API Comm

API's "Fueling Confusion" Initiative Attempts to Divert Attention
from Subsidy Reform as a No Regrets Carbon Control Strategy

Facing increasing evidence that it is not "business as usual" in the oil sector, it is easy to understand API's attempt to reclassify the many government programs that subsidize our nation's reliance on oil out of existence (http://www.api.org/issues_and_research_papers.htm).  Put in some graphics of clouds, overlay the results of one of the most detailed assessments ever conducted on U.S. subsidies to oil in the form of a pie, gradually remove each slice of this "pie-in-the sky" analysis until there is the merest morsel left, and then conclude that this morsel surely has no effect on oil markets.  Add to API's recipe for a climate change counter-offensive only the barest reliance on logic and the sometimes blatant disregard for the actual claims being made in the Fueling Global Warming (FGW) analysis,[1]   and it is no wonder that API titled its "analysis" of the extensively peer-reviewed FGW study "Fueling Confusion."[2]

The fact of the matter is that government subsidies can be confusing, and the more confusing they are the less likely they are to be called into question and eliminated.  Obscurity can be of great benefit to the recipients.  However, we hope that people are not confused into believing the oil industry's rhetoric, but rather view subsidy reform and increased transparency in fossil fuel pricing in the same way that we do:  as one of the lowest cost, no regrets strategies to meet a part of the commitments made under the climate change treaty developed in Kyoto.  Independent of climate change, accurate pricing of natural resources improves the long-term efficiency of an economy;  reduces the peripheral environmental damages that generally accompany natural resource extraction, refining, and consumption; and can save substantial public funds.

Exhibit 1 provides a brief analysis of API's claims; a more detailed text description follows.  We address their cross-cutting claims first, then evaluate their claims on specific subsidy programs.  In an effort to make the absurdity of some of these arguments easier to understand, we have provided examples of how API's logic would translate into other parts of the economy.

Exhibit 1

Summary of API Claims

API Claim

Position Taken in Fueling Global Warming

1. FGW Subsidy Definition "Simplistic"

API counts only direct monetary payments or special tax treatment that is intended to increase demand or lower production costs so that the levels of production or consumption are increased.

Markets are about risks and rewards, and the probabilities associated with each.Government actions affect oil production and consumption decisions in far more ways than the two API endorses as subsidies.Furthermore, these actions need not be intended in order to be important.

2.Subsidies are overstated because industry taxes and regulatory burdens have not been netted out.

Taxes have been netted out as appropriate throughout the FGW report.Where taxes on oil pay for oil-related expenses (e.g., oil spill cleanup) they have been applied against the cost of providing these services.Regulatory burdens are only properly netted from subsidies if (a) they do not control for negative externalities; and (b) if negative externalities not currently controlled by regulations are credited against them.These adjustments would yield a much higher, not a lower, subsidy to oil.

3.FGW erroneously challenges detailed estimates of the economic costs to meet the Kyoto accord.

In actuality, the analysis does not discuss the costs to meet the Kyoto protocol at all, and such costs are irrelevant to whether subsidy reform is a useful first tier compliance strategy.We believe API created this false linkage in an attempt to discredit the subsidy work.We further believe that most of the economists who worked on the studies API references would support greater transparency in oil prices through subsidy reforms.

4.Greenpeace presents subsidy reform as a "costless" strategy for meeting the Kyoto targets.

Economic change is never costless, and there is no claim in FGW that somehow removal of oil subsidies would be such a miracle.We believe that reforming oil subsidies would make most people (though not all) better off, through improved environmental quality, fiscal efficiency, and incentives to develop substitutes for oil.The report explicitly advocates that transitional costs, especially in rural areas, be managed, but in a way that decouples support to rural communities from natural resource extraction.

5.The subsides shown do not affect oil consumption levels, but only the size and composition of domestic producers.

What API really means by this statement is that the subsidies they mark as "true" subsidies (not suprisingly a small fraction of the real total) are not large enough to affect consumption.Any reasonable evaluation of how large subsidies to oil are shows a very different picture.Not only would consumption levels be affected, but comprehensive subsidy reform might actually improve the position of domestic producers relative to imports.

6.FGW presents subsidies that benefit other fuels as though they are subsidies to oil.

Every single subsidy contained in the report has been pro-rated to reflect only the oil portion.The argument that any subsidy benefiting more than just the oil sector should not count as a subsidy to oil is without merit.

7.Defending oil supplies from the Persian Gulf does not constitute a subsidy.

API implicitly acknowledges that a key mission for the military presence in the region is oil security, and that this presence benefits oil markets.However, they argue that because the marginal cost of protecting oil is small (the forces would still be there for other reasons), one can not say there is any subsidy.

