OPINION

Quarry Elusive in President Biden’s Oil and Gas Subsidy Hunt.

To appease leftists, the President is exploiting a wonky subject ripe for political opportunism.

In his crusade against “handouts to big oil to the tune of $40 billion in fossil fuel subsidies,” President Biden would serve the republic grandly by explaining what in the world he’s talking about. Disagreement abounds over what is and what is not a “fossil fuel subsidy,” and how much the U.S. Treasury disgorges on account of it. The issue is wonky and ripe for political opportunism.

[T]he natural assumption, like much said publicly about this subject, is quite wrong.

The President offered scant clarification when he promised, as part of a January 27th executive order addressing climate change, to slay the subsidy dragon. Over what period, for example, are those huge “handouts” supposed to occur? Biden didn’t say. The natural conclusion is that the Treasury transfers $40 billion per year to ExxonMobil, Chevron, and other such villains of progressive lore. And the natural assumption, like much said publicly about this subject, is quite wrong.

To arrive at $40 billion, President Biden probably just rounded a number from the administration he served as Vice President. Each of the federal budgets proposed by Former President Obama called for the elimination of fossil energy tax mechanisms disparaged as “subsidies.” The routine assertion was that the effort would save the government $39 billion over ten years.

“As we work to create a clean energy economy, it is counterproductive to spend taxpayer dollars on incentives that run counter to this national priority,” a team led by then-Treasury Secretary Timothy F. Geithner said in a joint statement to the House Appropriations Committee on March 16th, 2010. “To further this goal and reduce the deficit, the Budget eliminates tax preferences and funding for programs that provide inefficient fossil fuel subsidies and undermine efforts to deal with carbon pollution. The Budget proposes ending 12 tax breaks for oil, gas, and coal companies, closing loopholes that raise nearly $39 billion over the next decade.”

President Biden, too, will try to purge the federal budget of assistance to fossil energy. His climate executive order directs agency heads to seek ways “to eliminate fossil fuel subsidies from the budget request for Fiscal Year 2022 and thereafter.”

This sounds easy. It is not. Many subsidies, real and imagined, bury themselves in the thick wool of tax law and regulation, through which most Americans (understandably) wish not to comb. Politicians, however, happily exploit what voters not trained in accounting have good reason not to know.

Gas refinery.

Gas refinery.

WHY EVALUATING ‘SUBSIDIES’ IS DIFFICULT

The word “subsidy” covers a broad range of measures aimed at assisting business. Not all of them have to do with taxation, and certainly not all targeted to oil and gas, and few such tax measures benefiting oil and gas represent direct handouts. This complexity makes evaluating oil and gas “subsidies” difficult.

[T]he deduction for oil and gas companies was three percentage points below that available to companies in other industries.

Eye-popping estimates exist. A 2019 International Monetary Fund working paper, for example, estimated the value of U.S. fossil-energy subsidies in 2015 at $649 billion. The authors defined “subsidies” as “fuel consumption times the gap between existing and efficient prices (i.e., prices warranted by supply costs, environmental costs, and revenue considerations).” A definition incorporating that many variables, and open to so much interpretation, is a license to conclude anything.

Other subsidy estimates reach exaggerated totals by including tax breaks that oil and gas companies share with companies in other industries. The domestic manufacturer’s deduction, adopted in 2004 in lieu of reduced corporate income taxation to help U.S. companies compete internationally, once ranked high in dollar value among tax provisions benefiting oil and gas, for example. But it was no special favor to the industry since manufacturers and producers in other businesses also qualified for the deduction. In fact, the deduction for oil and gas companies was three percentage points below that available to companies in other industries. Although the Tax Cut and Jobs Act repealed the deduction for tax years after 2017, the cost to the government appears in estimates of oil and gas “subsidies” still cited by fossil-energy opponents and their political friends.

When politicians go hunting for oil and gas subsidies to kill, they sometimes produce howlers.

