. I want to sell hotdogs, and I want to make 10 percent profit on each one. The cost of making the hotdog (for the bun, wiener, et cetera) is $1.00, so I sell the hotdog for $1.10. Say my costs, due to a beef shortage, increase to $1.50. Since I want a ten percent profit, I set my price at $1.65 ($1.50 cost and 15 cents profit).

My profits have increase from 10 cents to 15 cents! That's a 50% increase! Of course, it's not really that much, only 5 cents, but since I want ten percent rather than simply ten cents, my profit varies with the price of the product.

Gas companies make 7.7 cents a dollar. That means, if the price at the pump increases from two dollars to $2.50, their profits increase 25% (15.4 cents at two dollars and 19.25 at $2.50). Less than 4 cents turns out to be 25%. That's not gouging; that's setting a reasonable price for a product.

So let me get this straight, so the government is making more than twice the profit as the oil companies on a gallon of gas while imposing restrictions that are driving up the price even more? And still they call the oil executives to Congress to demand answers on price gouging?

The oil companies are not the problem here. Congress is. Instead of holding these hearings, they need to be talking about lifting some restrictions and lowering the tax. After all, if anyone is gouging here, it's them.

-Paul Lytle,
Primum Mobile Magazine

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