FGW contains an extremely detailed discussion of how to look at common costs such as the military presence.For activities with high fixed costs and joint production of two or more outputs, marginal cost is not a viable metric for allocating costs to the respective products.For example, if airlines charged every passenger only the direct cost of their lunch and ticket printing, there would be no airlines.FGW used a common cost approach to estimate the subsidy, and advocates funding these costs through a tax on oil consumers rather than through general tax revenues.

8.The Strategic Petroleum Reserve (SPR) subsidy estimate is based on "an assortment of questionable methods."

These "questionable" methods involve imputing a finance charge on the construction of the facilities and oil inventories, methods that API's member companies use every day to stay in business.Because financing costs have not been reflected in SPR's books, the entity has had interest-free use of billions of dollars for decades.These costs should be properly reflected in SPR's accounting, and the Reserve should be funded through a tax on oil not by general taxpayers.

9.Because SPR benefits more than just oil consumers, the cost should be paid all sectors in the economy.

We agree that SPR provides important macroeconomic stabilization, and for that reason think the program should be maintained.However, this stabilization is needed because of an over-reliance on oil.Therefore, following precedents throughout the economy (described below), the costs are properly borne by oil consumers.

10.Accelerated depreciation is not a subsidy because it is available to all sectors of the economy.

Accelerated depreciation, especially in a low-inflation environment, allows investors to write-off capital expenses more quickly than their actual service lives.FGW presents the value of this benefit associated with oil-related buildings and equipment only.Because the write-off period relative to actual service life differs across industries, the rules can introduce inter-sectoral distortions.In addition, the provision overall tilts energy markets away from less capital-intensive methods for meeting energy demand, and directly disadvantages many energy conservation and end-use efficiency investments.

11.Foreign tax credits.

These provisions ensure oil companies aren't double-taxes on foreign income, are available to all sectors, and do not constitute a subsidy.

We agree that avoiding double taxation is appropriate, and do not count foreign taxes that are really taxes as a subsidy.Where companies have been able to reclassify what are really oil royalty payments as taxes in order to obtain more favorable tax treatment within the U.S.(e.g., in a country where nobody pays corporate income taxes other than oil companies), we do very much see subsidization.API made no mention of this critical point.

12.Deferral of foreign source income.

Because this provision is available to all industries, it is not a subsidy.

Clearly this is a subsidy, since foreign operations can defer when they send earnings back to the US, and hence when they have to pay taxes on the earnings.This is why the item is tracked every year in the US tax expenditure budgets.Given the large international presence of US-owned oil companies, this subsidy is much more important to the oil sector than to other international companies.

13.General government expenses such as market regulation, health and safety oversight, information gathering, and managing resource sales on public lands are basic functions of government, not subsidies.

Not every type of energy requires the same level of government oversight, and subsidy removal can help the markets choose sources that are less "oversight-intensive" (e.g., windmills over nuclear power).Though beneficiaries may define these services as "basic functions" of government, the activities often benefit one sector far more than others.API also erroneously alleges that we count managing oil sales on federal lands as a subsidy.These items are not in fact included in our subsidy totals.

14.Royalty payments

API states that the federal government has not been underpaid royalties owed by integrated producers for oil produced from federal land.

Since many API members have litigated this issue, we understand their need to take this position.However, there is substantial evidence that artificial transfer prices used by different divisions of the same companies (and on which royalties were calculated) understated the real value of the oil, and hence the payments to the federal government.This would not be the first time such as strategy was used.Throughout the 1960s, integrated oil companies often transferred much of their global profits (again using transfer prices) into tanker subsidiaries registered in countries such as Liberia or Panama.These countries had extremely low tax rates, and the firms successfully avoided the bulk of their US tax obligations.

15.Subsidies disappear without a trace

API states "true" subsidies are only $0.4 to $1.3 billion per year, implying this is what is left from the original FGW subsidy listing.

In reality, once one subtracts all of the subsidies API complained about, a total of $2.0 to $3.5 billion is left, three- to four-times what API claims is left.Without any discussion, API zeroed out a number of very important subsidies to oil, perhaps to avoid calling attention to them.This includes subsidies to waterborne oil transport ($690 to $775 million per year); subsidized lending to sell U.S. oil-related equipment abroad, or to develop foreign fields ($205 to $270 million per year); oil R&D ($120 million per year); and inadequate bonding levels at operating wells ($170 to $550 million per year).

General Claims Made by API about Fueling Global Warming (FGW)


API False Claim #1:  FGW uses a simplistic definition of subsidy.


