Earth Track is pleased to release A Review of Fossil Fuel Subsidies in Colorado, Kentucky, Louisiana, Oklahoma, and Wyoming.  The report documents hundreds of subsidies to established fossil fuel industries and fossil fuel consumers in five U.S. states.  Many of these policies have contributed to environmental damage, energy market distortions, and fiscal shortfalls.

Political power drives state subsidies to fossil fuels

The United States news cycle as of late has been focused on the pending "fiscal cliff," a combination of automatic spending cuts and tax increases that put at risk the country's emergence from recession.  In an effort to flag ways to safely cut the US' burgeoning deficit, an unwieldy array of special tax breaks, often the result of political deals over many decades, have finally gotten some attention. 

state subsidies report coverYet the very same political drivers that have led to subsidizing powerful industries at the federal level have flourished at the state level as well.  And in many states, among the most powerful industries are those involved with coal, oil, and natural gas.

These subsidies have come through the operation of the state tax code to be sure, but also through every other available mechanism of government market intervention -- a list that includes subsidized credit and insurance, infrastructure provision, unfunded oversight, direct grants, and below-market resource sales.   And, just as these other types of support have received insufficient attention in federal fiscal cliff discussions, they are too often ignored at the state level as well.

This report is a first pass at inventorying the subsidies.  We have no illusion that we have captured everything.  But we hope that others will continue to build on this inventory so that the full scale of state-level support for the fossil fuel sector will gradually become visible.

Even based on the subset of policies we have captured, it is clear that these programs have contributed to the fiscal turmoil in which so many state governments now find themselves, and to significant environmental degradation as well.

Filling in subsidy data gaps at the sub-national level

Although data on fossil fuel subsidies around the world have been growing, most of this information focuses on national level policies.  The thousands of subsidies at the state, provincial or local levels are largely untracked -- with little systematic documentation either in the United States or in most other countries of the world. 

These gaps are unfortunate:  in the aggregate, sub-national subsidies transfer billions of dollars per year to fossil fuel industries just like their federal counter-parts.  They are additive to federal supports, further distorting the economics of specific projects and investment incentives across energy options.  This review also illustrates that not only are subsidies purposefully targeted to oil, gas or coal large, but that the fossil energy sector captures a significant share of more general state incentive programs as well.    

There is a great deal of money at play.  The Tax Exemption Budget for the US state of Louisiana, for example, contains a dizzying array of exemptions, exclusions and reductions that, all told, manage to forego three quarters of the state's corporate income tax revenue, more than half of its sales tax revenue, and nearly one-third of its severance tax revenue.  Severance tax breaks in Louisiana were worth more than $350 million in 2010, nearly all benefiting the fossil fuel sector.  Colorado has so many exemptions and offsets to severance taxes that only five of the more than 30 oil-producing counties in the state paid any net severance taxes on oil and natural gas, according to past reviews. 

In Kentucky, public spending on coal haul roads comprised one of the state's largest subsidies to the coal sector in years past.  Yet, the spending is poorly documented, a common situation with spending on energy-related infrastructure across the states evaluated. 

Fossil fuel exemptions from state sales and motor fuel taxes are also frequent, and result in significant revenue losses to state Treasuries.  Yet, in many of these situations, blanket exemptions don't make sense and should be narrowed or eliminated.

Reducing market distortions:  high value targets for state fossil fuel subsidy reform

The patterns in fossil fuel subsidies across states offered a number of high value areas for reform.  Some of these are highlighted below:

1)  There is no excuse for not tracking your subsidies.  There are only a handful of states in the entire country that have no formal tax expenditure budget at all, but two of them (Colorado and Wyoming) were in our sample.  None of the states evaluated had centralized public reporting of the many different programs to provide credit subsidies to private activities and businesses.  Further, clear and consistent reporting on energy-related oversight and maintenance by governmental agencies and how it is funded was also largely missing.  In all of these areas, small improvements in reporting would pay large dividends to taxpayers.

2)  Don't ignore "general" subsidies when looking at subsidies to fossil fuels.  Subsidies flow to power.  Not always, not completely.  But often and mostly.  Fossil fuel industries are powerful, and they tap into any source of subsidy they can.  The review of subsidies to oil and gas in Louisiana illustrates this quite point well, with substantial portions of some of the "general" subsidies flowing to fossil fuel beneficiaries.