In 2017, a group of Senate Democrats proposed legislation, the Close Big Oil Tax Loopholes Act, “to repeal tax subsidies for the ‘Big 5’ oil companies, and shift the $22 billion in savings over the next ten years towards deficit reduction.” One of the targeted provisions was percentage depletion, which is a tax-accounting mechanism used by companies in extractive industries to reflect the amount by which a natural-resource asset, such as an oil field or gold mine, shrinks as minerals are extracted. (It’s analogous to the depreciation of fixed assets, which accounts for wear and tear of, say, a farmer’s tractor.)

Integrated oil and gas producers … haven’t been able to use percentage depletion since the enactment of the Tax Reduction Act of 1975.

With percentage depletion, the asset writedown occurs at a fixed rate set by law—15% for oil and gas. The mechanism can and sometimes does allow accumulated deductions for an oil field to exceed the asset’s original value. Amounts by which tax liabilities are lowered by those extra deductions constitute a genuine subsidy—a transfer of public money to favored taxpayers. Under the alternative accounting method, cost depletion, where the deduction rate reflects the value of production in proportion to the value of minerals remaining to be produced, this shouldn’t happen. But cost-depletion accounting is complicated and hampered by the imprecision inherent in estimating the amount and value of resources not yet produced. That is why Congress allows some taxpayers to use the simpler percentage-depletion method.

So, by how much does percentage depletion help oil and gas companies and hurt taxpayers? The congressional Joint Committee on Taxation includes an estimate in its annual assessment of the myriad “tax expenditures,” or federal-revenue losses, that help specific taxpayers in all categories. For any given year, the oil and gas percentage-depletion subsidy (revenue loss) is the amount by which total percentage-depletion deductions exceed what deductions would have been under cost depletion. In 2020, that estimate, for corporate taxpayers, is $600 million.

Here’s the howler: None of the percentage-depletion subsidy helps “big oil.” Only small independent producers (those without refining and retail operations) and royalty owners (the owners of land on which oil and gas are produced) can use percentage depletion, and even that is subject to limits. Integrated oil and gas producers, which are large companies that refine as well as produce crude oil and sell the products—such as the “Big 5” outfits targeted by those Democrats in 2017—haven’t been able to use percentage depletion since the enactment of the Tax Reduction Act of 1975.

Gas prices.

Gas prices.

A CLOSER LOOK AT ‘SUBSIDIES’

Favors to many industries riddle the U.S. tax code, often in the form of tax credits, which directly lower tax liabilities and thus represent handouts. Oil and gas producers get some of them, but not many. One example is a tax credit for projects that “enhance” oil recovery from mature wells. But it’s strictly limited in its availability, and costs the government less than $50 million per year, and, in many years, nothing at all. Another credit is available for wells producing oil and gas at rates too low to interest any but the smallest companies. As with the enhanced-recovery credit, the cost to the government is minimal.

[O]il and gas operators spend a lot of money on geologic and geophysical surveys to determine where, even whether, to drill. When they do drill, some wells never produce revenue.

Most tax provisions benefiting the oil and gas industry involve preferential timing of deductions—expenses lowering the amount of income subject to taxation. For all types of taxpayer, in almost all cases, deductions are worth less to the taxpayer than credits, which are dollar-for-dollar reductions in the amounts of tax due the government.

For oil and gas taxpayers, preferential timing of some deductions accommodates peculiarities of the business of finding and producing oil and natural gas that can confound normal accounting practice. General accounting principles say expenses should be aligned in time, to the extent possible, with associated revenues. To accomplish this, a taxpayer typically bundles expenses into an asset account on its balance sheet and writes down the amount, through charges to expense against revenue, on income statements over time.

In oil and gas exploration and production, matching expenses with revenues in this manner can be difficult. For example, oil and gas operators spend a lot of money on geologic and geophysical surveys to determine where, even whether, to drill. When they do drill, some wells never produce revenue.

