tar sands

More than most mainstream publications, The Economist has regularly covered energy subsidies and consistently called for their elimination.  Too many newspapers pick and choose which subsidies they care about.  The Wall Street Journal, for example, rails on subsidies to renewables -- particularly wind and corn ethanol.  But government largesse to fossil fuels and nuclear power always seems to be illusory figments of greenie imaginations.  Midwest publications too often turn a blind eye on subsidies to ethanol or the corn (and water) that makes it. 

The Economist has been more even-handed in trying to get markets working and price signals behind technological transformations.  Their January 17th piece "The Oil Crash Has Provided a Once-In-A-Generation Opportunity," focusing on fixing policy failures in the energy sector, is no exception.  They call for stripping subsidies to all forms of energy as a way to right precarious government finances and to more accurately price carbon.  And on top of simply eliminating subsidies to carbon that flow from subsidies to fossil fuels, they call as well for a carbon tax to address the non-internalized environmental damage associated with today's patterns of fossil fuel production and consumption.

The core of their argument is this:

  • When energy prices are soaring, it is hard to boost taxes and eliminate subsidies because consumers are already stretched.
  • The falling prices of fossil fuels, along with technological innovations in substitutes, allow a transition to real energy prices to be done at a much lower political cost.
  • Politicians should fix energy prices during this window.  They should eliminate subsidies to consumers, and they should fix fuel taxes (such as the one in the US that funds our nation's highways) to bring them in line with inflation-adjusted values and current funding requirements.
  • Even better would be the addition of a tax on carbon to more accurately align the market prices on carbon-based fuels with their social impacts.  "As fuel prices fall," the magazine notes, "a carbon tax is becoming less politically daunting."

The approach makes sense.  Indeed, we'd surely be in a better place if these recommendations were to be implemented quickly.

The rub is that the article simplifies both the interactions between energy resources and the manner in which governments provide energy subsidies.  As a result, lower prices do not mean that constraints to reform have all gone away. There are three main impediments:  subsidy type, the political power of the beneficiary, and subsidy interactions between different energy options.

1)  The optimal time to reform subsidies varies by the type of subsidy.  For energy consumers (which include large industrial users as well as households), The Economist is spot-on:  the time for reform is now.  Lower prices create political wiggle room for reform because many energy consumers are less attuned to the rate of decline in energy prices than they are to the fact that their absolute prices are lower than they were a year or two ago.  Long-time structural flaws in energy pricing systems -- such as the exemptions that most US states provide to all fuel and power consumers from sales taxes -- should also be corrected so energy is on a equal basis with the other goods and services in an economy.

For energy producers, however, the exact opposite is true.  The rapid decline in fuel prices has led to financial losses, layoffs, cancelled projects, and growing fiscal distress on the producer side.  There were some fat years before today, so we've not yet seen waves of bankruptcies.  However, the shift in fortunes has been quick.  The optCrude oil price trendimal time to have rid ones statutes of producer subsidies was during the fat years (see graphic) when fuel prices were surging:  2007-08 (before the credit collapse), or again the past few years when prices for fuels were again quite high. 

Did our politicians carpe diem?  Well, no.  In most situations, they missed that window entirely. Their arguments for inaction vary by time period, though it has been inaction all the same.  During surging energy prices, they commonly argued (doing their best to do so with a straight face) that nearly all of the supports weren't really subsidies.  During the current market environment, the politicians are more likely to focus on the challenging fiscal enviornment for producers and the additional jobs that would be lost from subsidy cuts. 

 

2)  Locking in lower subsidies requires political action, but the politics of subsidy reform vary across subsidy types and location.  Economics aside, the political environment drives the ability to deliver reforms, and this fact makes it difficult to achieve coherent reforms even within a country, let alone multinationally. 

Both subsidy creation and subsidy reform are creatures of political economy.   The economics certainly influence the political economy, particularly in the fringes -- such as where the very wealthy are being subsidized or the gross cost of support rises so large that the country is destabilized.  But for the majority of subsidies in place today, the political dynamics may run largely independent of the economic benefits of reform.

Consider what seems to be a no-brainer of a reform:  boosting the US federal excise tax on motor fuels for the first time since 1993 to stem the growing deficit in highway funding.  A rational review of the issue from either political perspective should conclude that increased fees make sense. 

