The U.S. Government's Black Box of Fossil Fuel Giveaways

In the 2020 presidential election, then-candidate Joe Biden pinpointed the U.S.’s greatest challenge as “the climate emergency.”[1] Twelve percent of all voters and 22 percent of Democratic voters agreed, naming climate as their number one issue.[2]

One of President Biden’s big takedown targets is fossil-fuel subsidies, specifically those for the oil and gas (O&G) industry. One of his first moves was to pause O&G leasing on federal (public) lands and offshore. The move won him no friends in the O&G sector with the American Petroleum Institute claiming that cumulative GDP losses will total $700 billion and cost 416,000 sector jobs.[3]

Beyond halting leasing on federal lands and offshore, most of these nebulous subsidies reside in a black box stuffed with complex tax deductions, accelerated depreciation, arcane accounting methods, and industry’s piggybacking on work already done by the government.[4] Subsidy estimates range from a conservative $2.3 billion per year all the way to $7.3 trillion if the cost of defense to protect foreign oil supplies is considered (U.S. aircraft carriers in the Persian Gulf between 1976 and 2007).[5],[6] Minus externalities, the U.S. Treasury Department tags total subsidies to O&G as $4.7 billion annually.[7] The lower estimates, including Treasury’s, often omit externalities – knock-on system effects not accounted for like climate-induced damages and health-and-human impacts – as much as $188 billion per year.[8]

Meanwhile climate change is already having a big impact on U.S. economic growth, resulting in destruction of assets, property, and businesses. One estimate ties the burning of fossil fuels to “extreme weather events” costing the U.S. economy a minimum of $418.4 billion per year over the past decade, and this omits three major hurricanes plus 76 western wildfires in 9 states.[9],[10] Those events alone totaled $300 billion in 2017, and the 2005 superstorm Hurricane Katrina itself left a $160 billion swath of destruction in its wake.[11],[12] Additionally, if reserves are developed, the carbon released into the atmosphere hurtles temperature rise way past the 1.5℃ safety net (See Figure 2).

Figure 2 - Fossil Fuel Developed Reserves and Gigatonnes of Carbon Dioxide Burned to Stay Within Intergovernmental Panel on Climate Change Limits (Redman 2017, 8)

It's All Relative – Over the last decade, the U.S. economy added $610 billion per year (average, minus year 2009).[13] For reference, the U.S. GDP in 2019 was $21.43 trillion, and the federal government predicts tax revenue of $3.5 trillion for 2021.[14],[15] So extreme weather events from fossil fuels that cost the United States $300 billion to $400 billion per year, jeopardizing 50 percent of U.S. economic growth or more, or 1.4 percent of GDP (conservative).[16]

How much does the U.S. government subsidize the fossil fuel industry, especially O&G? And do those benefits outweigh the growing trendline of economic devastation left after their use?

It’s History – For the past 200 years, the U.S. government has supported power and energy generation for two reasons (See Figure 3).[17] First, to help fledgling industries, and second, to cover the spread between a public and a private good.[18] Coal helped fuel the Industrial Revolution, both here and in Europe.[19] Oil became the dominant fuel with the ascendance of the internal combustion engine in the early 20th century, and oil pipeline conversion to carry natural gas was a World War II defense measure.[20] The U.S. government subsidized large-scale hydro power during the Depression, and peacetime nuclear power also came from World War II research.[21] NASA funding boosted solar R&D with $1 billion (in 2010 dollars) spent between 1950 and 2006.[22] The unprecedented growth of the U.S. economy is inextricably tied to energy use – mostly fossil fuels.[23]

 Figure 3 - Primary U.S. Energy Consumption vs. GDP (Pfund 2011, p. 11)      

One O&G industry watchdog group, Oil Change International, defines subsidies as “any government action that lowers the cost of production, lowers the cost of consumption, or raises prices received by producers.”[24] Some examples are direct payments (like grants), transfer of opportunities or risks, foregone revenue (like capping liability), or providing below-market rates for goods and services.[25] While defining subsidies is often a hair-splitting exercise, O&G subsidies are usually synonymous with tax policy.[26]

It's Hidden in the Tax Code – Oil Change says that, all in, the U.S. government gave O&G $20.5 billion in production subsidies between 2015 and 2016.[27] Federal breaks totaled $14.7 billion, and states gave $5.8 billion.[28] Oil Change’s 2017 report provides a complete list of all fossil-fuel subsidies (Appendix I), with a few of the most valuable listed here (See Figure 4).