To accommodate, tax law allows most oil and gas producers to deduct geological and geophysical expenditures over two years (seven for integrated companies) rather than treating them as a capital cost recovered over an asset life. In 2020, the provision is estimated to have lowered government revenue by $100 million relative to what it would have been in its absence. The government eventually gets its money, though. For any specific revenue stream, an expense that lowers tax liability early isn’t available later. The advantage to the taxpayer is acceleration of cost recovery, which frees up cash for reinvestment.

A larger timing preference, one usually targeted by crusading politicians because of its dollar amount, is the ability to promptly deduct, or “expense,” intangible drilling costs (IDCs). These are outlays for services and supplies used up immediately, which represent 60-90% of the money spent drilling an oil or gas well. The Joint Committee on Taxation estimates the budget effect of IDC expensing at $500 million in 2020 and $400 million per year through 2024.

[T]he production tax credit for wind and investment credit for solar energy, helped corporations by $10.1 billion. Those are real handouts.

But remember: Expenses taken immediately for a specific property can’t be charged later, when the associated revenue will be fully subject to taxation. Because the government still gets its money over time, a single year’s glimpse never tells the whole story about IDCs. When drilling activity plummets, IDCs can fall so far below production revenues that their relative absence siphons money into rather than away from the Treasury. This happened in the period covered by a 2018 energy-subsidy study by the U.S. Energy Information Administration (EIA), which compared fiscal years 2010, 2013, and 2016. The EIA estimated that “Expensing of Exploration and Development Costs” represented “tax expenditures” of $440 million in 2010 and $573 million in 2013. In 2016, though, the category yielded a $450-million net gain for the government. What happened? An oil-price plunge slashed oil and gas drilling activity, as measured by the annual average number of active rigs, by 73% between 2014 and 2016.

IDCs are especially important to independent oil and gas producers and individual investors, on which companies in the former group heavily depend and which account for 20-25 percent of the Joint Tax Committee’s estimate of the IDC budgetary effect. Unlike independent producers, integrated companies fund drilling mainly from internal cash flow rather than money from individuals investing in drilling projects. And, as a penalty for being large, they may “expense” only 70% of their IDCs and must write down the balance over five years. For these reasons, elimination of current-year expensing of IDCs would hurt small companies and individuals more than “big oil.”

The two big oil and gas tax breaks, current-year expensing of IDCs and the excess of percentage over cost depletion, helped corporate taxpayers by about $1 billion in 2020, according to the Joint Tax Committee. For comparison, the committee estimates that the two biggest renewable-energy provisions, the production tax credit for wind and investment credit for solar energy, helped corporations by $10.1 billion. Those are real handouts.

Gas nozzle.

Gas nozzle.

PUNISHING FOSSIL ENERGY

President Biden, of course, wants to punish fossil energy to show how serious he is about responding to climate change, and to placate party colleagues pulling him leftward. And he probably feels trapped by his walk-back from the plan he announced, in his October 22nd, 2020, debate with then-President Trump, to veer away from oil.

Toward the end of the debate, Trump asked Biden, “Would you close down the oil industry?” Biden answered, “I would transition from the oil industry, yes… because the oil industry pollutes significantly.” Later responding to controversy aroused by that hint of things to come, Biden’s aides said he wanted to end subsidies for oil and gas companies, not the industry itself.

Since taking office, though, the President has made his intention clear. With measures like suspending federal oil and gas leasing, revoking the Keystone XL pipeline border- crossing permit, and—soon—punishing drilling with tax code changes, he is obstructing work essential to fossil-energy development. And he’s doing so even though the U.S. will continue to need oil gas for many years, increasingly to meet needs of the energy forms that really do enjoy lavish handouts from taxpayers.

Written By:

Bob Tippee is an energy writer in Houston, Texas. He was editor-in-chief of the Oil & Gas Journal for 20 years.