The following section is taken from a recent article of ours, “Dominant Capital and the New Wars” (pp. 305-306). http://bnarchives.yorku.ca/archive/00000001/

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“On the face of it, this relationship [between the relative price of oil and the global profit share of the oil companies] seems counterintuitive. For the oil companies, crude oil is the principal input, not output. It is the raw material which they refine into gasoline, diesel, petrochemicals and other derivatives. Consequently, should they not lose when crude oil becomes more expensive? The answer is negative. If the price of refined products were fixed, higher crude oil prices would probably mean lower profit. But the price of refined products is not fixed. On the contrary, it tends to move up and down with the price of crude oil, causing profit and cost to move not inversely with each other, but together.[*]

[*] For the mathematically inclined, assume for simplicity that the oil companies buy all their crude oil from others; that they refine the oil into final products; and that they sell those products for profit. By definition, the companies’ dollar profit (Π) is the multiple of their output volume (Q), the dollar cost per unit of output (C) and the decimal profit markup (K), such that:

(1) Π = K • C • Q

Using lower case notations to represent rates of change, we have:

(2) π ≈ k + c + q

Suppose now that the price of crude oil goes up, so that c > 0. Assuming that the other costs of production remain unchanged, what happens to profit depends on the relationship between c and (k + q). Profit will fall if, and only if, (k + q) < –c; in other words, if, and only if, the multiple of the markup and output (K • Q) falls by more than the rise in C. Although possible, this outcome is very unlikely for two reasons. First, rising crude prices tend to both ‘fire up’ the profit expectations of oil companies and galvanize their cooperation. This closer cooperation, tacit or otherwise, usually works to keep profit markups from falling, and often helps them go up. (Technically, there is nothing to prevent oil companies from changing their markups as they see fit. But in the absence of an external ‘shock,’ such as a hike in the price of crude oil, raising the markup significantly is too blatant an act to contemplate politically, and one which often is difficult to coordinate and maintain.)

Now, since higher costs and higher markups lead to higher prices, one would expect to see output fall. Oil products were made more expensive, so it is only natural for consumers to use less energy overall, as well as to substitute to alternative, non-oil sources. As it turns out, however, this negative impact usually is very small (in the jargon of economists, oil is ‘price-inelastic’). To illustrate, between 1970 and 2001, the annual growth rate of crude oil consumption varied between a low of –3.9 percent in 1980 and a high of 8.4 percent in 1970 – an overall range of only 12.3 percent. By comparison, the range of price changes during the same period was 230 percent – prices fell by as much as 53 percent in 1986, and rose by as much as 267 percent in 1974 (computed from British Petroleum Annual). Moreover, there was no clear correlation between the two movements, with higher prices often coinciding with higher rather than lower consumption. To sum up, then, higher prices for crude oil (c > 0) tend to be associated with stable or even higher markups (k ≥ 0), as well as indeterminate but very small changes in output (q ≈ 0). The net impact of higher crude prices on oil company profits therefore is almost always positive.”

1. We do not speak about “demand” but about consumption (demand is an unobservable neoclassical category; it has to do with the “desires” of buyers on which we know nothing). The consumption of crude oil is not very responsive to its relative price.

2. The oil companies are interested in profit, not consumption, and profit is affected mostly by price. So, no, the oil companies do not get shot when the price of crude rises. On the contrary (Figure 9 p. 40 in the Epilogue).

3. Would it be better for the oil companies to control crude oil directly? Not really. The politics of the oil business is complex, and goes way beyond the issue of “cartels”. We describe the history and nature of this political economy in great detail in Ch. 6 of our Hebrew book (http://bnarchives.yorku.ca/archive/00000005/) and Ch. 5 of our English book (http://bnarchives.yorku.ca/archive/00000008/).

I think that we are not on the same wavelength. Our book develops an approach that rejects the traditional separation between “politics” and “economics.” There is no sense debating these issues unless you are familiar with our broader argument.