Republicans should like the idea of users paying the full cost of the roadways rather than literally free-riding on the backs of general taxpayers. Democrats should like the idea that more highway funding creates construction jobs (often unionized) and makes it easier for workers seeking employment to travel to job opportunities.  Both groups should recognize that the purchasing power of the existing tax has dropped sharply, since it has not been adjusted for inflation in more than two decades; that the Highway Trust Fund tasked with building and maintainings the nation's interstate highway system is facing growing shortfalls; and that incremental improvements in fuel efficiency are reducing the excise fee per road-use mile even independent of inflation.

And yet inaction continues to be the norm.  Even with the large drop in gasoline prices over the past year, and the clear need, the political will to boost the tax may not exist.  Instead, boosting gasoline taxes continues to be a "third rail" of politics -- a reference to the electrified middle rail of some urban subway systems (including here in Boston) that if you touch it you die (or your political career does).

The politics of fossil fuel subsidies to consumers elsewhere in the world are thankfully a bit more mixed.  Much of the $550 billion or so that the International Energy Agency estimates flows in fossil fuel subsidies to consumers each year originates with interventions in fuel pricing.  The objective is to dampen price increases or to keep fuel prices low.  Ostensibly, this helps poor consumers make ends meet, but  empirical assessments by the IEA, IMF, and World Bank all indicate much of this support leaks to wealthier consumers. 

When prices fall, required levels of public support do generally fall under most of the pricing schemes now in place.  This is, of course, a helpful trend for governments who are trying to balance their budgets.  But unless the rules behind the price buffering mechanisms are permanently changed during the pricing downturn, the gains will quite often be reversed as soon as energy prices move back up recover.  (For a detailed review of price passthrough policies and reforms, see this paper by Masami Kojima of the World Bank).

Changing the rules can be done more easily when prices are low, but that doesn't mean the subsidies are gone for good.  If prices surge again, even with altered rules that curb government price caps or other supports, the political pressures to reintroduce the supports grow rapidly.  Many introduced reforms ultimately fail because of this dynamic.  Case studies, such as those in this IMF study, can help map a reform path that lasts.

Political reform of producer subsidies is almost always challenging as well, regardless of the direction of energy prices.  Because the benefits of existing policy are large and the beneficiaries concentrated, the incentive to invest in lobbying is quite large, and recipients invest heavily to delay reforms and expand benefits.  More established industries are often better at the political influence game than are startup firms or emerging technologies, and this dynamic is another reason why systemic reform treating all sectors equally (as The Economist rightly advocates) is challenging to achieve in practice.  The risk that subsidy reform will affect the newer, weaker industries while defining away the subsidies to the strong is quite real. Even in the Tax Reform Act of 1986, widely viewed as the model for eliminating special interest tax subsidies, the US Congressional Research Service notes that subsidies to oil and gas survived:

While the Reagan Administration did successfully reduce the number of energy tax provisions, the Administration did not accomplish all of their stated goals. Specifically, the primary tax incentives for oil and gas (expensing of IDCs and percentage depletion) were not eliminated, although they were scaled back...1

3)  Subsidy-related cross-fuel interactions.  All reforms have winners and losers, and even systematic elimination of fiscal subsidies to all fuels at once can affect industry sub-sectors in very different ways.  Here are some examples of the problem:

  • New versus old subsidy beneficiary.  Support to renewable energy (including some no-so green resources such as ethanol and landfill gas) has been rising sharply in recent years.  However, subsidies to oil and gas have existed for 90 years; to large-scale hydro nearly as long; and to nuclear for more than half of a century.  Proponents of renewables argue it is unfair to eliminate their support when their competitors have benefitted at the public trough for so much longer.  Historical support, they argue, has been baked into the cost structure we see today from their competitors.  Yet subsidies need to end a some point, so how does it get done? 
  • Fiscal versus environmental subsidies.  Clearly ending support to renewables without dealing with the environmental impacts of fossil fuels at the same time would be a recipe for failure.  This is because environmental damages from the fossil fuel cycle -- whether via ghg emissions or damages to land, air, or water resources -- are a significant factor in the competitive position of these fuels against renewables.  This cost advantage would remain even after fiscal subsidies were removed; demand and supply-side options with more favorable environmental footprints would be displaced. 

