Subsidies to Oil and Other Energy Sources-Becker

 

President Obama and members of Congress are calling for a sharp reduction in the substantial direct subsidies to American oil companies. Many countries also give an indirect subsidy to oil producers and refiners by subsidizing the purchase of gasoline. In Saudi Arabia, for example, subsidies have reduced the price of a liter of gasoline (1 gallon equals about 3 ¾ liters) to 12 cents, which had made gasoline there cheaper than bottled water. The largest subsidies to gasoline are usually found in oil producing countries: Saudi Arabia, Iran (although the Iranian government greatly reduced gasoline subsidies in 2010), Russia, Venezuela, Indonesia, and the UAE. Yet, the economic case for either direct or indirect subsidies to the production and refining of oil is quite weak.

One argument commonly made for subsidizing gasoline prices, especially when, as at present, oil prices are rising rapidly, is that this helps the poor. Yet these subsidies disproportionately favor the middle classes and the rich since poor families in general, and especially those in developing countries like Indonesia, Egypt, and Iran, are much less likely to own cars, and the poor drive fewer miles with the cars they do own.

Since subsidies lower the retail price of gasoline, this increases the demand for gasoline. Especially after subsidies have been in place for a number of years, the response of demand to lower gasoline prices is substantial as consumers drive more miles, shift consumption toward gas-guzzlers, keep older cars on the road longer, and make other adjustments that increase the consumption of gasoline. Government-owned oil producers in countries that subsidize the purchase of gasoline must divert more of their production to domestic use, and hence are prevented from getting the world price for this oil used domestically. Subsides obviously harm poor countries like Egypt that have subsidized gasoline so much that it has gone from being self-sufficient in oil to becoming an importer of oil.

The United States and other developed countries like Japan and those in Europe tax rather than subsidize gasoline consumption. The US is also a large producer of oil, and as I indicated at the beginning, the US does directly subsidize oil producers. Although estimates of the exact value of these subsidies vary, most analysts put them at several billion dollars per year. One justification frequently given for subsidizing domestic producers of oil is that this increases domestic oil production at the expense of imports. Greater domestic production is considered valuable because of national security concerns about the availability of imported oil during world crises, especially oil from the unstable Middle East and from Russia.

However, a fiscally better way to meet national security concerns would be to tax oil imports rather than subsidize domestic producers since an import tax would bring in additional tax revenue, whereas subsidies to oil companies are financed by tax revenue. Also better than subsidies to oil producers would be for the US to encourage rather than discourage offshore drilling for oil, and greater drilling on government-owned lands. President Obama has just indicated that he is taking steps to allow greater oil and gas drilling offshore and on public lands.

From an American national security point of view, the development of effective hydraulic fracturing, or “fracking”, methods to recover natural gas from rocks deep underground is a godsend since the US has enormous reserves of such gas-among the two or three largest in the world. Some states are encouraging greater natural gas production through fracking, although others have severely restricted the use of this procedure because of environmental concerns. Fracking pumps enormous amounts of water deep underground, and this could contaminate water supplies, although the level of this risk is still controversial.

As this discussion indicates, energy policy depends on more than national security concerns since global warming and local pollution caused by fossil fuels are also important. Domestic oil may be better than imported oil from a national security viewpoint, but it is worse from a pollution perspective since producing and refining oil causes local pollution. Domestic natural gas produced through fracking methods directly causes some local pollution, but it is less harmful to the environment than domestic coal, which is the main alternative to natural gas for electricity generation.

A potential alternative to greater domestic production of fossil fuels is much greater output from other sources of energy, like nuclear power, wind, and solar power, which all cause little pollution and are domestically produced. The governments of the US and of many other countries already heavily subsidize wind power and solar energy. Nuclear was making a return to popularity, but the disaster in Japan has as least temporarily greatly stalled its return. Some subsidy may be justified for these alternatives, but energy from either wind or solar is unlikely ever to be produced at a reasonable cost on a large enough scale to replace fossil fuels as the major source of energy. I still support expansion of nuclear power, but the safety issue clearly needs further attention.

It would be preferable to limit subsidies to wind and solar, and increase government support of basic research on various alternative ways to either produce energy, such as with batteries, or contain the pollution from oil, coal, and natural gas. The private sector generally has weak incentives to work on basic research since the results of such research are not patentable. Clearly, governments have very imperfect incentives as well, but still some government help to the private sector seems warranted for basic research in the energy field that is looking for effective ways to reduce pollution and find alternative sources of energy.

