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11/09/2005 Archived Entry: "The innumerate media"

I just heard Miles O'Brien on CNN interviewing some flack from the American Petroleum Institute, hammering him with the question, "if crude oil prices went up 33% [or something like that], why did oil company profits rise 62%? Isn't that price gouging?" (I'm quoting from memory here.)

The flack waffled on about how you have to look at short term variations vs. long term, and more obscure spin which didn't convince me and surely won't convince any Congressional committee. He should lose his job for incompetence.

The real answer is much simpler. Whenever you subtract two large quantities to get a small difference, a small change in either of the quantities can make a huge relative change in the difference. Sales and costs are large quantities. Profit is the difference.

For example: Suppose I sell a widget for $1.00, and it costs me $0.99 to make it. That's a profit of $0.01 per unit. Now suppose I raise the price to $1.01. My profit is now $0.02 per unit. A 1% increase in price has caused a 100% increase in profit! I don't know the normal profit margin of an oil company*, but if there's a 62% increase in profit after a 33% increase in cost, I'd hazard a guess that the price rise actually tracked costs pretty well, with only a small overcompensation.

Even a CNN anchor, or a Congressman, should be able to understand that.  —brad

* Update: Google to the rescue. Exxon Mobil reported 3Q05 earnings of $8.3 B on revenue of $100.72 B. That's 8.24% profit. In 3Q04 they reported earnings of $6.23 B on revenue of $76.38 B. That's 8.16% profit. CNN is further confusing the issue by reporting raw earnings growth, rather than percentage profit growth.