While many in America are suffering from higher prices at the pump and are aiming their anger at oil firms, the true reason for high prices is far more complicated. While there is certainly a correlation between oil prices and gasoline prices, the real problem is a lack of refining capacity. Since there have been no new refineries built in the last 30 years, the infrastructure to support the country’s gasoline needs, which have increased over the last few decades, has not been expanded. Recent evidence of this is the supply disruption due to a fire at a refinery in California, which has driven gasoline prices higher. This has nothing to do with oil firms manipulating the price, but has everything to do with shortsighted politicians who pander to voters, rather than making good long-term economic choices.
The truth is that America is becoming awash in both oil and natural gas. The new technologies developed can now unlock both of these commodities, which has meant that America is seeing far lower oil prices and natural gas prices than other nations. For example, American oil prices as best represented by West Texas Intermediate (WTI) are approximately $22.00 per barrel lower than Brent North Sea oil prices. As well, natural gas prices internationally are approximately five times higher than what companies can obtain in America.
The truth is that firms related to the extraction of oil and natural gas, as well as companies that use these as inputs, are seeing substantial benefits through corporate earnings. This is part of the reason why we’re seeing manufacturing pick up, as many companies that use natural gas as an input benefit from lower prices with higher corporate earnings. With oil prices and natural gas prices so low, this makes it that much more attractive to do business in America.
One issue that’s holding back the corporate earnings of oil firms is that they don’t have access to the international markets to sell oil. However, this might be changing. Recently, Royal Dutch Shell plc (NYSE/RDS-B) applied to the U.S. Department of Commerce for a permit to export oil. (Source: “Shell Seeks to Export U.S. Oil,” Wall Street Journal, October 12, 2012.)
With oil production set to hit its highest level in almost two decades, corporate earnings for firms involved in this industry would grow much more over the next decade if they were allowed to sell into the international market where oil prices are substantially higher. The current problem is that America is awash in a glut of oil. This means that oil prices are far lower in America than in the international market, which hurts corporate earnings of the domestic oil firms.
Of course, this ends up being a political issue. Politicians like when oil prices are low, as it helps them win votes. For some firms that benefit from lower oil prices compared to the international market, corporate earnings will also benefit. However, there are also millions of jobs directly and indirectly tied to oil prices. This is not a black-and-white issue; it is far more complex.
What is certain is that America has enormous potential for growth in this industry, as the resources are certainly plentiful. In spite of the current administration’s attempts to curtail the expansion and development of the oil and gas sector, the growth continues. If the current policy stands, firms that use oil and natural gas as an input will have a competitive advantage over their international peers, helping boost corporate earnings. If policies change and firms are able to export and take advantage of the huge price differential between American and international oil prices, then this would be a huge driver of corporate earnings for the oil firms. At this point, the only thing that is certain is America has tremendous potential regarding these natural resources; how best to utilize them is still uncertain.