    The discussions around subsidy reform often focus on fiscal subsidies alone (spending, credit and insurance, etc.)  Yet, if support for renewables is to be removed at the same time as that to conventional fuels, the large external costs of fossil fuels on human health and environmental quality must be addressed concurrently.  Otherwise, it will be impossible to achieve the magazine's goal of a neutral energy playing field. 
  • Legacy subsidized infrastructure.  The magazine argues that "the more cross-border pipelines and power cables the better," in reference to political opposition to the Keystone XL pipeline and the export restrictions many countries (including the US) place on energy products.  The core logic here is good:  price systems ration goods to their highest value uses, and trade allows that rationing to occur on a global scale.  But two factors impede this grand vision.  First, the legacy subsidies may be what enabled uncompetitive projects to move forward in the first place; absent such support they would never even have been built. 

    This is both a trade and an environmental issue, as the projects that win as a result may well be associated with imports (undermining local jobs or industries), or with harmful environmental impacts.  This issue is certainly relevant to the transport infrastructure to move tar sands to markets:  both the Keystone pipeline, other transport lines as well, and to the refineries focused on processing this type of crude.  But is is most important relative to the Alberta tar sands themselves, that were heavily subsidized for many years. The issue is also one that appears to be central in the push to drill for oil and gas in the Arctic circle

    Second, the infrastructure associated with the energy exchange may be moving commodities that are not properly addressing external costs, expanding the geographic range of the distortions.

    How should this legacy support play into current decisions?  Ignoring the subsidies entirely and starting fresh as though they never happened doesn't seem entirely fair.  And since pipelines and massive tar sand extraction sites last a very long time, these decisions will exacerbate environmental damages for decades to come.

Eliminating fossil fuel subsidies to consumers now makes sense.  Though low fuel prices may give cover to politicians to make such changes now, these reforms nonetheless do need to address issues of energy poverty from the outset, ensuring policies are in place to poorest once energy prices rise again. Otherwise, the subsidy reform "successes" will be short-lived.

User fees should also be brought up to appropriate levels, and clear exemptions from consumption taxes across many countries in the developed world should be eliminated as well.  It is also a very good time to establish even a quite low carbon tax -- one that gets the tax system structure right, and grows slowly over time according to pre-established rules that are nearly impossible to derail once in place.  These are all no regrets policies; indeed, had we implemented a low, but regularly-escalating carbon tax soon after the Rio conference in 1992, we'd be in a very different place by now. 

  • 1. Molly Sherlock, Energy Tax Policy: Historical Perspectives on and Current Status of Energy Tax Expenditures, (Washington, DC: US Congressional Research Service), May 2, 2011, p. 5.

Back in May, Earth Track teamed up with Oil Change International and NRDC to look at the tar sands exemption from tax used to finance the US' Oil Spill Liability Trust Fund.  We estimated that the exemption was worth nearly $400 million between 2010 and 2017, despite the fact that tar sands have higher expected spill liabilities than conventional crude.  We concluded that the exemption made no logical sense, and should be repealed or replaced with a separate charge (potentially at a higher rate) on products.  You can read our analysis here.

Tar Sands Exemption is Getting More Attention

In an article published today in Inside Climate News (Is Dilbit Oil? Congress and the IRS Say No), Lisa Song reviewed the tax exemption and solicited input from industry, the trade press, and the Internal Revenue Service.  Among the interesting findings:

  • Esa Ramasamy, an editorial director at trade publication Platts, noted that "[o]il sands tend tAlberta syncrude siteo be more acidic and corrosive than conventional crude.  It takes a special kind of refinery to process them, because of the toxicity of [the] crudes. So I find it hard to believe there is no environmental tax on those crudes."
  • The industry wasn't willing to speak on the exemption at all.  "InsideClimate News also contacted three pipeline companies (TransCanada, Enbridge and Kinder Morgan), three refineries that process tar sands crude (Valero, Suncor Energy U.S.A. and BP Whiting), and the Canadian Association of Petroleum Producers (CAPP) to ask about possible taxes on tar sands imports.  Spokesmen from TransCanada and CAPP said questions about tax policy should be directed to tar sands refiners, producers or the IRS. Enbridge, Kinder Morgan and the refineries did not respond."

