Taxpayers for Common Sense

Subsidizing Oil Shale: Tracing Federal Support for Oil Shale Development in the United States

Although the oil shale industry is still in its commercial infancy, it has a long history of government support that continues today. The Bureau of Land Management recently issued two new research, development, and demonstration leases and new federal regulations for commercial leases and royalty rates are expected any day. Before the federal government goes down that road it’s important to take a look back and ask whether we should be throwing good money after bad.

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With pressure building in Congress to strip out at least the most obvious subsidies to oil and gas, Taxyapers for Common Sense has released a new tally of some of the major ones.  The report is useful in providing updated cost estimates, and for going beyond the narrow set of provisions that the legislation has targeted.  For example, they pick up the billions in losses due to negligence by the Minerals Management Service in structuring lease contracts for 1998 and 1999 that resulted in taxpayers getting no royalties at all for massive quantities of oil and gas in the Gulf of Mexico. 

There are some areas where I disagree with how provisions are characterized, however.

VEETC.  The single largest subsidy tagged in the report is the volumetric ethanol excise tax credit.  The arguments I've seen presented to include this as a subsidy to oil rather than to ethanol have been that (a) the subsidy is paid at the point of blending, and the blenders are often oil companies; and (b) the subsidy is totally unnecessary since blenders would have been required to use the ethanol anyway under the Renewable Fuel Standards (RFS).  The RFS mandate use of pre-set levels of ethanol in the nation's motor fuel supply. 

Both arguments are inaccurate.

  • Regardless of what point in the value chain the credit is earned, it is earned only for using ethanol and skews markets towards this input rather than other blending agents or fuel extenders.  The economic incidence of any subsidy (who ends up with the improved economic returns) often differs from the point of payment, and often shifts over time as the relative market power of different parts of the value chain shift.  But the policy clearly provides government payments for using ethanol, not oil.  
  • It is true that the tax credit and the RFS are, indeed, duplicative.  But this duplication plays out through the price system.  The larger the tax credit, the lower the incremental cost (as measured by the trading price of a compliance unit under the mandate called a "Renewable Identification Number" or "RIN") will trade for.  Proper accounting for ethanol subsidies would be the sum of subsidies under the RFS and the credit (plus other policies as well).  All of these support the use of ethanol.  But the existence of dual systems merely means the full subsidy cost needed to reach the mandated level of consumption is split between taxpayer costs (through the credit) and consumer costs (through RIN prices pushed through into fuel prices).  It does not mean that the entire credit is a windfall to oil companies.

LIFO.  Last-in first-out accounting is one of a range of inventory accounting methods allowed to all industries under US law.  During times of rising prices (including those due to inflation), LIFO approaches result in higher near-term tax deductions.  During times of falling prices, first-in last-out (FIFO) results in higher near-term deductions.  With flat prices it doesn't matter much.  Over a longer period of time, the tax impacts of large past price surges begin to subside.

Thus, during a run-up in oil prices LIFO will provide large benefits, but if prices stay high for awhile the benefits to the Treasury from banning LIFO will diminish because more and more of the investory will have been procured at the new, higher prices.  Estimates of the tax savings from eliminating LIFO in oil and gas were done during a time of rising prices, and reflected the time window during which the changes in tax revenues were highest.  However, this is a short-term surge, not one that will result in continued higher revenues, year-in and year-out.  In constrast, overdue reforms such as eliminating the silly percentage depletion rules would generate recurring subsidy reductions.

LIFO may well fall in order for the US to comply with international accounting standards (which bar LIFO), but I don't consider it a subsidy to any one sector today.

The other two "general" tax subsidies TCS listed were the Manufacturing Tax Deduction for Oil and Gas Companies and Deductions for Foreign Tax Credits that are really related to resource payments.  I believe there are strong arguments for at least substantial portions of both of these programs to be counted as subsidies to oil and gas, and would actually favor including that portion within the primary list of subsidies to the industry (TCS has included these in a separate table).  More on the Manufacturing Tax Deduction here.

The TCS report did not cover all subsidies to oil and gas.  Among those left are large subsidies to bulk transport of oil via our inland waterway system, subsidized financing and operation of the Strategic Petroleum Reserve, oil defense, a variety of other accelerated depreciation provision for oil and gas infrastructure, and massive shortfalls in fuel tax collections to finance the nation's interstate highway system.  Thus, I expect that even with the adjustments noted above, the aggregate subsidy levels to oil and gas would be higher, not lower, than what they have reported.

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Tomorrow's event (November 30th), titled Department of Energy Loan Guarantees: Should Taxpayers Bear the Risks for the Energy Sector with Loan Guarantees? A Conservative Take, looks to be an interesting one tomorrow.  The discussion brings together panelists from the Heritage Foundation, the National Taxpayers Union, the Competitive Enterprise Institute, and the Nonproliferation Policy Education Center to provide views on multi-billion dollar loan guarantees to conventional and renewable forms of energy.