 

 

Comments

[Jack]

Sam..; We're on the same page. What we're seeing just now is a tremendous change in the relationship between oil and NG. Just a few years ago $20 oil and $8 mcf NG. Some savings for NG. ( I know of an electrical contractor who switched when gasoline was under $2 in the $8 NG era and figured $1.20 for NG -- I suspect with ducking hwy taxes)

Now with oil (building a base?) of $60 plus and who knows how much more, with $4 NG --- Pickens estimates an all up $2 gallon equiv for NG....... for a trucker burning 10 gallons/hour that is BIG! almost what the driver earns. And when the biggest customer for imported oil lowers demand, we pick up more chips as oil prices revert to something close to the costs of extraction.

"Government intervention and leadership" This area intrigues me. Consider, the stops and starts of getting wagged by roller coaster oil prices, seems to have put us in a much worse position, than had we set something of a course to lower consumption and reliance on imported oil from the mid-70's on. Even, say '86 when we peaked and it was obvious that our reliance on imported would continue upward.

National security, relating both to being cut off, or getting embroiled in "foreign entanglements" out of oil concerns, AND the "wisdom" of our corpies in not diversifying as one would tend to do with other crucial component suppliers come quickly to mind. Trouble is we had no "crisis" to rally around.

So, on some of these "big trend" issues, I'd favor government (US!!) acting on the knowledge that we've "100 years" of NG......... and precious little oil, and that importing $100 oil is hardly doing our economy any good........ a major component of the trade deficit and draining what few spendables the (former?) "middle class" has to spend.

Ethanol. Ha! that is one that makes even me nervous about gov intervention! But, let's say that with developing an eth consuming fleet, and that enzyme produced eth or other tech might make it cheaper etc. that it hasn't been a complete loser. But TIME to begin phasing out corn based subsidies. (Ha-ha! with a dozen or more states? enjoying the pork -- good luck!)

And yes! if we ARE believers in "globalism", relative advantage, and trade, time to let the Brazilians compete in our eth markets. Also, (whatever was done to sugar, HFC's corn again? ) I'm understanding it killed the Mexican sugar industry that used to employ 75,000. They're in good cane growing latitudes so could also provide eth from the far more efficient cane sugar and could surely use the employment. It seems they being better at making eth -- than us is the very essence of both profiting by the trade born of relative advantage -- rather than that of simply being a low wage venue.

Yeah, tricky........ Archer Daniels fills the coffers of both Dems and Repubs.

This "government intervention" issue is an interesting equation. While the chant is that of cutting government (lay off yet more folks) but we've trillions of long delayed infrastructure maintenance and needed upgrades, many of which would be energy saving......... and millions of construction guys laid off as housing starts are off 80% from the peak. Even if we're "broke" is it wise to pay out unemployment, or spend a bit more to get work done while bonding rates are low and contractors likely to sharpen their pencils?

With these in mind, I'd lean toward rolling back the unaffordable tax cuts, AND passing the hat for a temporary surtax to fund those billions of projects--- but! I'd surely have a tough job selling it!
"Put America back to work!" A real "rising tide of increased gdp that lifts all the boats!"

[Xavier L. Simon aka Xavier]

Jack, your latest comment is very interesting. Implicit in what you say is a misalignment between short and long term prices, and their resulting role in allocating resources and in determining the role of government vis-à-vis the private sector or your beloved “corpies.” I too have struggled with this dilemma, including the immense difference in the incentives of actual short term and expected long term prices, and of what the government should do, or not. Understanding the dilemma a little bit further may also shed light on whether the corpies are bad or not, why, and under what circumstances.

You call for more government planning, including bigger bureaucracies to do the job. But is that the best alternative? Before getting to the one I prefer, however, let me clarify a bit more the roles of government and the private sector. As I understand you, you only advocate planning by government but would leave implementation to the private sector, at least in energy (I know that in healthcare you would have the government not only be the single payer but also run the whole system directly like in the VA hospitals). If we accept that in energy the private sector is the implementer, then we can explore other options for government.

Government only gets into the equation because it foresees shortages and believes it is necessary to begin mobilizing investments. The private sector does not do it because the shortages and thus higher prices are so far in the future that they don’t have an effect on the discounted cash flows they use as yardsticks for investment. To simplify let’s assume that the government is right and there will be shortages. Economists don’t like this because alternatives that are not yet known may materialize as a result of technology and price creep; thus the best thing is to let the markets do their job. That has been the case with NG and even new oil reserves. But let’s assume we have perfect vision and government does have to do something.

