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Unread 24 May 2006, 14:35   #1
acropolis
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Big Oil Profits

So anyway, gas prices in the US are going up, almost to $0.70 /L, which you can clearly see is grounds for revolution.* At the same time, the major oil companies released their annual reports, and bragged about how they all had record profits. This did not go over well with the general public, and populism and demagogery have been the general response of our elected officials. Lastly, chic among pundits, responding to politicians who are responding to the public who are responding to the oil companies response to their profits, is to say "Those politicians really need to learn some basic economics/read "wealth of nations"/look up 'supply and demand'/what have you", to the general effect that the surging profits are an obvious result of basic supply/demand economic models that everyone should have learned in high school. However, in my extensive experience of intro econ courses, profit margins were never tied into the supply/demand models at all, and my intuitive model points toward the exact opposite result.

Here's my thought. I sell, say, apples, at $0.24 apiece, and buy them for $0.20 apiece, giving a tidy 20% markup/profit margin. Now, if one day my costs drop (maybe a good year for the orchards?), and I'm now buying them for $0.15, I might lower the price to maybe $0.21. Suddenly my profit margin per apple goes up to 40%, and I'm likely selling more apples per day with the lower price point, so my profits soar. Eventually, competition and price wars etc. might push my profit margin back to 20%, but either way I'm getting rich right now and I'm probably stealing some market share from the hated orange sellers.

On the other hand, if my cost per apple jumps from $0.20 to $0.25, I will likely try to shield my customers somewhat, if it jumps too suddenly people will likely say '**** that' and switch to oranges. Maybe my price goes up to $0.28, and if my costs stay up at $0.25 per, eventually I'll probably move my profit margin back up to 20% or so. In the meantime, however, I'm taking a beating, I'm not selling as many apples per day and my profit margin per apple has dropped a lot.

So intuitively I would expect that a jump in oil prices would result in a drop in oil profits, not the opposite. I would like to know how this result falls out of the basic supply/demand model, as I have been told dozens of times by pundits that it does (never accompanied by any explanation).

*I'd love gas prices to go way up, as I've said before (I love Norway's petrol policy). But that's irrelevant to the topic at hand.
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Unread 24 May 2006, 14:49   #2
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Re: Big Oil Profits

I suppose it comes down to what we consider to be an acceptable/stomachable "profit level". For me, thats zero.
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Unread 24 May 2006, 14:49   #3
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Re: Big Oil Profits

I cant believe you are serious with this "economy" comparison between apples and oil/energy.

Quote:
Originally Posted by acropolis
So anyway, gas prices in the US are going up, almost to $0.70 /L
On a sidenote to make americans smile - in germany i currently pay 1.72 US Dollar /L.
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Unread 24 May 2006, 14:59   #4
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Re: Big Oil Profits

Quote:
Originally Posted by horn
because there's no alternative to oil?
unless you're analogy of apple sellers and orange sellers was in relation to different companys.
Quote:
Originally Posted by Ramihyn
I cant believe you are serious with this "economy" comparison between apples and oil/energy.
if you can't make such a comparison (and i agree that you can't, because as horn says there is no real alternative),

then that is because the oil industry doesn't follow the same model.

which was kind of my point.
Quote:
Originally Posted by horn
On a sidenote to make americans smile - in germany i currently pay 1.72 US Dollar /L.
to make you germans smile, an american car might get 4 km/L.
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Unread 24 May 2006, 15:12   #5
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Re: Big Oil Profits

Quote:
Originally Posted by horn
i was just confused... no need to start hitting below the belt calling me german
my apologies.
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Unread 24 May 2006, 15:42   #6
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Re: Big Oil Profits

Quote:
Originally Posted by Toccata & Fugue
*cough*
there are plenty of explanations for profits jumping along with prices,

including the likely cartel/price fixing,

but i don't see any that should elicit the "Quit whining and learn about supply and demand!" response i saw.
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Unread 24 May 2006, 15:44   #7
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Re: Big Oil Profits

Quote:
Originally Posted by Appoco's Economics GCSE
Car tel
definition:
evil money grabbing bastards getting together and working out what they're selling their product at so they can all make a nice profit.
See OPEC
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Unread 24 May 2006, 16:09   #8
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Exclamation Re: Big Oil Profits

