Petroleum Economics - Capital Formation in the Petroleum Industry (TP 2431, Petr. Tech., Sept. 1948)

This paper describes the sources of funds required by the petroleum industry to finance capital expenditures and also presents a discussion of the effect of rising construction costs on these expenditures. The petroleum industry obtains its capital funds from several sources: (I) internal, from retained cash earnings; and (2) external, from borrowings and the sale of securities to the public. The upward trend of capital expenditures of the petroleum industry is caused in the main by the influence of two powerful factors: (I) the physical growth in the demand for oils; and (2) the rising cost of drilling wells and constructing refineries, pipe lines, and other facilities. The segregation of these factors is accomplished by deflating the actual capital expenditures so that they are shown in terms of 1939 costs and then subtracting the adjusted series from the actual figures to yield a set of data representing the expenditures made on account of higher costs. Rising costs affect prices and the portion attributable to this factor had to be generated from the cash earnings of the industry, which called for higher oil prices. Introduction Capital may be defined as "wealth employed in or available for production." All production requires capital. Expanding industries require more capital than static ones, and technological industries employ more capital than. those in which little equipment is needed. The petroleum industry is both rapidly growing and highly technological, and, being a large industry, its capital requirements are prodigious, amounting to about one-seventh of the total of all American business, excluding agriculture.* Capital formation may be defined as the method by which the wealth or capital needed in the productive processes is created. There are various ways in which capital funds may be obtained but there is only one way in which capital can be created—out of production in excess of consumption, that is, savings. The physical realities are simple, but the monetary concepts are complicated because the mechanism of credit can draw upon future savings. Source of Capital Funds An industry, such as the petroleum industry, can obtain its capital funds from