Federal Subsidies for the U. S. Energy Industry

Summary.  Two reports on federal subsidies to the energy industry are examined here.  Despite very different approaches to the topic, both agree that federal subsidies have supported, and continue to support, the oil and gas industry to a far higher extent than the renewable energy sector, by factors of 2.5 to 5.  This effect is very pronounced during the first 15 years of a subsidy program (on a constant dollar basis), when the effects of subsidies will have the greatest effect in promoting development of a technology.

It is concluded that deploying renewable energy technologies in the U. S. is an important objective, and that federal subsidies supporting renewable energy should be expanded 3- to 5-fold.

Introduction.  The role of the U. S. government in supporting new energy technologies and startup companies has come under scrutiny recently.  Some have questioned whether research and development (R&D) of new energy technologies is an appropriate function for the federal government.  On the other hand there is no question that subsidies are also provided to established fossil fuel companies.

A subsidy in the energy economy has been justified first, as a way to encourage new technologies during early phases of R&D, and second, to account for the lower value of an enterprise viewed by the private sector compared to its value to the public at large (see Ref. 1).  The U. S. Energy Information Agency (EIA; Ref. 2) identifies several types of subsidies, defined as originating from the federal government, targeted for energy, and providing a financial benefit with an identifiable budget impact.  These are

Direct Expenditures generally are legislated programs for direct payments to support activities that provide a financial benefit to producers or consumers of energy.  Support for R&D in areas such as increasing energy supply, increasing energy efficiency, and transmission, is closely related, being a direct expenditure yet likely not having a direct payoff during the period of the expenditure.  Since direct expenditures are legislated, they may be subject to expiration and a need for reinstatement.

Tax Expenditures are features incorporated into the federal tax code, and so are relatively permanent.  The terminology is deceptive; in fact these are tax credits against a taxed amount due, or deductions against income prior to calculating the tax due, and are based on having engaged in a particular action in the energy economy considered to be desirable.  Tax expenditures result in lower taxes collected, so that they correspond to outlays from the government.

Loans and Loan Guarantees provide federal support for designated technologies and undertakings, typically through the Department of Energy (DOE).  The loans support “innovative clean energy technologies that are typically unable to obtain conventional private financing due to their ‘high technology risks.’ In addition, eligible technologies must avoid, reduce, or sequester air pollutants or anthropogenic emissions of greenhouse gases."  (Office of Management and Budget, Analytical Perspectives of the Budget of the United States, Editions 2009 and 2012 (cited in Ref. 2)).

Two Reports on Energy Subsidies in the U. S.

The Environmental Law Institute (ELI) issued the report “Estimating U. S. Government Subsidies to Energy Sources: 2002-2008” in September 2009 (Ref. 3).  The report follows trends in subsides directed to fossil fuels and to renewable energy sources over the seven Fiscal Years 2002-2008.  This group defines “subsidy” as “actions by the U.S. government that provide an identifiable financial benefit associated with the use or production of a fossil or renewable fuel.” (Ref. 3).  The report includes conventional fossil fuels and most renewable energy sources; it omits nuclear energy from consideration. It garners detailed fiscal statistics and enumerates all subsidy expenditures, classified as to direct expenditures and tax expenditures (see Details, below).

The study concludes that, for the seven fiscal years considered, by far the largest subsidy amounts supported the various fossil fuels, i.e., energy sources that emit large amounts of the greenhouse gas carbon dioxide when burned, compared to subsidies supporting renewable energy sources (see the graphic below).  Specifically, federal subsidies granted to the fossil fuel industry totaled about US$72 billion in the period studied.  Most of these are essentially permanent features incorporated into the U. S. tax code.  The report notes that fossil fuels are a mature and highly profitable industry, and questions whether taxpayer funds should justifiably be spent supporting them.

On the other hand, subsidies supporting renewable energy, including corn-based ethanol production, totaled about US$29 billion (see the graphic below), of which only about US$12 billion went to “traditional” renewable energy sources such as wind, solar and hydropower.  (Recent analyses have suggested that production of corn-based ethanol, when considered over the full life cycle of the technology, is at best neutral with respect to reducing emissions of carbon dioxide.)  “Traditional” renewable sources represent young, developing technologies, and so are worthy of subsidy support.  In contrast to the case for fossil fuel subsidies, subsidies for renewable energy are legislated at frequent intervals with statutory “sunset” provisions, i.e., specific short-term expiration dates.  These features limit the ability of renewable energy businesses to plan energy projects over the long term.

