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BP: Beyond Profits

“Obscene profits.” “Greedy oil companies preying on American consumers.” This was the tune blaring from the populist bandwagon just 18 months ago. Various commentators in the mainstream media, including FOX news, were condemning the oil companies for their high profits.

BP’s profit in 2008 was $25.6 billion, an all-time high and up 40% from the previous year. Many commentators claimed no company should be allowed to earn that much money and called for legislation to cap the size of oil company profits.

Yet what I never heard or saw reported was that the company had a value of $205.36 billion. The all-time high profit in 2008 represented a return on investment of 12%.

To put that in perspective, most investors in small businesses look for a minimum return of 20% on their investment. Obscene? Not when you consider the risks that come with owning a business and cause 75% of all new businesses to fail within five years.

Drilling for oil is one of the most risky businesses on the planet. It takes a huge investment to drill a well; one on land can easily cost two million dollars, and those at sea cost exponentially more. There is no guarantee the well will repay the investment. An oil industry rule of thumb is to expect only one in nine wells drilled in a new area to hit oil. Each successful well needs to pay for its dry neighbors, not just itself.

When a well is successful, the profits are often large. They need to be to make up for the high costs and the losses that are also a normal part of this high-risk industry. Indeed, oil companies need “obscene” profits to pay for obscene losses. Just consider what is happening in the gulf.

The liability BP incurs in deepwater drilling is enormous. The cost of the cleanup of the gulf oil disaster is now at $37 billion. That’s 150% of the record high 2008 profits. Perhaps it’s a good thing BP had such a great year in 2008. If those who wanted profits capped had their way, BP would not have the financial resources to fund the cleanup.

Now, some are calling for the government to punish BP by driving it into bankruptcy and nationalizing the company. Robert Reich, in a May 31 piece on the website tpmcafe, writes: “If the government can take over giant global insurer AIG and the auto giant General Motors and replace their CEOs, in order to keep them financially solvent, it should be able to put BP’s North American operations into temporary receivership in order to stop one of the worst environmental disasters in U.S. history.”

How taking government control of BP will stop the disaster is beyond me. Given the high cost and the damage to its reputation, no one has a stronger incentive to cap the spill than BP. It makes more sense for the government to work with, not against, BP to solve the problem. Yet that isn’t the case.

As reported online in The Wall Street Journal on June 1, U.S. Attorney General Eric Holder said that federal authorities have opened criminal and civil investigations into the gulf oil spill, though he wouldn’t specify the companies or individuals that might be targeted. BP lost billions in market value when shares dropped in the first trading day since the company failed yet again to plug the gusher.

Upon Holder’s announcement, the market fell 112 points. Perhaps investors are becoming increasingly concerned that the former rules of free markets no longer apply in the United States of America.

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3 Responses to BP: Beyond Profits

  1. Bobbie in Atlanta June 7, 2010 at 12:29 pm #

    Uh oh, my post in progress erased itself while I was on the phone. Probably a good thing. Just know that this Florida panhandle native thinks that if they knowingly cut corners re: good operating procedures and that led to this mess, I definitely think they should be found criminally negligent with all the penalties that would entail. All I ask is that you think of how you would react if the big bird of life took a massive dump on your monuments and the surrounding areas for miles and miles and miles. I still believe in free markets but you have to play by the rules (which means I would have let the banks go to hell in 2008).

  2. Rick Kahler June 7, 2010 at 12:37 pm #

    Bobbie,

    I agree with you. My column was meant to be an educational defense of free markets and capitalism, not BP.

    It’s important that companies abide by the rules. When they don’t, there should be consequences. What is happening in the gulf is a total tragedy which initially appears as if it was avoidable. So sad.

  3. T June 7, 2010 at 2:17 pm #

    “U.S. Attorney General Eric Holder said that federal authorities have opened criminal and civil investigations into the gulf oil spill, though he wouldn’t specify the companies or individuals that might be targeted.”

    “Upon Holder’s announcement, the market fell 112 points. Perhaps investors are becoming increasingly concerned that the former rules of free markets no longer apply in the United States of America.”

    Or perhaps investors realize that the government is serious about holding BP accountable for causing the worst environmental disaster in history and its going to effect their profits.