What does the government then do? If it does the detail planning then it inevitably also ends up telling implementers what to do and what not to do. It gets into areas of detail that are better left to the implementers. The alternative is to change relative prices and risks, and thus the incentives to invest. In Brazil they did precisely that when they decided to go for ethanol. They didn’t build up a huge bureaucracy. They just changed the incentives and risks. They dictated that for a certain period the gasoline distributor Petrobras would buy ethanol at a certain price. The government then provided huge investment incentives making the construction of ethanol mills almost free (investors only paid in the order of 15 to 25 percent of the actual investment cost). A strict requirement was that sugar cane be produced in land not previously open to cultivation. And so on.

What the government in effect did was to raise the prices of fuel without taking it all in as taxes. Instead consumers paid the extra price directly at the pump. In Europe the government takes in the taxes and is then free to use or misuse the proceeds. In Brazil the equation is direct with no surplus taxes left for the government. Yes, Brazil did create more corpies but they also made sure that those corpies contributed in the ways desired. (And I realize that the Brazil ethanol case was a bit more complex, including oil import substitution, which is also a US objective, but for the purposes here the example as laid out above is complete.)

So let me suggest that among the areas where corpies lose favor from you, not all but at least some, is when they fail to act in the interest of society more generally as a result of a misalignment between short and long term prices. But how to solve the problem of the misalignment is an entirely different matter. I much prefer creating incentives for implementers and then letting them do the job for which they are much better equipped and qualified. And I agree that the current incentives are way out of date—notice that Brazil always discontinues all incentives after a date or event certain—and insufficient, and as such they should be removed.

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Mr. Obama’s proposal rekindles a long-running debate over federal subsidies for energy of all kinds, including petroleum, coal, hydropower, wind, solar and biofuels. Opposition to such subsidies — often euphemistically referred to as incentives, tax credits, preferences or loan guarantees — spans the ideological spectrum, from conservative economists who believe such breaks distort the marketplace to environmentalists who believe that renewable energy sources will always lose out in subsidy fights because of the power of the entrenched fossil fuel industries.

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[Jason Collins]

"Some subsidy may be justified for these alternatives, energy from either wind or solar is unlikely ever to be produced at a reasonable cost on a large enough scale to replace fossil fuels as the major source of energy. I still support expansion of nuclear power"

Why do we need to make statements like this? How about setting a price on the externality and we'll find out? This does not require predictions by economists and we'll see whether wind and solar really can produce at reasonable cost or if nuclear is the cheaper option.

[Steven Howard Johnson]

Becker says "energy from either wind or solar is unlikely ever to be produced at a reasonable cost on a large enough scale to replace fossil fuels as the major source of energy." In saying this, Becker implies that fossil fuel reduction is something we can live with, a natural inference from the way this issue has been wrongly framed.

The situation we face is best understood as the natural consequence of the following logic chain.
1) The energy technologies we own compel us to consume fossil fuels.
2) Fossil fuel consumption produces carbon dioxide emissions.
3) Emissions of carbon dioxide raise the total stock of atmospheric CO2 to higher and higher levels.
4) A rising stock of atmospheric CO2 causes a warming planet. (It also causes ocean acidification.)
5) The warmer the planet becomes, the more climate change we have
6) The more climate change we have, the more damage we cause.

Work backward from the end point. If we wish to prevent the damage, we must halt climate change. To halt climate change, we must halt warming. To halt global warming, we must cap the stock of CO2. To cap the stock of CO2, we must halt CO2 emissions. To halt CO2 emissions, we must switch to technologies that don't require fossil fuels.

Many years ago environmentalists framed global warming as an "emissions" problem, one that required an "emission reduction" solution. That was a dreadful framing mistake and it still haunts us.

Here's the proper framing: We are in the midst of a global warming and climate change emergency. A complete shift to post-fossil fuel energy technology is a matter of life and death, and we should aim for full success within the next thirty years.

Can we make this shift? The American economy consumes about 60 terawatt-hours/day worth of energy. The American subcontinent receives about 50,000 terawatt-hours/day worth of solar energy. Of course we CAN make the shift to post-fossil fuel energy. We just have to recognize the urgency.

How are we to visualize this shift? As the result of millions of consumer purchases and capital equipment purchases. We dug ourselves into this hole one purchase at a time; in time, we will dig ourselves out in the same way. One consumer purchase at a time, one capital purchase at a time.

How are we to make the economics work properly for everyone? With proper use of all the tools at our disposal. Phase-out mandates to industry. Installation incentives for early adopters. Taxes to nudge fossil fuel prices upward. And many other tools as well.

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