How Real Is The O&G Tax Subsidy Number?
“Claims of $20 billion in subsidies for oil and gas are grossly overstated, but renewables are on track to reach that number in the next couple of years. We thought renewable energy was cheaper. Is something wrong? ”
The Biden administration’s plan to eliminate all government subsidies for the oil and gas industry is being greeted with great joy among environmentalists. Their glee ignores the realities of some subsidies, which are actual provisions within the federal tax code designed to create a level tax playing field for producers of oil and gas and other businesses. The problem is how significant are oil and gas tax subsidies?
A Google search of “oil and gas tax subsidies” returned 7.7 million matches. At the top of the list, one addressed the issue: “How much does the US subsidize oil and gas?” The answer was:
Conservative estimates put U.S. direct subsidies to the fossil fuel industry at roughly $20 billion per year, with 20 percent currently allocated to coal and 80 percent to natural gas and crude oil.” (emphasis in the original) July 29, 2019
What we have seen repeatedly is the $20 billion figure when people discuss government subsidies to oil and gas, ignoring the fact that 20%, or roughly $4 billion goes to the coal industry. Several earlier, but dated, responses put the subsidy at $18.5 billion, which may reflect how the estimate has grown over time due to U.S. production growth. The reason we suggest that explanation is that the primary tax breaks for the oil and gas industry relate to drilling activity as well as production volumes.
The activity subsidy is for intangible drilling costs (26 U.S. Code § 263). This provision allows companies to deduct a substantial amount of the costs associated with drilling new wells domestically. The production related activity is the percentage depletion deduction (26 U.S. Code § 613). Depletion is an accounting method that functions much like depreciation, putting oil and gas on the same basis as industrial companies. Depletion allows producers to deduct a certain amount from their taxable income as a reflection of declining production from a reserve over time. For an industrial company, depreciation is the annual charge to reflect the decline in the physical assets utilized to generate income.
The depletion allowance is somewhat complicated because a producer can utilize either the standard cost depletion, which means that if a producer extracted 10% of the recoverable oil from a property, the depletion expense would be 10% of the capital cost associated with the property and the producing well. In contrast, a producer could use percentage depletion, which allows him to deduct a fixed percentage from taxable income. Because percentage depletion is not based on the capital cost, the total percentage depletion deduction can exceed the capital cost. The depletion allowance has been battled over in the past when politicians wanted to limit subsidies to oil and gas companies. As a result, this provision is limited to independent producers and royalty owners at a 15% rate.
Many times, the various analyses of these tax deductions involve estimates for their reduction of the federal government’s tax collections (budget) over a five- or ten-year period. Thus, a much smaller annual number gets multiplied into a substantially greater number, which politicians often use to dramatize the subsidy.
Exhibit 9. Oil And Gas Subsidies A Fraction Of Claims SOURCE: Wood Mackenzie
The most recent analysis of the cost of these subsidies, along with some other nominal ones, was prepared by the Joint Committee on Taxation (JCT) of the Congress back last year. The data the JCT utilized was from last year’s Treasury Department FY2021 tax expenditure estimates. The JCT estimate for these two deductions put the FY2019 cost at $0.9 billion. The projection for the five-year period FY2019-FY2023 was $4.8 billion.
Besides those two deductions, there were tax breaks for the amortization of geological and geophysical expenditures employed in the search for oil and gas reserves ($0.1 billion for FY2019) and for the avoidance of double taxation of master limited partnerships ($0.2 billion). When all the tax subsidies are totaled for the FY2019-FY2023 period, the figure is $7.0 billion. That is a far cry from the $20 billion subsidy number thrown around by politicians.
Moreover, one should be careful about including the $1.7 billion “subsidy” for MLPs, as they are structured just as real estate investment trusts (REITs) are for tax efficiency. The income generated from the business is passed through to the limited partners, and the profit is taxed at the partners’ personal tax rates, which may be higher than the corporate tax rate. Since this “subsidy” is available to other industries, it should be excluded from being targeted for oil and gas. Therefore, the real U.S. tax subsidy figure for oil and gas is closer to $5.3 billion over the next five years, or about $1 billion per year.