TVM Application
Full value accounting in the oil industry

How much does a gallon of gas really cost?

COMMENTARY

Peter Burgess

How much does a gallon of gas really cost?

If you own a car, and use it to travel around, you might think that the cost of a gallon of gas is what you pay for it at the pump. There was a time, not so long ago in the United States when you could get a gallon of regular gas for 27 cents. That was the price I used to pay in Trenton when I was commuting daily to Secaucus in North Jersey ... circa 1975. A couple of years later, I remember Senator Bradley arguing that Americans would never put up with gas priced at a dollar a gallon ... and now (2011) we are positive about the economy when regular gasoline is under $4.00 at the pump.

It is about 20 years ago when I first started to talk about profit being the biggest single cost in the American economy. Few people understand what I mean by this, but it is very simple. When something is purchased, the price it is sold for becomes the cost to the buyer. To the consumer, that final price is the cost. But to the producer, the price is made up of the production (and all the associated costs ... marketing, distribution, overhead, etc) PLUS profit.

In a capitalist market economy, everything works well as long as there are adequate ... maybe a better phrase is ... big profits. Everything the oil company does has a cost element and a profit element.

This type of accounting is well understood, and management information systems and financial reporting in the oil industry is well defined, and the profitability of big integrated oil companies quite spectacular.

There is, however, one issue in the accounting that is totally ignored which makes the accounting totally wrong. Under GAAP** accounting rules there is no accounting for the the actual consumption of naturally occurring raw materials ... they are brought into the accounting at zero cost. The only 'costs' that are included in the accounting are the costs associated with paying for the rights to access the naturally occuring materials and the costs associated with such things as exploration, exploratory drilling and finally the extraction, storage and trransportation of the raw material ... the crude oil. Subsequent processing ... refining ... is costed ... but the consumption of the raw material is ignored.

This is a nonsensical state of affairs ... but it is the way oil company accounting is done. Because of this, oil companies seem to be highly profitable enterprises, and they are able to attract all the capital they want.

The question now becomes, what pricing should be associated with the consumption of a raw material like naturally occuring crude oil and similar materials. I would argue that the pricing should be the lower of actual cost or replacement cost, whichever is the lower. The actual cost in the case of most naturally occuring materials is essentially infinite ... crude oil deposits represent some millions of years of geological history, and the cost astronomical ... literally. The replacement cost is lower ... and may be computed by thinking in terms of the cost of alternative energy technologies at their present state of development.

The media often refers to the cost of alternative energy as being 10 times the cost of naturally occuring fossil fuels ... but this begs the question of full cost costing I have just described.

The gas that customers buy now for $4.00 a gallon has probably cost, not $2.00 a gallon to produce (assuming a 50% profit margin) but something more like $12,00 a gallon and society has a loss of $8.00 a gallon for every gallon used.

Native Americans, and most indigineous people have much more respect for the land and its bounty than the modern corporate state and the modern corporation. The corporate world has no interest in generational thinking ... but ten or twenty generations from now the corporate world will be bankrupt and out of business, taking humanity with it.

As a former corporate CFO I am something of a believer in having the right metrics to give incentive to making the best decisions. If we are interested in getting consumption of fossil fuels reduced and the use of alternative fuels encouraged, a starting point would be to start thinking in terms of full value accounting rather than the essentially wrong GAAP cost accounting that is now being used.

I am also aware that no corporate CFO is going to be allowed to change to full value accounting because of the impact it will have on profitability and stock prices ... but that does not mean that society needs to accept this. There is nothing to stop society making some external calculations to re=present the GAAP accounts into a full value accounting format. This will be a 'little messy' in the beginning, but it will sort out quite quickly, and the data should help move the dialog about alternative fuels forward in an appropriate manner.

The 'guts' of this concept are, I believe, pretty solid ... but as in many fields of endevour, the 'devil's in the details'. Please get in touch if you believe this is something that should be made something of a priority in developing the full framework of full value accounting (TrueValueMetrics) being developed.

** GAAP is Generally Accepted Accounting Principles