Quote:
Originally Posted by acropolis
So intuitively I would expect that a jump in oil prices would result in a drop in oil profits, not the opposite.
If oil companies were simply middlemen, then yeah, one wouldn't expect their profits to go up or down much based on the price of oil (demand being fairly inelastic, at least in the short term). However, oil companies are also producers--that is, they own oil wells. So if the oil they were pumping out of the ground yesterday for $60/bbl now gets $70/bbl then their profits go up. \o/

Looking at Exxon's 1Q financial results, for example, I see that their upstream (production) operations accounted for 76% of their profits.
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Unread 24 May 2006, 16:16   #9
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Re: Big Oil Profits

Quote:
Originally Posted by Tactitus
If oil companies were simply middlemen, then yeah, one wouldn't expect their profits to go up or down much based on the price of oil (demand being fairly inelastic, at least in the short term). However, oil companies are also producers--that is, they own oil wells. So if the oil they were pumping out of the ground yesterday for $60/bbl now gets $70/bbl then their profits go up. \o/

Looking at Exxon's 1Q financial results, for example, I see that their upstream (production) operations accounted for 76% of their profits.
I was about to say that. If the market prices for crude oil rise and these companies 'produce' oil, then obviously they are going to make more money. Doesn't make much sense to them to sell cheaper than the saudis, does it?
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Unread 24 May 2006, 17:33   #10
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Re: Big Oil Profits

Quote:
Originally Posted by Tactitus
If oil companies were simply middlemen, then yeah, one wouldn't expect their profits to go up or down much based on the price of oil (demand being fairly inelastic, at least in the short term). However, oil companies are also producers--that is, they own oil wells. So if the oil they were pumping out of the ground yesterday for $60/bbl now gets $70/bbl then their profits go up. \o/
this is definitely true, however,

you can approximate them as middlemen, despite owning fields. in the end, they have a cost to produce a gallon of gasoline, and a price at which they sell that gallon. the model doesn't fundamentally change if they are buying the gallon from someone else or paying to lease land, drill, refine, and ship.
Quote:
Originally Posted by Toccata & Fugue
To confuse the issue even more. In the case of most oil companies they make an awful lot of money on speculation and investment. In terms of oil money it is guaranteed money so they don't spend a lot of time competing on price since it doesn't matter.
investment etc. does make it pretty complicated; companies 'purchased' the oil they have today with investments they made years (sometimes decades) ago.
Quote:
Originally Posted by wu_trax
Doesn't make much sense to them to sell cheaper than the saudis, does it?
in traditional economics, the way you get people to buy your product is by selling it cheaper.

traditional economics also has a handy phrase for 'raising your prices to match your competitors'
Quote:
Originally Posted by Toccata & Fugue
Also as far as I know the high status of oil companies makes them pretty much beyond regulation.
quite literally true. i don't think there is anything, despite all the bluster, that the US government can do about oil companies profiteering off of the shortage.

Last edited by acropolis; 24 May 2006 at 17:42.
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Unread 24 May 2006, 17:53   #11
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Re: Big Oil Profits

It's probably true in the longer term that oil prices wouldn't actually be as amazing for Big Oil as it is now. They are insulated from short term price hikes because they are in long term agreements with governments which secure the value of their holding. Of course if they outright "own" the drilling rights in an area then it's a pure boost in profit, as Tact has said.
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Unread 24 May 2006, 17:54   #12
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Re: Big Oil Profits

Todays figures indicate that the per day demand for crude oil was +3 million barrels more per day than was produced. The gasoline supply was -2.5 million barrels per day less than was produced.

I don't know what all of that means short term or long term. However, some things I have noticed is that gasoline prices react upward immidiately and drasticly to any cause for alarm in the market. Gasoline prices react slowly and reflectively to any over supply or good news.

