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Sustainability Matters #22: Subsidies and Incentives for Government Policies

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Subsidies and incentives are paid by governments to advance certain policies. 

Subsidies can be in the form of grants, loans, and loan guarantees. They can also come in the form of a fiscal incentive, such as a tax credit. The US government has historically given subsidies to support the development of energy infrastructure and supply.

The United States has the largest economy in the known history of the world, and it wasn’t purely by accident that this happened.

The engines for our economy are run on energy. We depend upon an ever-increasing supply of energy to carry on our economic metabolism, and that metabolism got a tremendous jump from the development of fossil fuels.  

Our economy is tied to energy for its growth. 

The availability of affordable, seemingly inexhaustible energy has fueled the exponential growth of our economy. This lightning speed growth was accomplished because of direct and indirect support of a long-term policy correctly relating fossil fuels to economic development.

In the April 2014 edition of Mother Jones, an article entitled “A Brief History of Tax Breaks for Oil Companies” was published, which delineated a chronology of subsidies since 1916. Since that time, according to the article, the “Federal Government has pumped more than $470 billion dollars into the oil and gas industry in the form of generous, never-expiring tax breaks.”

From an historical perspective, these incentives may have served a good purpose, spurring the growth of our economy. Now, in the early 21st century, they have stuck around like an old DOS computer program which should have been erased from the hard drive a long time ago. 

Though the question is not what happened one hundred years ago, but what is happening now, a brief look at a few points made by the Mother Jones article may be instructive, particularly if you believe in the old adage that “Those who cannot remember the past are condemned to repeat it.” 

1916 A new tax provision allows oil companies to write off dry holes as well as all “intangible drilling costs” in their first year of exploration. Over the next 15 years, oil and gas subsidies will average $1.9 billion a year in today’s dollars.

1926 Congress approves the “depletion allowance,” which lets oil producers deduct more than a quarter of their gross revenues.  Texas Sen. Tom Connally, who sponsored the break, later admits, “We could have taken a 5 or 10 percent figure, but we grabbed 27.5 percent because we were not only hogs but the odd figure made it appear as though it was scientifically arrived at.”

1937 Treasury Secretary Henry Morgenthau calls the depletion allowance “perhaps the most glaring loophole” in the tax code. President Franklin D. Roosevelt urges Congress to close it and other tax-evasion methods “so widespread and so amazing, both in their boldness and their ingenuity, that further action without delay seems imperative.”

After more than 75 years, congress has not acted.

Recent attempts at changing the policy include the fiscal-cliff negotiations in 2012, five legislative attempts in 2013 and calls in 2014 for ends to corporate welfare spending.

According to an article in the Huffington Post: in 2013, the US spent 18.5 billion dollars on incentives for fossil fuels. This is up from 12.7 billion in 2009. In 2010, BP claimed a 9.9-billion-dollar deduction “due to cleanup costs from the New Horizon”

According to Oil Change International’s latest report, federal and state subsidies to the oil, gas, and coal industries result in a $21 billion windfall for carbon-polluting companies every year.

This occurs at a time when the biggest five oil companies are earning record profits, close to $93 billion last year, or $177,000 per minute. And according to corporate documents, risky drilling projects like those undertaken by BP would most likely never occur without this type of corporate welfare.

The charge that this oil spill would probably not have happened without government largesse is fact, not supposition. There are, in-fact, at least two major subsidies that BP took advantage of, both before and after the explosion of the Deepwater Horizon.

When a spill happens, it is not the companies that pay, but rather the taxpayers. A tax deduction for oil spill remediation costs allows companies to deduct costs of oil spill clean-up from tax payments as a “standard business expense”. The most notable example occurred in 2010 when BP claimed a $9.9 billion tax deduction due to clean-up costs for the Deepwater Horizon blowout and resulting oil spill in the Gulf of Mexico.

A second subsidy responsible for increased offshore drilling is not only employed in case of an accident, but rather is a regular part of the oil business.  Drilling expenditures, which result in billions of oil industry costs annually, are handled by current tax law in such a way as to give a break to oil companies in order to recover these costs quickly. Intangible drilling costs include wages, fuel, and repairs and in 2013 the federal government provided about $3.5 billion in support through intangible drilling cost recovery.

