The oil industry low-balls profits and the press goes along
COMMENTARY | May 07, 2008
One more time: in a free market system, profits are return on dollars invested, not return on sales or revenue. Is that too complicated, Mr. Will?
By Henry Banta
This is not another piece about oil prices. It is about how the media cover the oil industry and its political machinations. Over the past year, and with increasing intensity lately, the oil industry has engaged in a massive propaganda offensive claiming that its profits are no higher than many other industries. It makes this claim by comparing its return on sales with those of other industries. This is intentionally misleading and deceptive.
The very fact that a major industry is devoting massive resources to what is nothing more than an outrageous lie should be major news. Suppose Clinton, Obama, or McCain set out on a campaign of conspicuous lying? Wouldn’t it be news? Why should an industry with hundreds of billions of dollars in resources and a political agenda be immune? Why does it get a pass?
To understand why this is such an outrage and not just a dust-up over an arcane accounting issue requires a small – actually very small – bit of reflection of what profit means in a free market system. In the most basic sense it is the reward that the entrepreneurs get for taking the risks and putting up the money. Profit is what the investors get back for putting up money. Profit is not the return on sales or revenue; it is the return on the dollars invested. It is this return on capital that enables the market to direct investment where it will make the most money, and be used most efficiently. It is at the heart of why we consider our economic system efficient. It is why we call it “capitalism.” Comparing the return on sales for firms in different industries is meaningless. It tells you nothing to know that Microsoft earned a 27 percent return on revenue while Verizon earned only 6.6 percent on its sales.
By using a return on sales to make comparisons between industries, the oil industry is engaging in a gross deception. It is simply lying. No other word works. And the oil firms know better. They certainly do not talk that way to investors or the financial community. As Peter Ashton pointed out on Nieman Watchdog last year (June 15, 2007), ExxonMobil got it right in its annual Financial and Operating Review for 2006. The quote is worth repeating:
The corporation’s total ROCE [return on capital employed] is net income excluding the after-tax cost of financing, divided by total corporate average capital employed. The corporation has consistently applied its ROCE definition for many years and views it as the best measure of historical capital productivity in our capital-intensive, long-term industry, both to evaluate management’s performance and to demonstrate to shareholders that capital has been used wisely over the long term.
[And also see this by Morton Mintz in Nieman Watchdog on how to report profits.]
The oil industry’s massive effort to divert the public’s attention has an obvious purpose. Why the major media don’t confront the issue is less obvious. Last year Tim Russert, Washington bureau chief of NBC News, treated us to an interview with a CEO of a major oil company. One would have thought this would have presented a sitting duck for his brand of gotcha journalism. Alas, the subject never came up. Do his producers think that an issue so important to the industry has no real significance? Do they not read annual reports or financial statements? Do they need a refresher in Econ 101?
In fairness, one must admit that Mr. Russert has never pretended to have much interest in economic issues. George Will, on the other hand, would admit to no such limitation. Moreover, it is one thing to ignore the issue; it is another to join in the deception. In a Newsweek column (April 26, 2008) Mr. Will propounded questions for Senator Obama including this incantation of the industry line:
ExxonMobil’s profit of $40.6 billion annoys you. Do you know that its profit, relative to its revenue, was smaller that Microsoft’s and many other corporations’?
Coming from an intrepid defender of the free market this is no minor gaffe. He might be forgiven if he had noted that the nation’s largest corporation last year only earned a modest 3.4 percent on revenue. Of course, that would have exposed how silly his question was and how inappropriate his comparison.
I’d be remiss if I failed to mention an article that got it right – really right. Marianne Lavelle writing in U.S. News & World Report (February 1, 2008) observed that “There’s no business on the planet that gushes forth more profit than selling oil—nothing even close.” Making a comparison that should make Mr. Will blush, she notes that “If Exxon Mobil were a country, its 2007 profit would exceed the gross domestic product of nearly of nearly two thirds of the 183 nations in the World Bank’s economic rankings.” She goes on to explain the difference between return on sales and return on equity in language that even the laziest journalist could understand. She understands the significance of the fact that the oil industry as a whole earned a 27 percent return on equity and that this was 10 points higher than all other industries.
There are other issues raised by the industry’s propaganda offensive, like the amounts being reinvested. While these numbers in absolute terms seem large, over the last several years the actual rate of reinvestment has not been particularly high. In fact, the major companies have spent considerable sums buying back their own stock. For example, ExxonMobil’s capital and exploration expenditures in 2007 were $20.9 billion. But it spent $31.8 billion buying back its own stock, which certainly did nothing for meeting anyone’s energy needs.
What does all this matter anyhow? Doesn’t everyone expect the oil industry to lie? A long time ago, while working at the FTC on advertising issues, I had occasion to visit a considerable number of advertising agencies where, as a matter professional curiosity, I asked if one could sell a product with a claim that the consumer knew was untrue. Universally, the question provoked a laugh; of course they could. They all cited what they had learned from the world of political propaganda.