However, since a fair percentage of the money in the county's retirement fund is in oil stocks, it helps my security in my retirement fund.
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Unread 24 May 2006, 17:55   #13
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Re: Big Oil Profits

Quote:
Originally Posted by acropolis
this is definitely true, however,

you can approximate them as middlemen, despite owning fields. in the end, they have a cost to produce a gallon of gasoline, and a price at which they sell that gallon. the model doesn't fundamentally change if they are buying the gallon from someone else or paying to lease land, drill, refine, and ship.in traditional economics, the way you get people to buy your product is by selling it cheaper.

traditional economics also has a handy phrase for 'raising your prices to match your competitors'
OK, let me use your apple-example:
Let's say you own an apple tree and after a little calculating you figured out that you can produce an apple for 0.20$, you can sell them for 0.24$.
Now, all of the sudden, 1 billion chinese all want apples. You competitors suddenly can sell their apples for 0.30$. Even if your costs of 0.20$ per apple did not change at all, it would be rather stupid for you not to take the 0.30$. I guess that is pretty traditional economics.
ofc, there still is the whole issue of speculation to get higher prices, but I dont see how you can keep the prices higher than the actual market prices for a longer period of time. Even the Opec can't do that any more, they lost too much market share for that in the last years.
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Unread 24 May 2006, 18:13   #14
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Re: Big Oil Profits

I don't understand your analogy why has your cost per apple increased? if an apple is crudely (heh) a barrel of oil, the cost (of production) per barrel hasn't increased. Your model seems to be based on steady demand and increasing production costs, in which case id agree with you that you'd try and sheild your customers, but the price isn't going up because you're having to pay your mexican slave workers more money but because more people want you lovely apples.

If you still get your apples at $0.20 and suddenly idi and kura come up and start asking for more apples, then they're joined by Sunday8pm you'll start selling them at more than $0.25.


Quote:
So intuitively I would expect that a jump in oil prices would result in a drop in oil profits
If that jump was caused on the production end rather than increasing consumer demand, yes.

edit: think of it like this, in a simplistic airline company model, the increasing oil prices are increasing the 'cost of production' of an airline seat, hence the airlines are having to put the cost per seat up to offset, but profits are still down.
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Unread 24 May 2006, 20:22   #15
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Re: Big Oil Profits

I have no sympathy for US consumers.
Come pay UK prices then see how you like it, bitches!
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Unread 24 May 2006, 20:31   #16
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Re: Big Oil Profits

none of his arguments make the slightest bit of sense.

I am also flabberghasted if he expected 'sympathy'
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Unread 24 May 2006, 21:12   #17
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Re: Big Oil Profits

Quote:
Originally Posted by Yahwe
none of his arguments make the slightest bit of sense.
do you even know what the point of my post was?
Quote:
Originally Posted by Yahwe
I am also flabberghasted if he expected 'sympathy'
i'm actually curious here. a lot of the time i try to flirt with the border between satire and honesty, but in this case i thought i was being pretty blatant, even translating cost into a /liter basis for the less mathematically inclined around (for ease of comparison).

did most people understand my point (that despite recent increases, it's still heller cheap here?)
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Unread 24 May 2006, 21:31   #18
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Re: Big Oil Profits

Quote:
Originally Posted by acropolis
do you even know what the point of my post was?
i'm actually curious here. a lot of the time i try to flirt with the border between satire and honesty, but in this case i thought i was being pretty blatant, even translating cost into a /liter basis for the less mathematically inclined around (for ease of comparison).

did most people understand my point (that despite recent increases, it's still heller cheap here?)
you are as funny as a German.
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Unread 24 May 2006, 21:43   #19
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Re: Big Oil Profits

http://www.sovereignty.org.uk/features/eco/biofuel.html
http://www.guardian.co.uk/g2/story/0...878122,00.html
Why not use cooking oil?
after all petrolium will eventually run out.

It is renewable, has similar performace to petrol and it is cheaper.
wether the duty is paid on it or not is a different story.
(after all what happens if you "fill your tank" in france or in Southern ireland?)

I am no horticulturist but why not get the afghans to grow sunflowers instead of poppys? That way it kills off the oil and heroin cartels
2 birds with 1 stone and all that.

Also the fumes off the vehicles will be better.
rather than choking on the number 22 bus, It puts you in the mood for a bag of chips...Just for the laugh of a pisshead been on the saturday night bevy session runing for taxi but not sure if he wants a run home or a munchie.

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Unread 24 May 2006, 21:44   #20
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Re: Big Oil Profits

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Unread 24 May 2006, 23:08   #21
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Re: Big Oil Profits

Although this has probably been pointed out I can't be arsed to read and check.

