Signature Sponsor
Friendly Policies Keep US Oil and Coal Afloat Far More Than We Thought

 

 

By David Roberts


October 7, 2017 - The coal industry and its allies in the Trump administration have recently devoted considerable energy to arguing that subsidies to renewable energy have distorted energy markets and helped drive coal out of business. “Certain regulations and subsidies,” says Rick Perry, “are having a large impact on the functioning of markets, and thereby challenging our power generation mix.” You can guess which regulations and subsidies he’s talking about.


This is nothing new, of course. It is in keeping with a long conservative tradition of challenging the economic wisdom and effectiveness of energy subsidies.


At least, uh, some energy subsidies.


Energy analysts have made the point again and again that fossil fuels, not renewable energy, most benefit from supportive public policy. Yet this fact, so inconvenient to the conservative worldview, never seems to sink in to the energy debate in a serious way. The supports offered to fossil fuels are so old and familiar, they fade into the background. It is support offered to challengers — typically temporary, fragmentary, and politically uncertain support — that is forever in the spotlight.


So let’s change that. Let’s talk about “certain regulations and subsidies” — namely, the ones propping up US fossil fuels.


Three recent analyses can help. The first does the yeoman’s work of tallying up federal and state energy subsidies. The second shows the effect those subsidies have on oil and gas production. And the third shows how thoroughly the US coal industry is propped up by regulatory policy. Together, they paint a clear picture: The profits of US fossil fuels are built on a foundation of government assistance.


All right then. First: What gets subsidized, and how much?

 

US Fossil Fuel Production is Subsidized to the Tune of $20 Billion Annually

 

Researchers at Oil Change International (OCI) set out to quantify the level of US fossil fuel subsidies, but before we get to their results, a few important caveats.


OCI is only counting direct production subsidies. As they acknowledge, that leaves out a great deal.


For one thing, it leaves out the annual $14.5 billion in consumption subsidies — things like the Low Income Home Energy Assistance Program (LIHEAP), which helps lower-income residents pay their (fuel oil) heating bills. (There are better ways to help poor people, but let’s leave that aside for now.)


It also leaves out subsidies for overseas fossil fuel projects ($2.1 billion a year).


Most significantly, OCI’s analysis leaves out indirect subsidies — things like the money the US military spends to protect oil shipping routes, or the unpaid costs of health and climate impacts from burning fossil fuels. These indirect subsidies reach to the hundreds of billions, dwarfing direct subsidies — the IMF says that, globally speaking, they amount to $5.3 trillion a year. But they are controversial and very difficult to measure precisely.


Finally, OCI acknowledges that its estimates of state-level subsidies are probably low, since many states don’t report the costs of tax expenditures (i.e., tax breaks and credits to industry), so data is difficult to come by.


All of which is to say: OCI has produced about the most conservative possible estimate of the subsidies received by fossil fuels in the US. These are solely production subsidies — taxpayer money that goes directly to producing more fossil fuels.


So what’s the verdict?


Adding everything up: $14.7 billion in federal subsidies and $5.8 billion in state-level incentives, for a total of $20.5 billion annually in corporate welfare.


Of that total, 80 percent goes to oil and gas, 20 percent to coal. On the right, subsidies are broken down by stage of production. Extraction gets the most.


 

Notice that asterisk by remediation, which refers to the cost of cleaning up environmental messes and abandoned infrastructure left behind by fossil fuels. Shady insurance, bonding, and liability-cap policies mean that taxpayers are probably on the hook for lots more than this in the end, but it’s difficult to quantify in advance.


There are dozens and dozens of fossil fuel production subsidies — OCI’s report has a whole appendix devoted to listing them — but here they are broken down by the biggest offenders:


 

You probably can’t read that text, so here are the top six:


Intangible drilling oil & gas deduction ($2.3 billion)

Excess of percentage over cost depletion ($1.5 billion)

Master Limited Partnerships tax exemption ($1.6 billion)

Last-in, first-out (LIFO) accounting ($1.7 billion)

Lost royalties from onshore and offshore drilling ($1.2 billion)

Low-cost leasing of coal-production in the Powder River Basin ($963 million)

 

(I listed six because that sixth one is the biggie for coal.)


These kinds of obscure tax loopholes and accounting tricks are not widely known or debated, partially because you have to be a tax lawyer to understand them, and partially because they are simply old. The single biggest one, the intangible drilling deduction, has been around for over a century!


As subsidies age, they start to look less like subsidies. They start looking like fixed features of the landscape, like mountains or rivers, rather than choices we are making. They just look like the status quo.