·        Deduction for Intangible Drilling Costs (created in 1916), $2.3 billion per year – A 100 percent tax deduction for costs not tied to final operation of O&G wells, like exploration and development. [29],[30] Vertically integrated companies get 70 percent of this with a 5-year accelerated depreciation on the remaining 30 percent. This deduction incentivizes finding and developing new petroleum reserves.[31]

Figure 4 - Largest Federal Fossil Fuel Subsidies by Annual Average (2015-2016)(Redman 2017, p. 11)

·        Last-In, First-Out Accounting (LIFO), $1.7 billion per year – The most recent prices for reserve inventories become a cost (COGS), and the oldest inventories retain historical pricing. This allows O&G to undervalue reservoir inventory and take larger costs as deductions.[32]

·        Lost Royalties on Federal Lands, $1.2 billion per year – Outdated procedures and calculations on federal lands short royalty payments to government and, thus, taxpayers.[33]

·        Enhanced Oil Recovery (EOR), $235 million per year with Office of Management and Budget estimates of $8.8 billion by 2027 – A 15 percent tax credit for costs of hard-to-get oil using a tertiary injectant (like hydraulic fracturing fluid or carbon dioxide).[34] The much-discussed price for carbon is codified in current tax code as a credit of $20 per metric tonne to dump carbon underground (carbon capture) by using it as a well injectant.[35]

·        Master Limited Partnerships (MLPs), $1.6 billion per year – Special MLP entities are exempt from corporate income taxes and publicly tradeable on stock markets. The majority are fossil fuel firms.[36]

While these subsidies come at a price, it’s a bargain for the fossil fuel industry. For the annual subsidies the industry receives, it donated $354 million in campaign contributions with 88 percent of that going to Republican candidates.[37] Of the $20.5 billion fossil-fuel subsidy total, 80 percent of that went to O&G over other sources.[38] In fact, one economic analysis shows that of U.S. proven oil resources, nearly half aren’t profitable without government breaks.[39]

Figure 5 - Value of Permanent Tax Breaks for Renewable Energy Compared to Fossil Fuels (FY2016)(Redman 2017, p. 12)

Therein lies the issue – grey-suit tax policy is, at root, political. President Biden can issue executive orders impacting O&G by directing regulatory agencies like the Environmental Protection Agency, the Department of Energy, and the Department of the Interior. But any tax policy changes must go through Congress.[40]

To be sure, renewable energy development has also received government help but at nowhere near the level or consistency to that of fossil fuels. In 2013, the U.S. Energy Information Administration reported total energy subsidies as $15 billion per year with $5.3 billion for solar and $5.9 billion for wind.[41] This is a high-water mark, though, during President Obama’s tenure when the 30 percent Investment Tax Credit (ITC) goosed renewable emplacement.

Yet other relative figures may be more telling. As a percentage of inflation-adjusted government spending, nuclear subsidies equaled more than 1 percent (1.0%) of the federal budget in the first 15 years of subsidy life.[42] O&G received one-half of one percent (0.5%), and renewable energy one-tenth of one percent (0.1%).[43] In inflation-adjusted dollars, nuclear received $3.3 billion, O&G $1.8 billion, with renewable energy trailing at $400 million.[44]

Figure 6 - Historical Average of Annual Federal Energy Subsidies (Pfund, p. 7)

Tax-code fixtures like MLPs have never been extended to renewable energy ventures.[45] And permanent tax breaks in the tax code for fossil fuels are seven times those than for renewables.[46] Additionally, the two enticements to renewable energy investment – the ITC for solar, wind, and geothermal, and the Production Tax Credit (PTC) for wind – have been given short runways and allowed to lapse a number of times, creating a boom-bust cycle for renewable energy investment.[47]

It's Broken Economics – These O&G subsidies act as a negative carbon price, artificially depressing the costs of using hydrocarbons as well as producing them.[48] Not only do subsidies hide the truer costs of fossil fuels, these financial benefits incentivize infrastructure spending, which takes decades to fully depreciate and retire, thus locking in use.