As noted in our piece, the basis for all of the attention on the oil spill tax exemption is an IRS Technical Advice Memorandum (TAM) released in 2011.  A TAM provides technical guidance in response to questions from internal staff on how to apply particular tax rules to the circumstances of a specific taxpayer.1  In this case, the TAM was unambiguous, concluding that tar sands were not required to pay into the fund. 

In conversations with reporter Song, IRS spokesman Anthony Burke pointed out that the memo in question applied only to a specific set of facts and therefore only to the single refinery mentioned. Unlike tax court decisions, these memoranda would not set a precedant for all taxpayers.

But Burke and tax professionals dealing with complex tax issues know that many, many, tax issues are not black and white.  Often, firms must decide whether to take a filing position on how a particular statute applies to them.  Thus, precedant or no, this letter has nearly the same impact.  Because the conditions covered in the TAM were fairly general and common across the industry, it's release has likely given all of the firms confidence that they don't need to pay into the oil spill liability fund.

Questioning the IRS' Decision on the Applicability of the Spill Tax on Tar Sands Oil

Also released today was a report by the Democrats on the House Natural Resources Committee (not by the full Committee), led by Congressman Ed Markey of MA.  In addition to a review of current law and tax losses, Tax Free Tar Sands also interviewed the IRS staff who prepared the TAM and assessed the Congressional intent behind the oil spill trust fund. The conclusions:

The IRS lawyers who drafted the TAM told Democratic Committee staff that they did not consult with subject-matter experts or survey industry and government documents in deciding whether tar sands is crude oil or a petroleum product. Had they done so, they would have found that petroleum companies, their trade associations, and government agencies consider tar sands to be crude oil...

The Democratic Committee Staff argue that the IRS mis-interpreted Congressional Intent in their TAM:

Congress created the spill response fund in the wake of the Exxon Valdez oil spill when the enormous costs of cleaning up oil spills became better understood. Congress’s purpose in creating the spill response fund was clear: Petroleum companies that produce or handle dangerous products should pay for cleaning up their spills and insure against the risks they impose on the American people.

Congress’s intent is clear in the Oil Pollution Act, which authorized the fund. In defining oil covered by the fund, it states that “‘oil’ means oil of any kind or in any form, including, but not limited to, petroleum, fuel oil, sludge, oil refuse, and oil mixed with wastes other than dredged spoil.” Further, the presidential signing statement for the fund says, “The Act addresses the wide-ranging problems associated with… oil spills. It does so by creating a comprehensive regime for dealing with vessel and facility-caused oil pollution.”

Congress’ objective in creating the spill response fund has been severely hampered by the IRS’s position excluding tar sands from the definition of crude oil. As a matter of public policy, it is important that all oil companies be held  responsible for the disasters associated with the products they sell and that taxpayers not be forced to pay the bills of cash rich oil companies.

Not only does the IRS’s TAM misread congressional intent and fail on technical grounds; it also runs contrary to both public policy and common sense. If the oil spill response fund is to pay for costly tar sands spills, as required by law, then common sense dictates that Congress intended for the excise tax to apply to those responsible for importing it.

The Committee concludes:

The IRS’s conclusion that tar sands oil is neither crude oil nor a petroleum product is wrong. The TAM effectively creates a tax loophole and a subsidy for the refiner subject to the TAM and for others who might use the TAM as justification for avoiding the excise tax, potentially costing the oil spill response fund tens of millions of dollars a year.

Had the IRS lawyers performed more robust research and analysis, they should have concluded that the law is sufficiently clear and that the excise tax applies to all crude oil and petroleum products, including crude oil derived from tar sands. For this reason, the IRS should revisit its research and analysis and provide guidance and/or regulations to ensure that the IRS’s position comports with the law.

Congressman Markey also sent a letter to Treasury Secretary Timothy Geithner explaining why the current interpretation by the IRS was incorrect and requesting that it be corrected.

Update history:  This posting was updated 8/1/12 to clarify the difference between IRS Technical Advice Memoranda and Private Letter Rulings.

  • 1. The IRS also issues Private Letter Rulings that provide clarity to specific taxpayer issues as well. However, whereas a TAM results from staff questions, the tax issues within Private Letter Rulings are brought to the IRS by taxpayers.

