UNDERSTANDING SMALL BUSINESS

ENERGY

There is little doubt that energy costs are of great concern to small business. As energy costs soar, we all are affected. But first we should realize that providing energy is the role of thousands of small businesses involved in exploration and production, refining and marketing, the pipelines, service stations and other companies, not just the industrial giants.

Let me share some information so we better understand the domestic energy business.

It supplies about 6 million barrels (bbl) of crude oil daily while we import more than 8 million bbl. Major overseas supplies come from the 11 nation cartel called OPEC plus Mexico, the North Sea, Canada, Columbia, the UK, Norway and other smaller producing countries. This crude oil is processed through approximately 158 refineries (down from about 200 in 1990). They produce about 8.5million barrels of gasoline daily, plus other products such as aviation turbine fuel, heating oil, chemical feedstock and a myriad of other products.

There are over 30 recognizable oil companies involved in this effort. The second largest refining company in the country, incidentally, was put together and is controlled by a man who was born in Staten Island, New York, went to Manhattan College in the Bronx and got his start as a trader on Wall street. So much for the myth of the Texas oilmen controlling the industry.

Price is set by supply and demand as crude oil and other products are continually traded on the Mercantile Exchange (Merc) in New York (prices are always available on the internet and daily in the press). There are many other commodities from farm products to metals, traded on similar exchanges in New York, Chicago, London and other places around the world. All of these products are traded openly and price is continually transparent. In the refining sector, because crude oil, gasoline, turbine fuel and heating oil are all traded in an open and transparent fashion on the Merc, only the most efficient refineries can make a profit. An improvement in finished product margins immediately leads to an increase of raw materials as traders' arbitrage across the refineries.

Historically refineries do not make returns equal to the U.S. manufacturing sector OPEC, the oil cartel has the ability to effect price by holding back supplies from the market and they did this in 1999, after crude oil prices fell to around $10 to $12 per bbl. At that price, oil is being produced below cost, marginal production is shut in, profits are minimal and the cartel was forced to withhold production to increase price. The result was the crude oil price exploded beyond $30.00 a barrel and the price of gasoline approached and in some instances exceeded $2.00 a gallon, exacerbated by environmental demands for many different and costly fuel blends.

All oil producers benefited from this crude oil price increase. The cartel however, also wants some sort of equilibrium. If price gets too high, it encourages more exploration lessening their share of the worldwide market or worse, it runs the risk of causing a worldwide recession, resulting in reduced demand for crude oil. The crude prices of the late 1990's were clearly too low. The U.S. economy grew as a result. But many suffered. 70% of Mexico's off shore income is from crude oil. The percentage is higher in many Arab countries. Small producers shut in production because it was too costly to operate. Many economists and others believe that crude oil prices should range in the mid $20's per barrel.

Finally what do energy companies do with their profits? They invest and reinvest. The proposed pipeline from Alaska to the Midwest will cost in the $6 to 7 billion range. Drilling in deepwater in the Gulf of Mexico (up to $500 million per platform) and building new plants and facilities cost enormous sums. They also pay dividends to their stockholders, many of which are the very mutual funds you and I invest in. Finally they pay salaries to their employees and executives and while they pay well, they never paid at the level earned by the hi-tech companies we saw flourish in the late 90's.

The industry also contributes significantly to the government in terms of royalty payments, fees for off shore drilling rights and gasoline, diesel and aviation fuel taxes. In an industry as all encompassing, as widespread and global and as complex as the energy industry, there is no possibility of a conspiracy to set prices. What does all this mean to the small businessman? First of all it is important to understand that we need a national energy policy that insures the economy of our country continues to grow, policies that will assure supplies of fuel and electricity at affordable prices and policies that reasonably respect the environment. In my view, energy companies do not threaten small business. The real threat to small business is unreasonable regulation, price controls and excessive government intervention, the very suggestions so many are currently offering as a solution.