As gasoline prices have rapidly increased, red and blue sides of the political fence have both speculated that the latest escalation is an attempt to defeat Obama as he presses to end the subsidies the oil and gas industry has received for nearly 100 years. Whether or not this is true, one thing is certain.
Oil companies must be marketing geniuses for their ability to raise prices and create outsized profits at a time when the country is trying to emerge from the worst recession since the Great Depression.
In the 3rd quarter of 2011, the top 5 oil companies had profits of $33 billion – giving them combined earnings of $101 billion for the first 9 months of 2011.
These huge profits, even by oil industry standards, are happening as the average price at the pump in the US is expected to hit $5 per gallon by summer’s peak driving season. This is nothing new for the oil industry since the profits of the top five multinational oil companies approached $1 trillion over the first 10 years of the new millennium.
How large profits are typically generated
Most companies generate large profits by creating innovative, unique, or highly-desirable, got-to-have-it brands. Apple devices and Nike shoes come to mind. The gasoline we buy at the pump is not particularly innovative. It is basically the same as the gas we have been buying since we all started driving. It looks, smells, and works the same as it always has.
There also does not appear to be any significant uniqueness between brands. They are pretty much interchangeable. The only perceptible differences are in the marketing – the names, logos, colours, slogans, and other identifiers. In essence, gasoline is a commodity.
Commodities typically sell for less – not for more
As most economists will tell you, commodities typically sell for less because there is significant price competition and no clear reason for brand loyalty. To have control over price, marketers position their products as unique with no adequate substitutes. The more uniqueness, the more control. If buyers really want or need the product, they have to pay the price because they cannot get the same product somewhere else. Uniqueness, from effective branding, gives marketers a monopoly over the mind-space of buyers. This, in turn, creates an effect similar to that of an inelastic demand curve. With oil, there is very little or no uniqueness – making the high prices at the pump and resultant profits an amazing marketing feat.
More amazing is the fact that the oil companies have been getting tax subsidies from the U.S. government since 1916. In spite of their gargantuan profits, the oil industry has convinced the American public that these subsidies, which currently total $4 billion a year, are necessary to keep their prices lower than they ordinarily would be. If this is not another example of marketing genius, it is hard to fathom what is.
Serious side effects from high oil prices
It is not just the pain of paying more at the pump. Oil prices are an economic accelerator. Everything that is made or transported uses energy, and much of that comes from oil and gas. The prices of food, clothing, and just about everything are going up because of the rapid rise of oil prices that has enriched oil companies. The oil companies have said repeatedly that they need high profits to develop alternative energy sources and explore for more oil. They may be doing a lot of the latter but very little, if any, of the former. In fact rather than investing in alternative energy sources, the LA Times reported that the oil companies “used $38 billion, or 28% of annual net income, to repurchase their own stocks and invested in politicians to maintain the policies that led to their enormous profits over the past decade.” Meanwhile, consumers are experiencing nasty side effects including…
- Global warming, which more than a few scientists believe is creating strange weather patterns and erosion of US land
- Fracking, a process of extracting natural gas, has caused pollution of rivers, wells and ground water with known carcinogens, and in some cases earthquakes
- OPEC profits have been used to finance terrorism and dictatorships
How do they do it?
In addition to hiring lobbyists, the oil industry achieves this marketing feat of high prices and profits for a commodity product by doing the following:
- Using the news media. They do their convincing by sending press releases to the news media, which distribute their messages for free via news programs and articles – warning us that prices at the pump are going up to $5 a gallon.
- Invoking Supply and Demand. In the press releases, they convince the public that the high prices are the result of supply and demand forces that are out of their control. However, OPEC (an oil cartel) controls the supply and pricing of crude oil so invoking supply and demand, while a clever strategy, is a bit disingenuous.
- Providing believable reasons. They use world events as reasons (cynics might call them excuses) for supply and demand changes and higher oil prices. Typical examples include the following:
- China, India, and other large global users bidding up the price of oil
- Instability in the Middle East threatening supply
- Refinery outages, which seem to occur at the worst possible times
- Seasonal demand factors from heating, air conditioning, and increased driving
- Industrial demand factors from a healthy economy
Why is this marketing genius?
The fact that oil companies have continued to use the media for free to convince the public that escalating prices are due to forces out of their control is very clever. To do this while receiving $4 billion per year in tax-payer subsidies while making huge profits and not seriously investing in alternative energy sources is evidence of nothing short of marketing genius.
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