Federal energy subsidies for FY 2002-2008.  In each quadrant, the outer, darker ring represents tax credits or allowances (tax expenditures), and the inner, lighter sector represents direct expenditures, all in US$ Billions.  The upper half of the diagram relates to activities that lead to reduction of greenhouse gas emission.  The lower half relates to activities that contribute to greenhouse gas emissions.  The left half relates to fossil fuels, and the right half to renewable energy sources.  The key in the far lower right indicates that subsidies for Traditional Fossil Fuels in the lower left quadrant are damaging to the climate (i.e. their use results in emission of the greenhouse gas carbon dioxide); and that subsidies for Traditional Renewables in the upper right quadrant preserve the climate (their use reduces or eliminates emissions of carbon dioxide). 

*Carbon Capture and Storage (upper left quadrant) is an experimental  technology that would allow energy plants that burn coal and other fossil fuels to capture and store their carbon dioxide emissions away from the atmosphere (preserves the climate; see this post).  Although this technology does not make coal a renewable fuel, if successful it would reduce greenhouse gas emissions compared to coal plants that do not use this technology.
**Recognizing that the production and use of Corn-based Ethanol (lower left quadrant) may generate significant greenhouse gas emissions, the graphic depicts renewable subsidies with (lower right quadrant) and without (upper right quadrant) ethanol subsidies separately.

Source: © Environmental Law Institute; http://www.eli.org/pdf/Energy_Subsidies_Black_Not_Green.pdf .

Pfund and Healey, in their report “What Would Jefferson Do?” (Ref. 1), studied the use of subsidies and related expenditures from the beginning of the U. S. republic.  Early subsidies were granted by both states and the federal government, first to coal mining, then to oil production, as these fuels were discovered domestically and their production grew.  (The report adjusts all expenditures to current constant dollars.)  They make the point generally that the trajectory of growth of the use these fossil fuels for energy correlates well with the growth of the U. S. economy over time.  They analyzed subsidy data starting as early as they were available in preparing their report (see Details, below).  Unfortunately, even though coal was and remains an important aspect of the U. S. energy economy, their inability to recover meaningful subsidy information for this fuel from its earliest use led them to exclude it from their analyses.  In particular, their emphasis was on the role that subsidies played in the early years of the various fuel technologies, when each respectively was being developed into an economically viable energy source.  They do, however, include nuclear energy, while the ELI study (above) does not.

Pfund and Healy conclude that, over the earliest 15 years of federal subsidy grants to a new technology, nuclear energy received more than 1% of the federal budget, subsidies to the oil and gas industry amounted to one-half percent of the budget, whereas renewable energy sources received subsidies amounting to only about one-tenth percent of the budget.  Thus the proportional support for oil and gas in its early years as an industry was about 5 times greater than that for renewable energy sources.  The proportional year-by-year subsidy grant for four energy sources is shown below.

Inflation-adjusted energy subsidies as a percentage of the Federal budget during the first 15 years of each subsidy’s lifetime.  The percentage scale runs from 0.00 to 0.25.  The years of the subsidy life, with four bars for each year, runs from year 1 to year 15.  In each year the bars represent gray, oil and gas; purple, nuclear; orange, biofuels; green, renewables.

Source: Pfund and Healey (Ref. 1); http://i.bnet.com/blogs/dbl_energy_subsidies_paper.pdf

Pfund and Healey characterize the early years of a technology as the period in which it is most useful to invest public funds to seed and develop the technology for the public good.  The graphic above shows that, staged year by year, the nuclear industry received the greatest proportion of subsidy support, followed by oil and gas in its early years as a fuel source.  Biofuels and renewable energy sources garner much less proportional federal subsidy support (and, as indicated above, biofuels may not contribute significantly to abating greenhouse gas emissions).

The annual subsidies granted to each energy source averaged over its respective lifetime as a recipient of support is shown in the following graphic.

Historical average of annual subsidies in 2010 US$ billions received by gray, oil and gas (US$4.86, over 1918-2009); purple, nuclear (US$3.50, over 1947-1999); orange, biofuels (US$1.08, over 1980-2009); green, renewable energy sources (US$0.37, over 1994-2009).

Source: Pfund and Healey (Ref. 1); http://i.bnet.com/blogs/dbl_energy_subsidies_paper.pdf

It is clear from the graphic above that oil and gas received the largest annual average subsidy over almost a century of subsidy programs, and continues to receive them up to the time of the report.  The annual average for biofuels is 22% of that for oil and gas, and the average for renewables is only 8% of that for oil and gas.   

