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June 28,1974

The record profits earned by major
U.S. oil companies in the wake of
the Arab oil embargo have triggered
a public outcry against the industry
by a number of consumer groups.
Coming at a time of shortages and
sharply rising consumer prices, the
spectacular upsurge in oil profits has
aroused suspicions that producers
may have taken advantage of the
embargo to reap excessive profits.
Some of the industry's critics have
even suggested that the large com­
panies deliberately contrived the
energy shortage to push up prices
and profits, to drive out indepen­
dent refiners and marketers and to
force a relaxation of stringent en­
vironmental standards.
The oil companies categorically
deny these charges. They contend
that the nation's energy problems
are the outgrowth of inadequate
investment incentives, that the in­
dustry's profit gain in 1973 stemmed
largely from foreign sales, and that
domestic prices for refined products
have been raised only enough to
compensate for the rising cost of
imported and domestic
crude oil.
Size and performance
Some of the criticism levelled
against the industry undoubtedly
can be traced to its enormous size
and economic influence. In terms
of sales, the petroleum industry is
the third largest business group in
the United States, outranked only
by the agribusiness and construc­
tion sectors. The 18 largest U.S.
petroleum companies rank among
the top 100 manufacturing firms in
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the nation in terms of sales, and they
account for about one-half of total
U.S. crude oil production.
Even so, the uniqueness of the in­
dustry's structure lies not in the size
of its corporations nor in its high
degree of concentration, which
actually is somewhat less than in
other basic industries, but rather in
its high degree of vertical integra­
tion. The 18 largest producers are
fully integrated and are important
forces in all four of the industry's
major activities— crude-oil explora­
tion and production,transportation,
refining and marketing. These same
companies also account for the bulk
of the crude oil produced overseas
— in Canada, South America, the
Middle East, Africa and the Far East.
But in addition to those fully inte­
grated companies— the so-called
majors—the industry embraces
other large firms that are partially
integrated as well as several thous­
and smaller "independents."
In view of the industry's multi­
layered structure and international
involvements, the task of monitor­
ing its financial performance is quite
difficult. Nonetheless, by any meas­
ure of profitability, 1973 was a ban­
ner year for the American petroleum
industry. The 97 largest U.S. oil
companies boosted their total earn­
ings 53 percent in 1973 to a record
$9.9 billion, and thereby far sur­
passed the 31-percent annual gain
recorded by all of manufacturing
(First National City Bank data). The
industry's profit performance also
was outstanding measured by a
15.6-percent return on net worth.
(continued on page 2)

Opinions expressed in this newsletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System.

But the bright results achieved in
1973 and early 1974 followed a fouryear period which was perhaps the
flattest in the industry's postwar
history. During that 1968-72 period,
earnings rose at an annual rate of
only 1.5 percent, compared with a
5 .2-percent rate for all of manufac­
turing. Moreover, the industry's re­
turn on net worth not only moved
steadily lower over the period, but
averaged only 11.6 percent.
The Arab take
The oil-profits drama has been
played against a background of
changing relationships between the
major international oil companies
and the eleven members of the
Organization of Petroleum Export­
ing Countries (OPEC), who account
for about four-fifths of world
crude-oil exports. In 1970, Libya
took the lead by securing higher
taxes and royalties through means
of a production cutback. In early
1971 the Persian Gulf countries,
through the Tehran agreement,
achieved a pattern of higher
"posted" prices— reference prices
for calculating taxes and royalties—
as well as a higher tax rate on
profits. In early 1973, Saudi Arabia
and two other Gulf states moved
into direct ownership, with a 25percent shareholding scheduled to
reach 51 percent by 1982. From the
host countries' new share of output,
specified portions of oil were to be
sold back to the companies, with the
price of this "buy back" oil to be
higher than the cost of their own
"equity" crude. Iran and Iraq fully
nationalized their operations.2
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These agreements served to cloud
the 1973 supply outlook— even
before the imposition of the em­
bargo. For that matter, the supply
situation already was uncomfortably
tight, in part because U.S. produc­
tion of crude oil had been declining
ever since 1970. With demand
meanwhile soaring because of the
worldwide economic boom, market
prices for foreign crude oil began
to rise even faster than posted
prices, boosting the companies'
profit per barrel.
The denouement of course came
last fall, with the embargo, produc­
tion cutbacks, and unprecedented
price increases, following the deci­
sion by the Persian Gulf countries
to repudiate the 1971 Tehran
agreement and to become them­
selves the sole arbiters of crude
prices. By year-end, their actions
had raised their revenue to $7.12
per barrel, compared with $1.51 at
the start of the year. The Arabs also
indicated that the price of "buy
back" oil would have to be raised
to reflect the sizeable increase in
market prices, although the "buy
back" price remained undecided
throughout 1973, forcing the com­
panies to estimate this cost in their
earnings reports. Yet, despite these
actions, the companies' profits con­
tinued to benefit from soaring
worldwide demand.
Firming product prices also gave a
large lift to profit margins in Euro­
pean "downstream" operations of
refining and marketing— while over­
seas earnings also benefited from

