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Let’s Start by Getting Rid of Oil Subsidies

3p is proud to partner with the Presidio Graduate School’s Macroeconomics course on a blogging series about “the economics of sustainability.” This post is part of that series. To follow along, please click here.

By Megan Crocker, CAIA

For years, policy makers have galvanized a debate: Should the US fight climate change by implementing carbon tax or a cap and trade program?  But how can the US government possibly consider taxing carbon when they’re still subsidizing oil? Isn’t this an obvious contradiction? First, stop encouraging oil production and consumption by subsidizing it.Then tackle the climate policy debate and encourage the use of clean energy through either carbon tax or cap-and-trade.

Oil Subsidies. To address a range of domestic issues, including federal budget, climate change, jobs and a shrinking middle class, the US Federal Government needs to reduce incentives to produce oil, not increase its supply. The US government spends an estimated $41 billion on oil and gas subsidies each year.

Renewable fuels receive a mere $6 billion annually, the majority of which is in wind power. Environmental degradation, health care costs, climate change and the protection of interests in the Middle East add an incalculable figure to the real dollars that the United States spends on oil. Some estimate the value of global ecosystem services and natural capital are conservatively $33 trillion per year. The price tag on the BP oil spill alone is estimated to cost between $15 and $20 billion over the next 30 years.

US Government policy. In May, the US Senate killed a proposed bill that would have repealed $12 billion in subsidies to Big Oil companies such as Chevron and BP. Conservative policymakers claim that they’re concerned about the price at the pump, economic growth and jobs, particularly in recessionary times, but as described below, the US Treasury research suggests otherwise. House Democrats continue to press the issue but need voter and bipartisan support, and voters don’t necessarily understand the economic reality of the situation.  Fortunately more rational leaders including Senate Majority Leader Harry Reid are still forcing the issue, but progress will require bipartisan leadership and voter support.

Flawed Logic.  No one company or organization sets oil prices. Oil prices are set in the global market, and as China and the rest of the developing world vastly increase consumption, prices are going up everywhere. Reducing subsidies to Big Oil would effectively impact US oil prices by zero, and there is significant research to support this argument. The US Treasury estimates that that if oil subsidies were removed, domestic oil production would be reduced by less than half a percent in the short and long run, and consumers would pay a mere penny more per gallon at the pump.

Possible Outcomes. If the US government pulls the rug out from underneath Big Oil, there are several possible outcomes:

  • Rising Prices at the Pump. The likelihood of this is approximately zero. Global markets set oil prices. Unless domestic companies illegally manipulate the situation, consumers will pay the same.

  • Substitutes Prevail.  This will take several years but alternative fuel sources are guaranteed to prevail. Corporations will be financially incentivized to research and employ renewables. Consumers will have an increasingly broad range of sustainable energy source options. Governments will develop infrastructure that supports renewable energy consumption.

  • Climate Change. The transition from reliance on oil to renewables will reduce greenhouse gas emissions domestically and will help likely decelerate global warming.

  • Job Creation. As the US government invests in new infrastructure and corporations expand into renewables, middle class jobs will be revitalized, albeit at an uncertain rate.

  • Federal Deficit Reduction. The US Treasury estimates that elimination of oil and gas tax preferences would reduce the federal deficit by $31 billion by 2019. Although it is remarkably challenging predict this value accurately, it is a guaranteed budget win.
Looking Forward. Erase Big Oil incentives, then talk about taxing carbon-based fuels or trading permits. The US government can’t claim to both protect and defeat oil simultaneously. The answer lies not in increasing oil supply, but in reducing incentives to produce it.

Megan Crocker is pursuing a Masters in Business Administration at Presidio Graduate School in San Francisco and is a Chartered Alternative Investment Analyst (CAIA). She has ten years of experience in client services within the hedge fund industry. Megan is a mother, wife, certified yoga instructor and cycling enthusiast.


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