One way to fix the “broken economics” of carbon pricing is by capturing system externalities like increased air pollution and health effects, destruction of natural capital, and extreme weather devastation. In trying to assign a truer price to hydrocarbons, the Obama Administration assigned the social cost of carbon (“all in”) as $36 per metric tonne.[49] With the United States emitting 5.2 billion metric tonnes of CO2 (2016), that complete social cost was $186 billion.[50] The International Monetary Fund had a much higher estimate for the United States’ post-tax subsidy - $686 billion also considering climate change and infrastructure damage, and health and human impacts.[51]

Another system effect not considered is shifted liability.[52] For example, insufficient bonding for damages when deep drillers trigger earthquakes and taxpayers to cover the costs of infrastructure damage.[53] In Texas alone, O&G companies cause $2 billion worth of damage to roads annually, yet taxpayers cover the bill.[54]

Health costs are another area heavily impacted by the burning of fossil fuels. Globally, health and economic costs from burning fossil fuels totaled $2.9 trillion (2018) from work absences, years of life lost, and early mortality.[55] That equals $8.8 billion per day.[56] More than 43 million Americans live in areas with heavy air pollution.[57] The cost of health damages stemming from the U.S. energy sector totaled $188 billion (2011).[58] The 2006, 14-day heat wave in California affected 36 million people, sent more than 16,000 to emergency rooms, caused another 152,000 outpatient visits and 1,620 hospitalizations.[59] The total costs for these incidents was estimated at $207 million.[60]

Depending on the subsidy estimate ($4.7 billion to $20.5 billion and beyond), even the higher numbers are fractional compared to the human and property damages extreme weather events are wreaking. There are a couple of simple remedies for this broken economic system. First, put a price on carbon and bring all system effects into account. This is one option even ExxonMobil is lobbying for with one, “oh-yeah” catch – the company is indemnified from climate change liability.[61] And second, get rid of all subsidies, including those hidden in the tax code. This will, however, require Congressional approval.

At root, this is ultimately a demand problem. We keep burning fossil fuels, and industry keeps supplying them. Yet the negative carbon price subsidies artificially inflate petroleum’s value. Until this is fixed, the marketplace alone won’t reduce its use.

References

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[1] (Biden for President 2020)

[2] (Osaka, Biden green 2020)

[3] (American Petroleum Institute and OnLocation, Inc. 2020, 2)

[4] (Pfund 2011, 17)

[5] (RMPBS News Staff 2020)

[6] (Pfund 2011, 28)

[7] (RMPBS News Staff 2020)

[8] (Watson, McCarthy and Hisas 2017, 5)

[9] (Leahy 2017)

[10] (Watson, McCarthy and Hisas 2017, 2)

[11] (Leahy 2017)

[12] (Watson, McCarthy and Hisas 2017, 2)

[13] (Watson, McCarthy and Hisas 2017, 5)

[14] (TRADING ECONOMICS 2020)

[15] (Congressional Budget Office n.d.)

[16] (Watson, McCarthy and Hisas 2017, 5)

[17] (Pfund 2011, 11)

[18] (Pfund 2011, 11)

[19] (Pfund 2011, 11)

[20] (Pfund 2011, 11)

[21] (Pfund 2011, 11, 17-18)

[22] (Pfund 2011, 18)

[23] (Pfund 2011, 11)

[24] (Redman 2017, 7)

[25] (Redman 2017, 7)

[26] (Redman 2017, 13, 23)

[27] (Redman 2017, 5)

[28] (Redman 2017, 5)

[29] (RMPBS News Staff 2020)

[30] (Redman 2017, 17)

[31] (Redman 2017, 17)

[32] (Redman 2017, 17)

[33] (Redman 2017, 17)

[34] (Redman 2017, 18)

[35] (Redman 2017, 18)

[36] (Redman 2017, 17)

[37] (Redman 2017, 5, 16)

[38] (Redman 2017, 9, 10)

[39] (Redman 2017, 15)

[40] (Pfund 2011, 13)

[41] (RMPBS News Staff 2020)

[42] (Pfund 2011, 6)

[43] (Pfund 2011, 6)

[44] (Pfund 2011, 6)

[45] (Redman 2017, 17, 35)

[46] (Redman 2017, 12)

[47] (Redman 2017, 12)

[48] (Redman 2017, 9)

[49] (Redman 2017, 22)

[50] (Redman 2017, 22)

[51] (Redman 2017, 22)

[52] (Redman 2017, 10)

[53] (Redman 2017, 10)

[54] (Redman 2017, 10)

[55] (Mittelman 2020)

[56] (Mittelman 2020)

[57] (Watson, McCarthy and Hisas 2017, 5)

[58] (Watson, McCarthy and Hisas 2017, 5)

[59] (Watson, McCarthy and Hisas 2017, 4)

[60] (Watson, McCarthy and Hisas 2017, 4)

[61] (Irfan 2018)