Oil is a pretty much a monopoly (OPEC). There is also higher demand than supply, and the gap is only going to widen as production inevitably drops off and India and China continue to expand their use. Producers can charge what they like (within sensible margins) and be assured it will be paid, because there is no other source, no alternative product to buy, and the result of not buying is financial collapse.

This is where any analogy with apple selling falls apart as
a) You can go somewhere else for your apples
b) You can eat something else other than apples
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Unread 25 May 2006, 07:36   #22
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Re: Big Oil Profits

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Originally Posted by meglamaniac
Oil is a pretty much a monopoly (OPEC).
Obviously OPEC do have an impact on world prices, but they only constitute something like 50% of the world's supply (although more of the proven reserves). Remember, OPEC doesn't include countries like Norway, Russia, US/Canada, etc.
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Unread 25 May 2006, 13:29   #23
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Re: Big Oil Profits

There are some alternative explanations rather than "it's a cartel" and "money-grubbing oil execs". These explanations are consistent with market economics - this means that they're 'fair' in so far as they do not represent a conspiracy against the public, unless of course you regard the market system itself as a conspiracy against the public

One is that the oil companies are selling oil that they bought at old prices, but selling it at a price high enough to pay for buying the next installment of crude (which has gone up in price). So, temporarily, they're making a big profit on that cheap oil they bought in the past, but profits should decline in future because they won't be making nearly so much on the more expensive stuff that resupplying with. This is a concept that should be familiar to any businessperson, right down to the small-time drug dealer. You've got to make enough money from your current supply to afford the next supply.

To use the apple analogy, you might have 100 apples that you bought at $0.20. You want to make a $0.03 profit per apple, so you could sell them at $0.23. But (due to increased demand/reduced supply) the next batch will cost $0.25 each. You can't afford to replace your current apple supply if you're selling apples at less than the replacement cost of an apple. Putting prices up now (say to $0.28) means that you can afford to keep the apple supply going, and whilst current prices are higher than they 'need' to be, a future supply crisis (which would cause even higher prices) is avoided. You'll make a hefty profit on your current apple batch ($0.08 per apple instead of $0.03), but you'll end up spending a lot of it when it's time to buy the next batch. If apple wholesale prices fall, you'll end up making a lower profit next time because you might be selling those $0.25 apples for $0.23.

Also, there have been numerous supply shocks in recent years, against a background of approaching "peak oil" - the point where we can't find more new oil than we're using up, leading to an eventual drop in supply. Say something like Katrina happens, damaging oil supply. Clearly, the oil companies are not going to see any immediate effect, because they maintain stockpiles of oil. The supply squeeze might be, say, 6 months down the line. But since consumers know that at some future point, prices are going to go up because of a supply squeeze, it becomes necessary to put prices up now in order to discourage panic buying which would erode stocks and make the supply squeeze much worse, perhaps even leading to rationing.

This is how a market system is meant to work; prices are used to convey information about current and future supply, and rationing is avoided by ensuring that rising prices discourage over-use (of course, one can argue that this is simply a different form of rationing, but it does also have the effect of discouraging non-essential use).

These are the theoretical justifications of higher profits. An interesting test will be next year's profits: if there are no supply shocks and oil prices fall, oil company profits should also fall as they don't need to sell their oil so expensively in order to afford their next batch of oil. This could lead to temporarily falling profits, as they're selling expensively-bought oil at the (lower) price necessary to buy the next lot.

I'm not sure how much I agree with these justifications, but there they are
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Unread 25 May 2006, 14:41   #24
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Re: Big Oil Profits

For various political reasons the OPEC cartel has been tolerated by various governments around the world. This confers a level of legitimacy on its operations. Against this background, the oil companies are doing nothing but respond to incentives.

Quote:
Originally Posted by Toccata & Fugue
As was said before oil companies for the most part own their oil reserves so they don't "buy it at old prices" they already have it, but nice try though.
Perhaps 'buy' is the wrong word; 'pay for' might be better. They still have to pay the costs of extracting and refining the oil and this is getting more expensive. Reduction in supply (Iraq, OPEC cuts) or refining capacity (Katrina) will cause the cost of getting oil from the ground to the pump to rise, and the oil companies pay for that. The point is that if prices are held down, encouraging demand, stockpiles would have to be eaten into. The increase in demand puts more pressure on the supply system. Oil companies are prevented from increasing supply by OPEC, so eventually this means that they'll just run out of oil, and the price increases that happen then will make the current ones look like nothing. Nobody wants this to happen; it'd be an economic disaster.