Subsidies flow to power.  Not always, not completely.  But often and mostly.

3)  Energy is a product, and should not be exempt from general state and local sales and use taxes.  This common exemption costs state Treasuries hundreds of millions of dollars per year, but is difficult to justify for most recipients.  Concerns about energy poverty are real, since energy is a life-sustaining good.  However, ensuring the poor have reasonable access to energy services is already a central part of utility regulation across the country and thus can be separated from the issue of energy taxation.  Lifeline rates, energy assistance programs, or other similar tools are well established to ensure the poor stay warm in cold climes and cool in warm ones.   Particularly given the negative externalities associated with most fuel use, there is no justification for blanket tax exemptions for fuel.

4)  Paying for the roads.  Resource-intensive states do a poor job tracking extra construction and maintenance costs triggered by the heavier vehicles and more frequent traffic that routinely accompanies fossil fuel extractive activities.  This data needs to improve, with costs pushed back onto the industries that trigger the costs rather than buried in state or local government road budgets. 

Similarly, most states use motor fuel excise taxes to pay for transport-infrastructure (primarily roads).  Yet, exemptions for many user classes that do use the roads (e.g., government vehicles) are common.  In other cases, the states exempt forms of transport such as rail, boats, or aviation from fuel taxes entirely because they do not use roads.  But where governments are also spending money on rail, water, or air infrastructure or oversight, different earmarking might be prudent, but full tax exclusion is not.  These types of cross-subsidies are fiscally and environmentally damaging.

5)  Subsidizing favored extraction activities needs a rethink.  States routinely subsidize forms of energy they produce domestically or that come from lower productivity mines or wells.  Some of these subsidies provide incentives to boost production or consumption of higher polluting fuels such as lignite or high sulpher coal. The policies are focused on protecting employment and extraction levels.  They implicitly downplay the impact of the subsidies on environmental quality or on the ability of other fuels or energy services to compete.   Tax exemptions for fossil fuels consumed or lost during the extraction process are also common. 

In all of these situations, a rethink is needed.  Fossil fuels in lower productivity wells are one type of marginal energy resource, but they are not the only one.  Subsidies should not put higher cost fossil fuels at a competitive advantage to other, often cleaner, substitutes.  

Conventional wisdom on propping up extractive industries as productivity declines is equally problematic.  Old wells are sometimes reopened as prices rise or technology improves, regardless of the state subsidies for doing so.  Further, the declining returns on old wells as costs rise and volumes drop really isn't that different structurally from what happens in many other businesses as technology and equipment ages, and new alternatives come to the fore.  Yet we don't see the tax code littered with subsidies to keep other declining productivity businesses going in the face of new competitors.  Government policy should be neutral with respect to aging industries rather than favoring polluting fossil fuels.


State subsidies to fossil fuels have been neglected for too long.  They are wide ranging, large, and often exacerbate environmental harm while also acting as a competitive impediment to emerging energy resources and improved energy efficiency to compete on an equal footing.  By inventorying these subsidies in five states, we hope to start a conversation on how to get rid of many of them, and to provide a foundation on which others can continue to expand the subsidy knowledge base.


Further reading

Readers interested in sub-national subsidies may also find the following three resources of value:

1)  OECD's inventory of fossil fuel subsidies.  OECD partially funded our work, and a some elements of this review will be included in their updated installment of fossil fuel subsidies within OECD countries.  Their most recent subsidy data can be accessed here.  The updated printed report is slated for publication in January 2013. 

2)  Good Jobs First Subsidy Tracker database.  This is the most extensive database I'm aware of covering a wide variety of state-level subsidies.  The coverage on grants and tax breaks is strong and growing.  But weaknesses in state reporting on other subsidy instruments reduce the ability of Good Jobs First to comprehensively track some of the other types of support.  Thus, coverage of credit and insurance subsidies, below-market sales of publicly-owned minerals, or state-provided goods or services in the energy sector is more spotty.  The values in the database can be viewed as a lower-bound estimate for total subsidies in a state.

3)  United States of Subsidies database from the New York Times.  Supplements information from the Good Jobs First database with additional sources, and provides a nice interface to facilitate tabulations of state-level subsidies to specific companies.  Not fossil-fuel specific.