How does this compare to renewable energy subsidies? In terms of permanent tax expenditures, fossil fuels beat renewables by a 7-1 margin:

 

 

(The primary federal tax supports for renewable energy — the investment and production tax credits, respectively — are not permanent. They are set to phase out over the next five years, and are politically vulnerable in the meantime. But if you include them, Stephen Kretzmann of OCI confirmed for me over email, permanent fossil tax breaks still win, at $7.4 billion to $5.6 billion.)


If you ask people in fossil fuel industries, their support staff in conservative think tanks, or fossil-state politicians, they will tell you why these fossil fuel production subsidies are necessary. It’s always been this way. They’re more than paid back by tax revenue. Other industries get them too. (For the record: More than half the $20 billion is available to fossil fuels alone). They create jobs. They’re important for national security. Tax expenditures aren’t subsidies at all, if you think about it. Etc.


If the endless debate over energy subsidies has taught me anything, it’s that nobody thinks their own subsidy is a subsidy — and no one outside think tanks and universities really gives a damn about the economic distortions of subsidies as such. Everyone thinks their favored energy sources deserve support and the other guys’ don’t. Period. They use whatever economic argument is handy — “picking winners” if you’re against the subsidy, “supporting jobs” if you’re for it — but such arguments are always instrumental. As I said recently about coal’s rent-seeking, there are no true free marketeers in struggling industries.


Speaking of rent-seeking, here’s a final fun factoid from OCI:


In the 2015-2016 election cycle, oil, gas, and coal companies spent $354 million in campaign contributions and lobbying and received $29.4 billion in federal subsidies in total over those same years — an 8,200% return on investment.

 

Not bad.


So, do all these subsidies make a difference. Why, yes. Yes, they do.

 

How Much Do Oil Subsidies Matter? A Lot.

 

The effects of consumption subsidies are fairly well-understood, as it is fairly easy to aggregate consumer decisions and find patterns. But the effects of production subsidies are trickier to pin down; it is difficult to tie particular background subsidies to particular investment decisions by producers.


In a new analysis published in Nature, researchers from the Stockholm Environment Institute (SEI) attempt to clear this up, quantifying, to the extent possible, just how much a difference production subsidies make. They do this by focusing in on a specific economic decision on the part of producers: whether or not to develop a new oil field they’ve discovered.


After tallying up their own long list of production subsidies and attempting to calculate how those subsidies shift the economic returns of new production, they came to some pretty startling conclusions, emphasis mine:


We find that, at recent US oil prices of US$50 per barrel, tax preferences and other subsidies push nearly half of new, yet-to-be-developed oil into profitability. This potentially increases US oil production by almost 17 billion barrels over the next few decades, equivalent to 6 billion tonnes (Gt) of CO2.


The researchers acknowledge that the impact of subsidies on these decisions is extremely sensitive to oil prices. If oil prices rise back up to, say, $75bbl, as some forecasters project, the impact of subsidies will appear far smaller.

 

But at current low oil prices, subsidies are making a huge, huge difference.


Coal is Propped Up By Government Policy Too

 

As the charts from OCI show, direct federal tax expenditures on behalf of coal production are dwarfed by oil and gas subsidies. The main federal tax subsidy is cheap leases to mine coal on public land.


But as a recent report from Carbon Tracker details, coal is still very much propped up by public policy.


It’s no big revelation that new coal plants are uneconomic. There hasn’t been a new coal plant built in the US in years and there will probably never be another one, for reasons of raw economics. Here are net capacity additions and subtractions from the US power fleet, from 2011 to 2016:


 

As you can see, crappy old coal plants are coming offline and nobody’s building new plants to replace them.


Problem is, new coal plants have to be “clean,” which is to say, they have to have the filters and scrubbers to meet modern pollution standards. And as I’ve been saying for years, coal can either be cheap or clean, not both; making a new coal plant clean makes it uneconomic (to say nothing of what happens when you force it to bury its carbon).

What’s more striking is how imperiled existing, fully paid-off coal plants are. Even many of those can’t compete against natural gas or renewables.


Many existing coal plants are balanced on a fine edge. To the extent they can escape requirements to upgrade to modern pollution equipment — and believe it or not, decades after the Clean Air Act was passed, they still can — they can stay profitable for longer.


“When current costs are considered, 72% of operating coal units are unprofitable compared to the operating cost of an equivalent [natural gas plant],” Carbon Tracker writes, “and 98% when the anticipated costs [of environmental upgrades] are included.”


