Market distortions favour fossil fuels

Fossil fuel subsidies cost governments 550 billion dollars annually according to the International Energy Agency (IEA), an independent, Paris-­based think tank. The International Monetary Fund (IMF) believes the cost of these subsidies is even higher, comprising 6.5 percent of global GDP.

Oil subsidies for consumers

Subsidies take on many forms. In Saudi Arabia, Nigeria and Venezuela – big oil ­producing countries – citizens pay prices below the cost-of-production at the petrol pump. Oil companies are paying to sell petrol in these markets. Why would they do this? International oil companies can still make a phenomenal profit exporting even just a fraction of their output and selling it at international oil prices. So they’ll agree to production contracts, in countries such as Iraq and Venezuela, where a significant proportion of output is nevertheless destined for the domestic market and sold below-cost.

State-owned oil companies, such as Saudi Aramco, do the same thing, but have a different motive. Saudi Aramco explicitly supports government policy aimed at reducing citizens’ cost-of-living. It can also easily afford to supply domestic markets with below-cost petrol by exporting the remainder.

Be aware that policies aimed at reducing the cost of petrol locally do little to encourage fuel efficiency. Furthermore, the IEA believes that only eight-percent of benefits from such subsidies flow to the poorest fifth of the world’s population.

More sagely, the Saudis also fund public projects, such as schools and infrastructure, with profits reaped from oil exports.

Oil subsidies for producers

Tax-­breaks encouraging the exploration and development of local oil reserves are another means of subsidising the oil sector – to the advantage of producers rather than consumers. In the United States, Exxon, Chevron, BP, Royal Dutch Shell and ConocoPhillips all claim tax breaks for exploration and drilling, known as “intangible drilling costs.” On average, seventy­-percent of these costs are regained within a year. [1]

Also, overseas royalty fees paid to foreign governments by US­-based oil firms can be reclaimed against their corporate income tax. Royalties are essentially the fees set by governments for foreign oil companies who wish to do business with them.

Exxon, Chevron, BP, Royal Dutch Shell and ConocoPhillips are all Fortune 500 companies and remain amongst the most profitable in the world despite the recent decline in international oil prices. Yet they’re not required to pay the full corporate tax rate as other for-­profit US companies do.

What’s more, “small,” independent US oil companies are also permitted tax breaks when the amount of oil extracted from an ageing production site starts to deplete -on top of the tax benefits described above. This is very generous given that tax is already proportionate to profit. Imagine that in 2003 my profit-take is $10 million USD. If the tax rate is 30% then I owe $3 million in taxes. If my profit-take drops to $9 million in 2004 my tax burden declines as well, down to $2.7 million. However, this additional tax-­break promises the bill drops even further. I might only owe $2 million. In this case my after-­tax profit is the same in 2003 and 2004: $7 million. Further, the majority of these “small” independents still have an average market capitalisation of two billion US dollars according to Oil Change International.

Oil companies contest that native exploration and production would not be profitable in the United States without these tax breaks. Yet, if a project is not economically viable why should the government of a market-­based society fund your commercial project? Well, there are circumstances under which this is considered appropriate. Perhaps your project serves the public good. This is why governments pay for fire stations, a police force or infrastructure like roads and electricity lines. Or maybe your project is part of the transition towards a greener and more sustainable economy? Or an attempt to curb greenhouse gas emissions?

Green subsidies for producers

Germany’s generous subsidies for renewable energies aspire to such ends. The country’s ambitious Energiewende policy, meaning energy “turn-around,” is the experiment the whole world is watching.

So far, these subsidies have had questionable success. Coal’s resurgence in Europe, along with the decommissioning of the country’s nuclear fleet, have increased Germany’s greenhouse gas emissions over the past few years.[2] Also, subsidies for renewable wind or solar farms’ installation and operating costs are passed on to the consumer. Average electricity prices in Germany have risen since 2008.

Furthermore, feed­-in tariffs that guarantee renewable energy producers a minimum price for their power, and priority to sell into the grid every day, are threatening the traditional market’s stability. Unprofitable gas and coal power plants’ operating hours are decreasing and many have had to close. This could lead to supply shortages and brown-outs or black-outs in the near future.

Finally, it has been demonstrated that early subsidies for solar panels stunted the innovation that would’ve brought commercially viable solar technologies to Europe’s markets sooner. The same technology lag effect has been observed in offshore wind.

Nevertheless, if energy subsidies exist at all surely they should favour low or zero­-carbon energies? It makes no sense for governments the world over to subsidise – to the tune of billions of dollars – the energies increasing the concentration of greenhouse gases in the atmosphere to the disadvantage of other energy sources. Current subsides for renewables comprise but a fourth of what goes to fossil fuels annually. If renewables were to receive the subsidies that fossil fuels do then the market would favour carbon­-friendly energy production over fossil fuels. It is worth making renewable energy production more profitable than it would be otherwise given the global threat of climate change. The same cannot be said for fossil fuels.

[1] References: The Atlanticthe IEA & the IMF.

[2]  This applies primarily to the electricity sector, but overall emissions did rise between 2009 and 2014. The 2008 drop is attributable to the Global Financial Crisis and economic downturn across Europe. Hopefully 2015 is the year this trend will turn-around. Take a look at this graph.