US President Barack Obama summoned the oil and gas industry to two tasks when he called last month for an end to subsidies for fossil energy. One is to address confusion over the meaning of "subsidy." The other is to force attention to a central motive of Obama's appeal.
Subsidies take many forms. The US government provides a subsidy when it suspends royalty for initial production of oil and gas from deep waters of the Gulf of Mexico. The Iranian government provides a subsidy when it caps the price of gasoline. Economically, these two types of subsidy are poles apart. One encourages production; the other encourages consumption.
Shunning distinctions
Many other methods of subsidization are in place worldwide, not all of them as clearly definable as royalty relief and price controls. Their effects vary. In the US, for example, percentage depletion represents a subsidy to the extent it enables an independent producer ultimately to charge to depletion more than total spending on a property. It's vital to capital formation for small producers. But the accounting method represents much less subsidization of oil production, for example, than a direct tax credit does of ethanol blended into gasoline.
Politics shuns these distinctions. In his statement on ending fossil energy subsidies after the G-20 summit in Pittsburgh last month, Obama mentioned only one example: Indonesia's politically difficult dismantling of fuel price caps. His analysis seemed to aim at consumption subsidies of that type. But then he cited US efforts, all of which target production. The view thus seems to be developing that all subsidies are alike, and those applying to fossil energy must cease.
The oil and gas industry can't let this confusion dominate political debate. If it does, any tax measure that applies to oil and gas and that can be branded a subsidy will be in jeopardy.
An example of the confusion that can arise on this subject appeared in a September report on US fuel subsidies by the Environmental Law Institute. The report's headline conclusion is that during 2002-08, subsidies to fossil fuels totaled $72 billion while subsidies to renewable energy amounted to only $29 billion. The report's authors regret this disparity as contradictory to policy aspirations on climate change and energy security.
Promoters of renewable energy will pounce on the findings to seek more government help, arguing that an increase in aid will be only fair in view of what fossil-energy producers receive. The study, however, doesn't address what producers receive. Instead, it assesses "subsidy value through the cost of a subsidy to the government, rather than through its value to the recipient."
So $6.4 billion of the total fossil-energy "subsidy" represents block grants to states under the Low Income Home Energy Assistance Program. And $6.2 billion of it is for the Strategic Petroleum Reserve. The biggest single chunk is a $15.3 billion estimate of what the US government doesn't collect because of royalty payments to foreign governments accounted for as income taxes and therefore creditable against US taxes. Another major category is $14.1 billion in credits for production of nonconventional fuels, which mainly help coal producers.
Much of that $72 billion subsidy total thus does little for producers of oil and gas. The producing industry, though, can expect to be bludgeoned with the number in discussions about tax policy. It will have to address exaggerations about timing preferences, such as the ability to charge intangible drilling costs immediately to expense rather than amortizing them over asset lives, the "subsidy" value of which relates mainly to the time value of money.
Poisonous campaign
While seeking perspective in the subsidy debate, producers also must confront the stated reason Obama wants to press the issue. His administration sees merit in cutting domestic production of oil and gas. It has adopted an extreme environmental assertion that lowering production ultimately lowers consumption of fuels that emit greenhouse gases and thus should be a policy goal.
An assault on vaguely defined subsidies threatens to become a tool of that economically poisonous campaign. Producers must not let it happen.
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