The main lobbying group for the oil industry has argued that, without this tax break, most offshore oil drilling would not be economically feasible. According to research published in July 2013 by the American Petroleum Institute (API), the tax deduction for intangible drilling costs represent about 60 to 90% of a well’s total costs. Because deep offshore oil wells, like the one run by BP, are so far out at sea, they are much more expensive to operate and drilling expenses consume about 80% of total costs. Without this tax break, API says, many “projects will no longer meet investment criteria” and will not be drilled.

The IRS has provided companies with the ability to write off these expenses since 1918, when climate change and the social costs of oil drilling were barely on the radar. API’s analysis finds that one of the areas most helped by current tax law is drilling in deep waters off the Gulf of Mexico. The industry argues that drilling in deep water is much more costly and removing the tax break for intangible drilling costs would not only reduce the number of oil rigs in the deep waters of the Gulf but could also curtail exploration for future oil wells.

Subsidies to coal companies similarly distort the real price.

“… the Department of the Interior (DOI) has built a complex regulatory framework that provides agency officials with the power to reduce the effective royalty rate that coal companies pay and thereby subsidizes coal production. The subsidies that DOI officials routinely provide coal companies come in three forms:

  1. The assessment of royalties on the so-called “first arm’s-length sale” price of coal instead of the true market value. Coal companies pay royalties on the price that they receive at the first sale to another entity. This transaction can be to an affiliated or nonaffiliated entity but must be valued as an arm’s-length transaction irrespective of the buyer’s relationship to the coal company. This sale often occurs near the point of production, meaning that taxpayers typically receive royalties on the mine-mouth price of coal instead of the true market price at which the coal is sold to a power plant or other end user, such as a broker who exports the coal. As a result, the federal government assesses royalties too early in the sale process and on prices that are not reflective of the true value of coal, which in turn results in lower royalty returns to taxpayers.
  1. Royalty reductions for non-economically viable coal production or financial hardship. The BLM provides royalty reductions as low as 2 percent of the sale price if a mine becomes unprofitable due to unfavorable conditions—such as limited access to coal or a decrease in its quality—or if a mining company can show it is facing financial hardship.
  1. Subsidies for the costs of washing and transporting coal produced on federal land. Under the current system, coal lessees can deduct transportation and washing costs, with no cap on deductions, from the total sale price upon which federal coal royalties are due. This translates into an allowance for the full cost of transporting federal coal from the mine mouth to a remote point of sale or to transport the coal to a distant wash plant. Unlike coal, transportation deductions for oil and gas are capped at 50 percent of the value of the resource.

This article goes on to explain that the price of coal, on which the 12.5% royalty is based upon, is the cost at the first point of sale, not the cost of the value of the coal to a utility which is purchasing it to burn to make electricity. Close to 50% of the coal currently sold in the Powder River Basin of Montana and Wyoming is funneled through what is called ‘first arm’s length’ transactions, which allows it to be sold at an undervalued price.

To keep the price of coal artificially low for royalty, tax, and other valuation purposes, companies are allegedly cloaking sales to their network of subsidiaries and affiliates as arm’s-length transactions when they are in fact captive, non-arm’s-length transactions. 

According to the IEA in their World Energy Outlook:

The IEA’s latest estimates indicate that fossil-fuel consumption subsidies worldwide amounted to $548 billion in 2013, $25 billion down from the previous year, in part due to the drop in international energy prices, with subsidies to oil products representing over half of the total. Those subsidies were over four times the value of subsidies to renewable energy and more than four times the amount invested globally in improving energy efficiency.

Science tells us the relationship between fossil fuels and climate change is unequivocal; does it make any sense to continue providing incentives for fossil fuels?  What about renewable energy?

Worldwide there is a tremendous disparity between the subsidies paid toward fossil fuel versus renewable energy. 

In a later chapter we will discuss some strategies for including externalities in the economic equation as well as a discussion of the use of incentives and regulation to assist in the development of emerging technologies. 

Midnight Rambler, Wes Golomb

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