Friday, December 22, 2006

Oil Industry Subsidies

The subsidies that the US government extends to the oil industry are in the news today, with the following story from the New York Times:
Study Suggests Incentives on Oil Barely Help U.S.

WASHINGTON, Dec. 21 — The United States offers some of the most lucrative incentives in the world to companies that drill for oil in publicly owned coastal waters, but a newly released study suggests that the government is getting very little for its money.

The study, which the Interior Department refused to release for more than a year, estimates that current inducements could allow drilling companies in the Gulf of Mexico to escape tens of billions of dollars in royalties that they would otherwise pay the government for oil and gas produced in areas that belong to American taxpayers.

But the study predicts that the inducements would cause only a tiny increase in production even if they were offered without some of the limitations now in place.
Clearly there are excellent political reasons for the oil subsidies - otherwise they wouldn't exist. But are there any good economic reasons for the federal government to subsidize the oil industry at all?

I think that the answer is probably no.

The answer, of course, depends on what you think are the nominal goals of the subsidies. I can think of a few candidates:
  • To reduce the price of oil for consumers by increasing overall oil production;
  • To earn fair market value from an asset that is owned by the citizens - the US's offshore oil deposits;
  • To support jobs in the domestic oil industry;
  • To reduce the US's energy dependence, by replacing imported oil with domestic production.
Clearly the oil subsidies fail to acheive the first goal. The US is such a marginal and expensive producer of oil at this point that it's inconceivable that any additional oil production encouraged by subsidies could possibly have any impact on the world price of oil.

The second goal is also clearly not acheived with the present level of subsidies to the oil industry. As the article points out, raising the price charged by the federal government to oil companies would have a negligible impact on the quantity of oil produced, but would have a significant impact on the dollars earned by the people of the US for that oil. Put another way, think of it as being on the left-hand side of the oil revenue Laffer curve; if we reduced the subsidies given to the oil industry (or increased the fees charged them), the American public would receive a lot more money for its oil assets than they currently do.

As far as supporting oil industry jobs goes, it's not at all clear to me why we would want to do that in the first place, as oppsed to jobs in any other industry in the US. But since the impact of the subsidies on production is so tiny, the impact on jobs is also certainly tiny. If the subsidies result in 1% more employment in the oil industry (to go along with the estimated production impact of about 1%), then the billions of dollars per year in subsidies support a total of about 1,400 workers. (There are currently 140,000 workers in oil and gas extraction, according to the BLS.) That's works out to be a cost to taxpayers of a few million dollars for each additional job in the oil industry.

So the most compelling rationale for oil subsidies must hang on the last potential goal: to make the US more energy independent. This is not, strictly speaking, and economic goal; it may have national security implications, but from an economic point of view it really makes no difference where the gallon of gas pumped into your car comes from.

But does it even have any impact on national security? That depends on how much of a reduction in imports of oil it would take to enhance US national security. Would it need to be a 10% reduction? 25%? 50%? I don't know the answer, but I do know that even increasing US production by 50% - a mammoth increase in production that would not be possible in any oil-man's wildest dreams - would only bring the US's dependence on imports down from about 65% to about 50%. I fear that trying to acheive energy independence through increased domestic US production is like trying to catch the end of an oily rainbow.

In short, I think it's easy to punch holes in every reasonable justification that one might encounter for subsidies for the oil and gas industry. There are many changes that a Democratic Congress may make to the federal government's tax and spending policies. But eliminating these subsidies would be one of the ones for which I would cheer the loudest.


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