BP: Beyond Profits

by | Jun 7, 2010 | In The News, The Economy, Weekly Column | 3 comments

“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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