In other words, once the entire coal fleet upgrades to modern pollution standards ... basically none of it will be economically competitive. Cheap or clean; never both.


That’s a narrow path to remaining profitable, and coal plants are only on that path at all because of all the other ways they are propped up by regulatory policy:


Capacity markets favor already-built coal over new natural gas or renewables: Unlike electricity markets, which pay for power, capacity markets pay for the ability to spin up, just in case. They are a way of maintaining reserve capacity in case other power plants unexpectedly go offline. For various reasons (see the report), such markets favor plants that are already amortized and have readily available fuel, i.e., generally coal plants. So yeah, even coal plants that rarely produce power still get paid to sit around and ... not be closed.

 

In regulated energy markets, utilities get paid to keep investing in unneeded, expensive coal plants: In competitive energy markets, plants close if they can’t make enough profit from their power to cover their ongoing costs. But in fully regulated markets (which contain 67 percent of US coal capacity), a utility’s return on investment in a plant is guaranteed by regulators, whether or not closing that plant would be better for ratepayers (as it very often would). Ironically, that’s why more coal plants in regulated markets have pollution-control equipment. In competitive markets, that would render them uneconomic (better just to shut them down). But in regulated markets, hell, why not? Every bit of investment means more guaranteed profits.

 

 

Utilities shuffle coal plants from their deregulated side to their regulated side, to shield them from competition: This one is so devious. Utility holding companies — which own utilities in both regulated and deregulated markets — move coal plants from the books of the latter to the books of the former, to shield them from competition and keep them alive via regulation. “This accounting practice typically shifts the economic burden from the shareholder to the consumer,” Carbon Tracker writes, “with the former often benefiting to the detriment of the latter.

 

Utilities hedge against changing natural gas costs: Some forecasters expect natural gas prices to rise in coming years (though, honestly, everyone is guessing). To hedge against that, utilities often keep uneconomic coal plants open, just in case rising NG prices retroactively render them economic.

 

This is just a partial accounting. The broader point is that the edifice of regulation governing the US electricity sector favors coal incumbents in myriad ways.


If all coal plants had to adopt their full costs and face full market competition tomorrow, the US coal fleet would quickly shrink to negligible size. It only survives because, through taxes and regulations, the US has protected it.


All Three Reports Make it Clear We're Accelerating in the Wrong Direction

 

All three reports are very clear that, to achieve the global target of limiting temperature rise to 2 degrees Celsius or less this century, fossil fuels will have to be aggressively phased out.


As OCI shows, staying within a 2 degrees Celsius carbon budget means that we can’t even burn all the fossil fuels in already developed reserves:


 

Hitting our target means no new fossil fuel exploration, no new fields or mines, no new development.


Carbon Tracker, meanwhile, develops a detailed scenario for phasing out the US coal fleet on schedule with a 2 degrees Celsius carbon budget. Here’s what it looks like:


 

(B2DS and 2DS are two International Energy Agency scenarios. You don’t need to worry about the difference.)


The 2C carbon budget dictates an extremely rapid phaseout — far faster than anything currently projected by utilities themselves.


That is the background against which to understand fossil fuel subsidies: They are intrinsically incompatible with current climate goals.


So, let’s take a step back and sum up.


Right now, the US pays rhetorical fealty to a carbon goal that would require stopping all new fossil fuel development and phasing out all coal plants.


Meanwhile, US taxpayers are spending tens of billions of dollars a year subsidizing new fossil fuel exploration and exploitation, and US regulatory policy keeps the zombie coal fleet shambling on.


All the while, conservatives complain volubly about subsidies to renewable energy and the US energy secretary tries to use them as an excuse to dump even more public money on coal companies.


It’s a train wreck.


But still. The oil and gas companies making decisions to develop new fields and the utilities keeping coal plants alive are going to realize, at some point, that their vulnerability to “carbon risk” grows every year. (Arguably, big oil is way ahead of big coal in understanding this.)


The Obama administration identified $8.7 billion a year in federal fossil fuel subsidies to eliminate, but couldn’t get it past Congress. Now both sides of Pennsylvania Avenue are fossil-addled.


But if the US ever does get serious about mitigating climate change, those companies are going to be the ones caught with their pants down, holding a bunch of high-carbon assets that are destined to be stranded.


US fossil fuel companies and utilities are basically gambling on the continued perversity of US energy policy. It’s not a terrible bet — an odds-on winner, historically speaking, and probably for the next few years — but it can’t last forever.

 

 

Can it?