The US Congress has recently passed the Federal Energy Price Protection Act of 2006 which effectively outlaws "price gouging" as they describe it. Amazingly, the act does not specify what price gouging is, and merely says that the Federal Trade Comission must come up with a definition within 6 months!

Assuming they define price gouging as "putting prices up before stockpiles have fallen", then they may be creating a situation where prices are, by law, held down for a period of time. This means that prices are "artificially" low, and encourages people to buy the cheap petrol while it's still available - hardly the kind of behaviour you want to encourage when there's a supply crisis on the way. I'm not sure how big these stockpiles are, but I'd guess that a nationwide spike in demand would deplete those stockpiles pretty quickly. The point: present price restrictions increase demand whereas present price increases decrease demand. Knowing that there's a supply problem ahead, which do you want to do? The important thing here is the relative price levels, not the absolute price levels. The rush to buy would occur even if current prices were high-ish; the fear is of higher prices ahead.

I don't dispute that OPEC and the oil companies are responsible for the base price level being higher than it needs to be, thus guaranteeing fat profits all round at the consumer's expense. This is the problem, not prices rising in response to supply/demand issues.
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Unread 25 May 2006, 15:23   #25
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Re: Big Oil Profits

Quote:
Originally Posted by Toccata & Fugue
As was said before oil companies for the most part own their oil reserves so they don't "buy it at old prices" they already have it, but nice try though.

Furthermore there is controlled supply (through a cartel or oligopoly if you prefer), they could produce a lot more oil but they choose not to since it would flood the market and damage their own profits.

Also we are talking about profit rather than turnover, the oil companies are making more money above and beyond any extra costs of production. They have been making profits year on year and this year we have see profit growth of 75% and 89% which is just gigantic.

http://www.consumeraffairs.com/news0...ice_probe.html

In any case its questionable whether you can realistically have a "proper" market system for oil given the numerous political factors involved, given the human cost, the military presence in oil wealthy regions and the number of state owned oil companies and so forth.
First of all, I just stumbled upon this:
http://www.theglobaleducationproject...rgy-supply.php
This doesnt have much to do with the post above, I just thought that since we are at the topic of oil right now, some of the people around here might be interested in some statistical data. I didnt read much of it thought and I have no idea how reliable all of that is.

As for the post above, as far as I know the supply is not as much controlled as it used to be for example in the 70s. The countries in the middle east want to sell more oil and are investing lots of money in infrastructure to increase their production. The quotas set by the OPEC are mostly ignored anyway. I really dont see how any of these evil oil companies can do much to reduce the oil prices if even the entire OPEC has difficulties keeping the prices at the current level and not let them rise any further.
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Unread 25 May 2006, 15:34   #26
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Re: Big Oil Profits

Saddam Hussein invaded Kuwait for exceeding their OPEC production quota!


Well actually he invaded Kuwait because he was a deluded power-mad aggressive expansionistic dictator, but that was the reason he gave.
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Unread 25 May 2006, 16:20   #27
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Re: Big Oil Profits

Quote:
Originally Posted by Toccata & Fugue
Well As I said it's a complicated issue. I broadly agree with the logic of what you are saying but I think that it is naive to even attempt to apply market doctrine in a market where there are so many agravating factors
I sort of see your point, but I think it's important to separate out the issues about the general level of prices, and the current situation.

From the initial post in the thread, the complaints are not that oil/petrol is too expensive. The complaint is that prices have gone up and that oil companies are making a big profit on this. Nobody is saying "petrol costs too much", in fact people seem quite willing to accept that petrol is fairly cheap. The fact that Europeans pay far more for it than Americans proves the point; it's certainly not too expensive for people to keep buying it, even at European price levels.

What I'm saying is that the temporary elevated profit level is justified because the oil companies need to bring in more money today to pay for expensive oil tomorrow (whether buying it from a supplier or paying higher costs to extract and refine it). This is where the economic illiteracy comes in, because people are getting angry at a necessary rise in prices, whilst completely ignoring the big picture which includes a supply-restricting cartel (to be fair, the US govt. is starting to wise up on this, though it's mostly because the cartel includes Iran).
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