Natural gas fracking well in Louisiana

Houston-based DKRW Advanced Fuels has a dream:  they want to turn a chunk of Wyoming's vast coal reserves into 10,600 barrels of gasoline per day.  They want to capture most of the carbon emitted in the process and sell it to the state's oil and gas industry, which will use the CO2 to inject into wells, increasing oil and gas production.  In one fell swoop, the firm hopes to boost production of all of the state's major fossil fuels.  The facility would be located near Medicine Bow, a town that presently has about 300 people.

Dreaming with somebody else's money

Oh, and part of the dream that they don't broadcast quite so loudly is that they want to do it mostly with our money.  The firm has an application in with DOE for a $1.7 billion loan guarantee, which passed DOE preliminary review in 2009.  And they've recently gotten approval from the Carbon County Commission to issue $245 million in tax exempt bonds.  This debt is guaranteed by the project not by the County, but subsidized by taxpayers because the interest is free from taxation.  It will also use up most of the state's annual alotment to issue tax exempt, non-municipal bonds. 

There's more at the subsidy salad-bar:  the Commission also unanimously endorsed issuing $300 million in industrial development bonds, which DKRW has asked the state's Permanent Mineral Trust Fund to purchase.  From time-to-time, the Trust Fund does invest in Wyoming-based enterprises, and DKRW has indicated that they think their plant should be one of them.

The venture is also being supported by $10 million in state funding to support pre-construction studies both for the DKRW facility, and another project under consideration within WY that would convert natural gas into vehicle fuels. 

Bob Kelly, executive chairman of DRKW, is happy so far with the state's involvement.  As noted in a recent story in the Casper Star-Tribune, Kelly

said the bonds are "very helpful" in assembling the $1.7 billion to $2 billion needed to finance the plant's construction.  Kelly said the company is seeking bank financing to cover the rest of the plant's cost [emphasis added].

Where's the equity?

Billions at risk, leveraged from other people.  This should always be a flag that extreme due diligence is needed.  The fact that the entire top management team at DKRW Advanced fuels (Robert Kelly, Jon Doyle, William Gathman, Jude Rolfe, Robert Moss, and Wade Cline) are out of Enron does nothing to ameliorate the concern. 

Kelly's statement also begs the question "where's the equity"?  DOE's guarantees require a minimum of 20% equity investment.  It's not from DOE.  It's not in the tax-exempt bonds, and it's not in the "bank financing to cover the rest of the plant's cost."  That, perhaps, leaves the $300m that DKRW is trying to get the state of Wyoming to plow in.  That funding seems to be structured like debt, because there is no mention of the state getting a stake in the company for the money.  It is clearly like risk capital in terms of the investment it is supporting, however.  Nonetheless, the limited equity requirement under the DOE program was focused on aligning the incentives of managers with the venture's success by requiring them to have "skin in the game." Government money wouldn't seem to cut it.

To it's credit, Wyoming is approaching the investment with some caution.  The Treasurer's Office has requested input on deal soundness from the Wyoming Business Council, which in turn has asked for a technical review from Idaho National Laboratory.  Mike Martin, at the Business Council, did not think the INL review went beyond technical issues to include as well a review of the financial suitability of the project for the state's Mineral Trust Fund. He was also not clear whether the INL review would examine systemic risk factors, such as what would happen to plant economics should a price or cap on carbon emissions be instituted.  INL's review should look at both of these items, as federal and Wyoming taxpayers will have lots at risk if this plant moves forward with so much public subsidy.

A second check to the spending comes from the legislature.  An investment of $300m would require Legislative approval, making it more difficult to put state funds at risk foolishly.  However, investments up to $100 million would not, and State Senator Phil Nicholas, chairman of the Senate Appropriations Committee, has said the leadership would be comfortable with buying $50 to $100 million of the bonds.  As evident from the table below, even at these lower levels, the funding would materially alter the Trust Fund's asset allocations and DKRW would comprise one of its largest, non-diversified investments.