Fueling Global Warming provides a detailed and comprehensive description of what counts as a subsidy [link here to "subsidy basics"].  The general linking theme is that they include any government policies that benefit the oil sector of the economy, whether through direct payments, special exemptions from taxation or regulation, or shifting of risks properly borne by private parties onto the public sector.  All of these types of activities either increase returns, or decrease the risks, associated with oil production and consumption.


It is ironic that API calls this definition simplistic, and then states that government support for an industry is only a "subsidy" if it is in the form of "a monetary payment or special tax treatment intended to increase demand or lower production cost so that the level of production and consumption are higher than they would otherwise be."  While such a definition is certainly advantageous for API and its members, it hardly reflects the reality of the marketplace.  If a policy is not intended to alter production or consumption patterns, but has that effect, API would not consider it a subsidy.  If a policy significantly alters the risks and reward patterns associated with a particular type of activity, as is common with government-provided insurance or loan guarantees, API would not consider it a subsidy.  What of government-provided services that benefit some parts of the economy far more than others?  Using API's logic, since there is no direct monetary transfer, there can't be a subsidy.


In a marketplace that regularly uses sophisticated financial products, purchased by willing buyers, to mitigate many types of basic business risks, it seems as though it is API's definition that is simplistic.


API False Claim #2:  "No attempt is made in the Greenpeace study to net out provisions that raise revenues from petroleum or regulations that impose costs on it, though both are highly relevant to the petroleum industry."


We agree that consideration of subsidy offsets is an important component of accurately reflecting the net level of subsidization.  In fact, this was explicitly done in Fueling Global Warming, and it is surprising that the API researcher somehow missed this.


A)  Special Taxes and Fees on Oil.  Consider the following description from FGW regarding special taxes:


In addition to providing subsidies, the government also levies fees on oil.  While subsidies act to distort energy markets in favor of oil, certain fees may have the opposite effect, and are properly treated as offsets to subsidies…Where fees represent standard treatment of all industries, they are not considered subsidy offsets.  Where a fee is levied only on oil (or on oil plus a few other sectors), it must be evaluated further.  Many of these fees are earmarked to pay for government activities such as oil spill cleanup or the remediation of contamination from underground gasoline tanks.  If  the levies pay for oil-related government activities, then they are treated as user fees rather than subsidy offsets and they are credited against the oil-related government program spending that they support.  To the extent that a particular fee is levied only on a few industries (including oil) and receipts do not support an oil-related purpose, it is referred to as a special tax… We subtract special taxes from our gross subsidy numbers. (p. 1-3).


Section 2.3 of the report provides a detailed description of revenues raised from oil and Exhibit 2-1 provides a general overview of how we classified the various taxes and tax breaks to oil [link to user fees flow chart].


API makes very specific claims regarding the impact of these offsetting taxes.  They argue that earlier analyses (in fact, one single analysis) show negative aggregate subsidies to oil once excise taxes were eliminated.  This argument is flawed in two respects.  First, the subsidies one should subtract -- the portion of motor fuel excise taxes not used on highways -- were eliminated.  All of these taxes now support oil-related uses.  Second,  when these taxes were netted from subsidies to oil in a 1992 study by the Energy Information Administration (http://tonto.eia.doe.gov/FTPROOT/service/emeu9202.pdf), EIA neglected to add back in highway construction that was funded from general tax revenues rather than taxes on motor fuels.  In fact, many analyses (with the exception of those conducted by API) show that net collections from these taxes are insufficient to cover the costs of the highway infrastructure, yielding a potentially large additional subsidy to oil. 

B)  Netting Costs of Government Regulation of the Oil Industry


API argues that a "fair" evaluation of subsidies to the industry would subtract the costs the industry is forced to incur through government regulation.  At face value, this claim is highly simplistic.  Government regulation of industry is done for a purpose, such as protecting health, safety, or environmental quality.  In fact, without many of these regulations, the industry would receive a de facto subsidy by forcing negative effects of its production systems (known as negative externalities) onto a population without compensation.  These losses to general welfare take many forms, including illness, premature death, declines in fishery or agricultural production, and destruction of recreation or ecological sites.


Clearly there are a range of regulations.  Some may not address negative externalities as claimed, and may in fact constrain activities that are both equitably and efficiently provided by the market without government intervention.  Others may address areas of real concern, but do so inefficiently.  A "fair" treatment of net subsidies to oil would properly subtract this subset of regulatory costs, if such a subset could be determined with any accuracy.  However, this is but part of the picture.   Just as industry may be over-regulated, it may be under-regulated as well, and at the same time.  The oil industry may correctly argue that regulation "A" forces them to incur costs without addressing any negative externality issue.  However, environmental groups may also properly argue that in a host of other areas the industry is under-regulated, given rights to pollute air water or land, or expose their workers to hazardous conditions, without properly compensating those parties for their losses.