Irrational Exemption: Tar sands pipeline subsidies and why they must end

For the past decade imports of tar sands crude oil or bitumen have been increasing. Tar sands is stripmined and drilled in an energy‐and water‐intensive process from under the Boreal forests and wetlands of Alberta. In the process, Canada is destroying critical habitat while releasing three times the greenhouse gas emissions as conventional oil production.

Earth Track Blog Post

I guess if I'm to listen to Fareed Zakaria "The Case for Making it in the USA: Like it or not (and I don't) we need a manufacturing policy to stay competitive," subsidies up-and-down the Keystone XL pipeline should be viewed as just par for the course.  Though Zakaria acknowledges the government isn't good at picking winners, he thinks that, overall, public funding of a portfolio of private companies is necessary for the country.

Portfolio or not, I have far less confidence in the ability of our political system to make good choices on who gets public largesse and who goes hungry.  Frankly, I'm not all that convinced that the Chinese do it well either -- we don't really know how much they are subsidizing particular sectors, or the opportunity costs of those decisions on other parts of their economy or social safety net.  Perhaps time (or trade cases) will make the contours and costs of their subsidy policies more clear.

There are certainly reasons to be skeptical.  Japan, after all, used to be the model of government-favored corporate champions leading the country forward.  But their protection of favorites has contributed to economic stagnation, slowed restructuring, and thrown up impediments to innovation.  Some highly successful companies such as Honda had to buck government favoritism and focus abroad in order to thrive.  Still, targeted investments in particular sectors are probably more likely to work in a centralized authoritarian system than in one (like the US) based on political payoffs to every group and frequent shifts in strategy as political dynamics change.  The lack of checks on authoritarian systems has a downside however:  the targeted investments are likely to be much larger and run longer before being corrected -- making the costs of, and fallout from, mistakes bigger as well.

Zakaria continues:

when you move from high-level policy to specific cases, you will often find one element that is rarely talked about: a foreign government’s role in boosting its domestic manufacturers with specific loans, subsidies, streamlined regulations and benefits. In effect, these governments— many in Asia, though some in Europe as well—have a national industrial policy to help manufacturers.

Industrial policy is already here

Indeed.  But couldn't that paragraph describe just as well US energy investments over the past decade?  Do a quick query to Good Jobs First and their database of subsidies to specific firms and industrial plants, or a review of DOE's energy loan guarantees, if you disagree. 

With the Keystone XL pipeline project, and far too many others, it seems as though our reliance on government handouts has already moved into lead position in terms of what does and doesn't get built.  Relegated to second tier is the price mechanism, that supposedly miraculous signaler of scarcity and overstock on which an efficient market economy has historically relied. 

And it's not just about the pipeline itself.  It's the entire subsidy "ecosystem" of getting tar sands out of Canada, shipped through the US, and refined into products.  Subsidies along the chain combine in a perverse, though mutually reinforcing, system of pork and props.  The result is we get expensive and complicated infrastructure and machines built that most likely would not have been funded based on market demand alone.  The fact that most of the oil from the Keystone XL line, though refined in the US (albeit, not technically so since the refineries are in foreign trade zones), is expected to be re-exported merely adds to the irony.

Refinery expensing adds $1-1.8 billion to the Keystone XL Subsidy System

Earth Track recently teamed up with Oil Change International to look at one part of this subsidy ecosystem:  highly favorable depreciation rules.  Section 179C of the tax code, "Election to Expense Certain Refineries" was enacted in 2005, though eligibility wasn't extended to projects processing tar sands until 2008.  The three refinery projects we looked at (Valero, Total, and Motiva), all in Port Arthur, TX, will receive subsidies of between $1 and $1.8 billion dollars, net present value.   You can read the analysis here.  Additional background on the projects and their connection to the tar sands can be found in Oil Change's blog on the paper.

When the provision was first put in place, the justification was that the US was under-investing in refining capacity and had too much of its existing infrastructure located in the storm-prone gulf coast.  Yet today, the US is exporting ever-larger quantities of refined fuels.  By value, fuel was actually the country's largest export in 2011.  And the three investments analyzed will do nothing about diversifying our refinery assets geographically to reduce the energy security risks from large storm events -- they are all right in the hurricane zone.