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Tuesday, 13 February, 2001, 17:43 GMT
Q&A: Could oil profits be cut?
Graph showing petrol and oil prices
Major oil companies such as Esso, Shell and BP insist that although they are making money from producing oil, they are not making money from selling it. So where is the catch? BBC News Online looks for answers.


What does that mean - oil companies rake it in on one end, but lose it on the other?

Oil companies like to separate the different parts of their business.

At the moment they are making tons of money on the so-called "upstream" business, that is the crude oil exploration and production.

But they insist they do not make much money on the so-called "downstream" business, that is the refining of the crude oil and the selling of fuel to people and companies.

So what do the oil firms moan about? Surely, without selling fuel to consumers the oil giants would not make any money at all?

One part of their business is a customer of the other.

"Upstream" will sell crude oil to "Downstream".

When crude oil is expensive the seller will see a rise in profits while the buyer will see a rise in costs.

But if an oil company owns both the producing side of the business, as well as the refining and selling side of the business; why can't it decide on its own internal price?

This would amount to one business subsidising another, and this is illegal because not all companies operate in both "Upstream" and "Downstream".

Take a small independent refinery or petrol station. They would not be able to compete with Shell refineries and petrol station whose prices were subsidised by the profits from Shell's North Sea explorations.

So who decides how much a refinery should pay for the crude oil?

This is determined by supply and demand in the crude oil market.

The supply is partially controlled by the Organisation of Petroleum Exporting Countries (Opec). This cartel tries to steer the oil price by agreeing production cuts if prices fall too far, or production boosts if they rise too high.

Other oil producers, including the major oil companies, may seem large, but compared to Opec they are small.

Could the oil companies undercut the market price and thereby sell more oil?

In theory yes, but why bother? Since Opec adjusts world demand to match supply, the oil companies are able to sell all their oil anyway.

Besides, a single oil company would be too small to move the market price by selling its crude oil at a discount.

Doing this would only mean some oil traders would make extra profits from picking up a few thousand barrels of bargain oil, and the oil company would make less profit.

So does Opec therefore control the price of petrol at the pumps?

Partially yes, but other factors also influence the price of petrol - and the stuff that powers our cars is only one of many products made from crude oil.

Other products for example are jet fuel for planes and heating oil for houses, and numerous plastics.

If the supply of crude oil fails to respond to a rise in demand for fuel oil during a cold winter, the indirect result will be rising petrol prices.

This is because the combined demand from the fuel oil refineries and the petrol refineries will push up crude oil prices.

So if the crude oil supply goes up, the price will fall. But why don't petrol prices fall when crude oil prices come down?

Partly because refineries and petrol stations can make some money by letting prices float down slowly but bounce them up quickly in response to crude oil price movements.

But taxes play also an important role.

In the UK, fuel duty and value added tax (VAT) account for about three quarters of the total price of petrol.

So if a litre of petrol is sold for 84p, 61p ends up in the government's pocket.

The rest pays for the crude oil and the refinery costs, and whatever is left over goes to the petrol station as profits.

Esso says that a retailer makes about 5p for each litre of petrol sold for 84p, and that is before expenses.

These expenses can wipe out petrol stations' profits.

Esso's rival Shell says selling petrol in the UK is not profitable at all.

So why don't they just stick to oil exploration and ditch the unprofitable parts of the business?

The "Downstream" business is not always unprofitable.

When crude oil prices are low the refineries and petrol stations can make money, while the exploration arms may lose money.

Does that mean the oil companies always win?

Unfortunately for them, falling crude oil prices tend to hurt their "Upstream" businesses more than it benefits their "Downstream" businesses, because the exploration business tends to be bigger.

They also have to reinvest some of their profits into risky ventures. Many oil search projects fail and never bring back any money.

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See also:

03 Jan 01 | UK
Anger at 'token' petrol cut
22 Sep 00 | Business
Oil: New rules of the trading game
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