the devaluation of the dollar (which
raised the conversion value of
foreign profits) plus the rising value
of inventories and the strong de­
mand for petrochemical products.
As a consequence, almost two-thirds
of major oil company profits last
year came from overseas
operations.
The U.S. return
In the United States, the industry
benefited from the increased con­
sumption of refined products, the
end of gasoline price wars, and a
sharp increase in domestic crudeoil prices. However, price controls
prevented domestic prices from
soaring to foreign levels. Refiners
were allowed to pass on the higher
costs of imported crude, so that
refined-product prices jumped 39
percent at wholesale, but eventually
increases were allowed only once
a month, thereby slowing the rise
in profits. More importantly, price
controls held domestic prices for
crude below foreign levels.

Recognizing that the differential be­
tween foreign and domestic prices
was encouraging exporting and
hoarding, the Cost of Living Council
last August freed at least one-quarter
of U.S. production from controls
— "new" oil, or output in excess of
1972 levels— and also raised the
ceiling price on "old" oil. As foreign
prices continued to soar, however,
the weighted average of U.S. crude
prices under this "two-tier" system
lagged behind, and the CO LC finally
raised the price of "old" oil again.
In late December, foreign prices

averaged $9.50 per barrel, while the
weighted average of U.S. prices
stood at $6.50 per barrel. Nonethe­
less, the doubling of U.S. crude-oil
prices during 1973 transformed the
prospects for domestic producers
and encouraged an upsurge in
drilling activity.
Sharp increases in worldwide prices
for crude and refined products had
a significant impact on profits dur­
ing the first quarter of 1974. Profits
for thirty large U.S.-based com­
panies jumped 78 percent above
the year-ago level, partly because of
the huge inventory profits earned
on foreign oil— one-shot gains made
by revaluing earlier purchases of in­
ventory at today's higher prices.
Profits would have been even larger
had not the companies established
a contingency fund to cover antici­
pated but unknown costs of foreign
"buy back" oil.
Even so, the companies contend that
they might not be able to maintain
this strong profits performance, be­
cause of the need to acquire new
inventory at higher prices and
because of nationalization moves
abroad. Indeed, the recent "interim
agreement" between American
firms and the Saudi Arabian govern­
ment left the latter with a 60-percent
(up from 25-percent) participation
in Saudi Arabian operations. Agree­
ments such as this could signal an
end to American access to lowcost foreign crude, and over the
long-run might even result in the
complete elimination of U.S. owner­
ship rights overseas.
Yvonne Levy

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BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks

Amount
Outstanding
6 /1 2 /7 4

Change
from
6 /5 /7 4

Change from
year ago
Dollar
Percent

+
+
+
+
+
+

+
+
+
+
+
+
+
+
+
+
+

+ 12.07
+ 14.37
22.35
+ 15.02
+ 17.44
+ 10.38
11.37
+ 12.59
+
9.91
+
4.44
— 22.33
+ 12.73
1.89
+ 32.96
—
4.23
+ 46.93

83,476
65,111
1,827
23,070
19,267
9,281
5,162
13,203
78,882
22,480
327
54,825
17,829
27,367
6,897
14,138

Weekly Averages
of Daily Figures

Week ended
6 /1 2 /7 4

Week ended
6 /5 /7 4

Comparable
year-ago period

23
72
49

86
256
170

44
229
-1 8 5

+ 1,963

+ 1,371

+ 626

+

+

+ 575

-

+
+
+
—

-

+
—

+

876
632
484
67
35
23
14
258
229
671
113
39
29
120
190
174

8,993
8,179
526
3,013
2,861
873
662
1,476 .
7,112
955
94
6,190
344
6,784
305
4,516

Loans (gross) adjusted and investments*
Loans gross adjusted—
Securities loans
Commercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
Other Securities
Deposits (less cash items)-—total*
Demand deposits adjusted
U.S. Government deposits
Time deposits— total*
Savings
Other time I.P.C.
State and political subdivisions
(Large negotiable CD's)

Member Bank Reserve Position
Excess Reserves
Borrowings
Net free ( + ) / Net borrowed ( —)

-

-

Federal Funds— Seven Large Banks
Interbank Federal funds transactions
Net purchases (+ ) / Net sales ( —)
Transactions: U.S. securities dealers
Net loans ( + ) / Net borrowings ( - )

904

401

"■Includes items not shown separately.

Information on this and other publications can be obtained by calling or writing the
Administrative Services Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco, California 94120. Phone (415) 397-1137.
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