DKRW investment conflicts with the purpose of the Permanent Mineral Trust Fund

To look at the issue of financial suitability, I pulled existing data on the state's Permanent Mineral Trust Fund (summarized in the table below).  The purpose of this fund, and many others like it around the world, is simple:  mandate a portion of mineral revenues to go into an investment fund for the benefit of future residents of the resource-producing region -- be it a county, a state, or an entire country.  This solves two problems at once.  First, the mandate removes from political control at least part of the massive cash flow that comes from resource booms.  Without such a mandate, the potential benefits of resource booms were often lost as politicians squandered the surge in funds on foolish projects, empire building, or corruption.  Second, the Trust Fund approach requires an independent fund manager to invest in a widely diversified set of assets.  The income and growth of these other assets reduce the correlation between energy or mineral prices and the available revenues to the state, helping to dampen the boom-bust resource cycles as well. 

Based on the criteria for which the Mineral Trust Fund was established, investing in DKRW should be immediately rejected, even at funding levels well below the requested $300m.  Regardless of whether INL decides the plant is technically sound, the investment further concentrates Wyoming's financial exposure to energy prices rather than diversifying away from them, and therefore works counter to the intent of the Mineral Trust Fund. 

Further, as shown below, the scale of investment is far more concentrated that what currently exists in the Fund's portfolio.  At first blush, a $300m investment in the plant may not seem like a big deal, comprising well less than 10% of more than $5 billion in total holdings of the Trust Fund.  Yet, for any of the conceivable asset classes in which the investment could fit, exposure to DKRW would dominate the class, comprising at least than 2/3 of the resultant asset class sizing (current size plus DKRW holding) in every case.  This metric actually understates the risk since the existing portfolio has many small investments, rather than large lumpy ones like the proposed holding in DKRW.

I looked at four potential asset categories in which DKRW could possibly fit.  Because the investment would be debt with no equity interest, I considered corporate bonds.  However, the risk of this venture is far higher than what a normal corporate bond portfolio would entail; and if I were the Treasurer, I would require equity interests as well.  If we assume the state were to get an equity interest as well, conceivably small- to mid-sized (SMID) US equity would be an asset-class fit.  But again, the risk is higher than what a SMID portfolio would normally entail due to the high technology risks of the plant, and the investment would have some elements of debt rather than being pure equity.  Private equity is probably the best match in terms of risk level -- though one that would require much higher returns to the state than what is likely being considered at present. 

The final category considered was intra-Wyoming investments.  Like the other possible categories, DKRW would come to dominate the WY holdings at a $300m sizing.  Not only would be the size of the investment be larger than what currently exists within the intra-WY holdings, but many of the existing investments benefit multiple firms or people, not a single project.  Many of these projects also have a clear public interest component (beyond simple job creation), something that DKRW investment does not.

For additional reading on the planned DKRW coal-to-gasoline plant in Medicine Bow, Wyoming Public Radio just did an interesting series of reports.  Taxpayers for Common Sense also has a good backgrounder.  Update, 2/16:  An interesting op-ed in the Casper Tribune by Jason Lillegraven goes into some detail on problems with the environmental assessments done on the project to date, particularly with regards to water consumption.  For so many of these facilities, water is the achilles heel.  Too often, the facilities pay little or nothing for the amount of water they use.  Just as running a sensitivity on project returns assuming CO2 emissions won't always be free, it would be prudent to do the same with water.


Wyoming Ownership of DKRW bonds
I.  DKRW wants fund set up to diversify away from minerals to invest in CTL
Fund that would own the bonds  WY Permanent Mineral Trust Fund   
State investment requested by DKRW  $300,000,000  
Total Fund holdings, 6/30/11  $5,050,000,000  
II.  Concentrated DKRW investment would dominate any asset class it is attributed to
Possible asset class categories for DKRW investment  Asset class holdings as of 6/30/11  DKRW investment/ existing asset class sizing
Corporate bonds  $189,100,000 159%
Small/mid cap US equities  $186,200,000 161%
Private equity  $129,500,000 232%
Wyoming investments  $121,300,000 247%
III.  Scale of DKRW investment would be much larger than other intra-WY investments
   Amount Outstanding, 6/30/11  DKRW Investment/ Existing WY investment
Largest WY Investments    
Time deposit open banking program (multiple beneficiaries)  $162,100,000 185%
Basin Electric Power Bond  $33,702,000 890%
Farm loans (multiple beneficiaries)  $28,851,596 1040%
Shoshone Municipal Pipeline Treatment Plant  $13,286,088 2258%
Laramie Territorial Park Loan  $10,000,000 3000%
Source:  Wyoming State Treasurer's Investment Report, Fiscal Year 2011, September 2011