While conservative groups generally support property rights and competitive markets, some of the participants have also opposed elimination of subsidies to favored energy industries in the past.  Hopefully that is now changing.

More information and registration information can be accessed here.

Update:  See a December 8th joint letter issued by most of the organizations involved with this event encouraging Congress not to increase the loan guarantees to new nuclear power plants.  The letter notes that

Putting the full faith and credit of the U.S. government behind costly, risky projects that the private sector won’t finance is fiscally reckless and politically unwise. Because of the size of these nuclear reactor projects, taxpayers stand to lose more on these than any other Title XVII loan guarantee. Congress must face the reality that loan guarantees are anything but “free money” or a wise expansion of government authority and oppose further expansion of this program.

The Heritage Foundation was the only organization participating in the November 29th event that did not sign the letter.  No reason this is given on the Heritage or Taxpayers for Common Sense websites. 

In April of this year, Jack Spencer of Heritage clearly stated in Congressional testimony that these energy loan guarantees are both subsidies and distort market behavior in many unhelpful ways.  He supported more stringent guidelines on nuclear loan guarantees, as well as caps on the total taxpayer exposure.  However, he appears to support a substantially higher cap on loan guarantees to nuclear than the other groups, and this may have been the basis of disagreement.


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Faced with expiration of the ethanol blender's credit in only a few months, the ethanol lobby has been working the halls Congress to fashion together a fallback mix of subsidies -- even though mandates to use ethanol in vehicles remains in force.  Taxpayers for Common Sense summarizes the state of play, including assorted loan guarantees, support for new pumps and pipelines, and extension of the blender's credit, albeit at a slightly lower rate.

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Taxpayers for Common Sense (TCS), a Washington, DC-based organization focused on improved transparency in government budgeting and spending, has just completed a nice summary of the state-of-play in federal oil and gas royalty subsidies

Royalties are the payments that private firms make to the government to compensate the states owning the resources for natural resource wealth the firms have extracted from public lands.  They are normally a percentage of the market value of the resources extracted, so inherently adjust to changing market conditions.

While many countries have far worse transparency than the US in terms of who gets access to resources and what they pay, the US system continues to have its fair share of problems. These have spanned decades, and include problems with calculating the proper amounts, auditing the payment systems, and even some basic soap opera sleeping around messing with royalty collections.

Poor wording (assumedly unintentional, though at one point there was talk of a criminal inquiry though I'm not sure where it ended up) in lease agreements for production in the Gulf of Mexico has led to royalty-free extraction of billions of dollars of oil and gas even in periods of very high energy prices.  A lower court ruling in favor of oil companies was let stand by the US Supreme Court in October, and will result in an estimated $53 billion in lost royalties over the next 25 years.

Basic rules of risk sharing are routinely ignored in these contracts, with absolute royalty reductions granted rather than contingent reductions available only in adverse market conditions.  Won't happen again?  The Gulf incident was not the first time the feds have been tripped up on proper risk sharing for complex contracts.  The core issue is that legislators focused on changing rules for current market conditions have a hard time viewing technologies and markets as dynamic, or trying to plan for the wide array of potential outcomes as basic facts and conditions change. 

Foolishly worded contract agreements to provide a federally-run, break-even, repository for civilian nuclear wastes with little risk sharing by the private firms is another example of this generic problem.  As with the royalty scandal in the Gulf of Mexico, poor risk sharing on the nuclear waste repository is already starting to cost taxpayers dearly.

These two examples should be cautionary tales of how expensive simple mistakes in statutory wording can be.  Energy legislation running thousands of pages is becoming ever more frequent while the language and concepts contained in these bills are growing increasingly complex.  It should be expected that gaffes or intentional loopholes such as the Gulf royalty-free zone and the lack of risk sharing on nuclear waste contracts will sneak into the murky depths of this new legislation as well.  Yet, even as the public financial commitments keep growing, few people have read and understood the details of what is being proposed.

At least in the area of royalty relief, fixes seem straightforward.  New types of fuels in harder to reach locations are regularly trotted out as deserving of royalty relief.  Yet every industry has emerging technologies and applications with higher costs than existing products.  It is not surprising that the oil and gas sector, too, has a rising cost supply curve where some types of deposits are not economic with existing technologies or at current market conditions.  This is not a defect; it is a routine part of market functioning.  Oil and gas producers should be treated more like a routine industry, forced to innovate on their own dime towards making these emerging resources competitive, rather than continually seeking subsidy.  It hardly makes sense spending large amounts of public money to clamp down on carbon emissions on the one hand while subsidizing carbon extraction with the other.