Oil industry subsidies for dummies

Wonder how big oil got big? Here's an insider's look at fossil fuel subsidies, how they've worked until recently, and what greentech industries might expect in America soon if the newly-Democratic U.S. Congress gets its way.

On news this week that the newly-elected U.S. Democratic congress is considering playing Robin Hood, and taking at least some money previously allocated for oil and gas and reallocating it to renewable energy, we thought it'd be useful to look into fossil fuel subsidies and how they work.

First: how much money are we talking about? Figuring out exactly, or even roughly, how much oil companies receive in subsidy turns out to be a complicated challenge.

Greenpeace believes Europeans spend about $10 billion or so (USD equivalent) annually to subsidize fossil fuels. By contrast, it thinks the American oil and gas industry might receive anywhere between $15 billion and $35 billion a year in subsidies from taxpayers.

Why such a large margin of error? The exact number is slippery and hard to quantify, given the myriad of programs that can be broadly characterized as subsidies when it comes to fossil fuels. For instance, the U.S. government has generally propped the industry up with:

• Construction bonds at low interest rates or tax-free
• Research-and-development programs at low or no cost
• Assuming the legal risks of exploration and development in a company's stead
• Below-cost loans with lenient repayment conditions
• Income tax breaks, especially featuring obscure provisions in tax laws designed to receive little congressional oversight when they expire
• Sales tax breaks - taxes on petroleum products are lower than average sales tax rates for other goods
• Giving money to international financial institutions (the U.S. has given tens of billions of dollars to the World Bank and U.S. Export-Import Bank to encourage oil production internationally, according to Friends of the Earth)
• The U.S. Strategic Petroleum Reserve
• Construction and protection of the nation's highway system
• Allowing the industry to pollute - what would oil cost if the industry had to pay to protect its shipments, and clean up its spills? If the environmental impact of burning petroleum were considered a cost? Or if it were held responsible for the particulate matter in people's lungs, in liability similar to that being asserted in the tobacco industry?
• Relaxing the amount of royalties to be paid

While it's easy to get bent out of shape that the petroleum industry "probably has larger tax incentives relative to its size than any other industry in the country", according to Donald Lubick, the U.S. Department of Treasury's former Assistant Secretary for Tax Policy, remember that subsidies are important across all sectors of the energy industry. Even yours (I'll bet you, gentle reader, work in cleantech/greentech)! For instance, nuclear power wouldn't be viable without subsidies—most governments pay between 60 and 90 percent of the cost of construction of new plants. Solar wouldn't be what it's become without significant German, Californian, U.S. federal and other incentives. Ethanol and biodiesel in the U.S. enjoy large subsidies, but let's resist getting into the rat-hole of agricultural industry subsidies.

Subsidies, per se, aren't a bad thing. How does the oil industry defend its substantial incentives?

• Energy security - The fossil fuel industry has, rightfully, long pointed to the strategic nature of a company's oil and gas supply. Theirs is an industry that can't afford to go away, they argue.
• Environmental compliance - Far from being big beneficiaries, some oil companies claim they are net victims. They point to gasoline taxes and environmental regulations, such as fuel-efficiency standards for new vehicles.
• Bolsters domestic production - Supporters of drilling incentives say they make sense for a country that wants to reduce its dependence on foreign oil and whose biggest untapped reserves are in water just offshore, albeit thousands of feet deep.
• Defense requirements - Some have suggested that the demands of defending Middle Eastern oil fields added (pre-Iraq war that is) between $10 billion and $20 billion a year in subsidies to the true cost of oil.
• Which begs the question - even if America greatly reduced its imports of oil, would it necessarily reduce its military activity in the Gulf region?
• It's not really that much money - A few years ago, Ronald Sutherland, an energy economist affiliated with the Cato Institute, a think-tank in Washington, used statistics from the Department of Energy to argue that oil actually gets rather little at the end of the day. All told, after subtracting this and allowing for that, he suggested oil receives less than a billion dollars in subsidies, in all.

Critics of oil subsidies in America, however, maintain that:

• Subsidies don't increase domestic production - A few weeks ago, a U.S. Interior Department report obtained by the New York Times suggested that the billions of dollars American oil companies stand to benefit from as incentives for drilling in the Gulf of Mexico (royalties they wouldn't otherwise have to pay the government) wouldn't add appreciably to any increase in production. Says an analyst who worked on the report, "if they took that money, they could buy a whole lot more oil with it on the open market."
• The U.S. gives far too much away - Industry analysts who compare oil policies around the world say the United States is much more generous to oil companies than most other countries, demanding a smaller share of revenues than others that let private companies drill on public lands and in public waters. In the U.S., the government’s take - royalties as well as corporate taxes - works out to be about 40 percent of revenue from oil and gas produced on federal property, according to Van Meurs Associates, an industry consulting firm that compares the taxes of all oil-producing countries. By contrast, according to Van Meurs, the worldwide average government take is about 60 to 65 percent. The United States has even increased some of its incentives in recent years, while dozens of other countries demanded a bigger share of their oil producers' revenue. This is the low hanging fruit Democratic lawmakers are eying.

In 2004, the then-Republican Congress passed a manufacturing tax cut that critics said gave unnecessary incentives to the oil industry. Democratic leaders this week said they want this rolled back, and want to capture lost royalties from companies drilling in the gulf coast. They're also considering rolling back the Energy Policy Act of 2005, according to the Washington Post, an act supported by many Democrats.

While the Democratic U.S. Congress says it wants to change the historic ratio of the flow of subsidies for fossil fuels vs. that of renewables, don't expect government floodgates to open immediately for greentech/cleantech companies.

There's no clear consensus even among Democrats as to how the new funds should be used. Some lawmakers want public hearings to figure out how the money should be divided. It will likely be set aside in the short term while the government determines how to put it to use.

One thing is certain, however. While the fat lady, as they say, hasn't quite sung - and likely isn't even practicing scales, yet - this week marked the first steps on a long road to reshaping American petroleum policy. And, at the same time, potentially infusing renewable greentech energy sectors with a vigor that would have been only a dream a year ago.

Dallas Kachan was publisher and acting editor of Inside Greentech when he published this in 2007. Today, he's managing partner of cleantech researcha and advisory firm Kachan & Co. The closest thing he'd ever gotten to a subsidy at that time was a sandwich shop in Iowa.