The ultimate question, then, is whether in the case of oil, the negative externalities exceed the costs of inefficient or inappropriate regulation.  The answer is not likely to favor API's claim that direct subsidy figures should be reduced to reflect the cost burden of regulation.  Much more likely, the negative externalities associated with oil extraction, refining, and consumption far exceed the portion of regulatory costs that act as a de facto tax.  A brief survey of the literature done in 1993, for example, found that the "tax" associated with oil overcharge funds, the gas guzzler tax, and auto fuel efficiency and emissions standards ranged from $3.2 to $15.6 billion per year.  In contrast, the values associated with damages from auto emissions ranged from $4.6 to $200 billion per year; externalities associated with oil-fired electricity added another $2.7 to $6.4 billion per year in uncompensated costs.[3]


API False Claim #3:  Greenpeace challenges estimates done by parties such as the Energy Information Administration, WEFA, and Charles River Associates on the costs of complying with the Kyoto accord.


Fueling Global Warming says nothing about the cost of complying with the Kyoto protocol.  In fact, some of the studies that API claims the report "challenges" weren't even published at the time of the Greenpeace release.  It's not that we believe the cost estimates by EIA, WEFA, and CRA are necessarily correct (estimates of long-term economic dislocations from environmental regulations are difficult to make and often assume less flexible responses than actually occur); it's just that the specifics of the Kyoto accord and the costs of meeting them were not relevant issues in our detailed documentation of government subsidies to oil.  Why then would API make such an obviously inaccurate claim in the very introduction to its "Fueling Confusion" initiative?  We believe that they hoped to broaden opposition to the subsidy analysis through this tactic, especially among constituencies who had never read the study.  In reality, however, we anticipate that many of the economists who served as reviewers for the costing studies of Kyoto compliance promoted by API would be in favor of more transparent pricing of fossil fuels through subsidy removal or reform.


What the Fueling Global Warming report does say, in its forward, is that any strategy to control carbon emissions should look to subsidy reform as an early step in achieving those goals:


Eliminating subsidies and incorporating environmental externalities into energy prices are achievable, market-based solutions that can play an important near-term role in combating climate change.


Because subsidy reform improves market price signals and encourages the development of substitutes for oil, subsidy reform can reduce green house gas (GHG) emissions in a manner that provides a number of other important benefits to the economy.  It should be a first-tier, no regrets component of a Kyoto compliance strategy.  If implemented well, subsidy reform could also contribute to reducing the total costs of meeting the targets.


Note that while the Greenpeace study focused on US subsidies, this issue is an international one.  An OECD review of pricing distortions for all fossil fuels across over 25 major producing and consuming nations found widespread government interventions that both increased and decreased domestic energy prices relative to the world reference price.[4]  Below-market prices, the result of domestic subsidization programs, contribute to increased reliance on fossil fuels.  Interestingly, however, even above market prices sometimes inhibit appropriate energy consumption patterns.  This is because the protected sectors can be the more highly polluting fossil fuels (coal, heavy diesel), and the protections can prevent entry of cleaner substitutes either through trade or new start-ups.  Trade barriers (these are often an important driver behind above-market prices) may also protect government-owned oil monopolies, preventing more foreign from coming in and establishing more efficient and less polluting infrastructure and technology.


API False Claim #4:  Subsidy reform is presented as a "costless" strategy for meeting the Kyoto protocol.


Economic change is never costless, and there is no claim in FGW that somehow removal of oil subsidies would be such a miracle.  Any change in economic conditions creates some groups that are worse off, even if the vast majority are made better off.  The report does believe these transitional costs are worth paying, given the environmental and economic benefits of the shift.  However, the transition must be managed so that the policy changes do not create pockets of hardship.


Towards this end, the report puts as its very first recommendation to "Decouple oil subsidies from rural economic development."  This is a critical and very significant change in public policy in the energy sector.  Subsidies to many natural resource extraction activities -- oil among them -- have often been justified on the ground that they provide jobs and livelihoods for isolated rural populations.  Data suggest that development policies focused on natural resource extraction have rarely been successful.  In addition, rapid advances in telecommunications and computer technology provide an increasing range of development options for geographically isolated communities.  By decoupling oil development and jobs, governments can stop subsidizing environmental degradation and work to create cleaner, higher value job opportunities for rural populations.


Continue >>>