Pfund and Healey conclude, after considering the purpose of subsidies to encourage new technologies and to enhance the value of an enterprise in the  eyes of the private sector, that “today’s government incentives for renewable energy pale in comparison to the kind of support afforded emerging fuels during previous energy transitions” (Ref. 1).

Details

The Environmental Law Institute report (Ref. 3) itemizes subsidies granted during the seven years studied.  The three largest for fossil fuels are:

A foreign tax credit totaling US$15.3 billion.  This credit is intended to prevent double taxation when taxes are paid to a foreign state, but for oil and gas, this credit permits royalty payments (ordinarily a cost of doing business) to be preferentially treated as a foreign tax (see Ref. 3).

A credit for production of nonconventional fuels totaling U$14.1 billion.  This credit has historically benefited coal mining, but also applies to oil from shale, tar sands, biomass, and other special fuel sources.

A provision that permits up-front accounting for Intangible Drilling Costs rather than long-term amortization, totaling US$ 7.1 billion.

For renewable energy sources, the largest subsidies include

The Volumetric Ethanol Excise Tax Credit totaling US$11.6 billion, excludes ethanol on a per gallon basis from the general fuel excise tax imposed throughout the U. S.

The Renewable Electricity Production Credit totaling US$5.2 billion applies to electricity production from wind, solar, biomass, geothermal, hydropower, and other sources.

A direct payment subsidy from the Department of Agriculture totaling US$5.0 billion for raising corn.  Although not intended by statute for ethanol production, this subsidy operates in conjunction with a Congressional mandate from 2005 that stimulates demand for ethanol.

The report by Pfund and Healey (Ref. 1) provides details on several aspects of subsidy policy.  They note that “not all subsidies are created equal.”

Although they did not analyze the early years of coal mining for lack of data, they point out that a reclassification of royalties received on coal mining as capital gains during the Korean War permitted the recipients to pay far less income tax, since the top marginal individual rate at the time was as high as 91%.  This tax provision was considered in the national interest during the Korean War, but it is still in effect even though that war is over, and the top tax rate is far lower now.  In its early days in the 19^th century, coal was promoted largely at the state level as a source of energy, although a 10% tariff on imported coal was in effect from before 1800.  Subsequently, the growth of the coal industry was closely coupled to that of the railroad industry, including its interests in real property and mineral assets.

The oil and gas industry, the authors point out, benefits from two subsidy provisions.  The first, introduced in 1916, permitted rapid recovery of intangible drilling costs and dry hole costs in the year incurred rather than being depreciated over several years.  The second, the excess of percentage over cost depletion deferral, introduced in 1926, permits deduction of a percentage of gross revenues rather than a deduction based on the value of the extracted resources.  Even in the mid-1980s, these two provisions represented the largest tax credits, and hence, the largest estimated losses in federal revenues, arising from the oil and gas industry.

The nuclear industry benefited from the Price-Anderson Act, which granted federal protection of utilities operating nuclear facilities in the event of a nuclear accident.  This provision was likely crucial in development of the nuclear industry, since no utility was likely to proceed with nuclear energy in its absence.

Subsidies for renewable energy began with the Energy Policy Act of 1992.  It grants a production tax credit of 2010 US$0.015/kWh for electricity generated from wind or biomass, now extended to other sources as well.  An investment tax credit has applied off-and-on for residential solar, and is now in place until 2016.  The production tax credit for wind has also been in force in fits and starts, being reinstated, after several expirations, for only one- or two-year terms.  The result is a great variability in installation of new wind generation capability, as shown below:

Cumulative wind generating capacity (left axis, blue line) and capacity added each year (right axis, green bars) for years from 1981 to 2006. The arrows show years in which the Production Tax Credit expired without being renewed.
Source: Pfund and Healey, Ref. 1; http://i.bnet.com/blogs/dbl_energy_subsidies_paper.pdf.


The three arrows in the graphic above show years in which the Production Tax Credit (PTC) lapsed without being reinstated.  This break in the continuity of support had a drastic effect, reducing the rate of installation of new wind generating capacity dramatically in the affected years (see the graphic above). 

The EIA report “Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2010” (Ref. 2) gives a detailed exposition of the expenditures in all the energy subsidy programs operating in FY 2010.  These data are referenced to corresponding data for FY 2007.  The reader is referred to the original for more details.

Analysis

Two separate studies of U. S. federal energy subsidies are considered here.  The first, by ELI (Ref. 3), reports on subsidies in the restricted period of the seven U. S. fiscal years 2002-2008.  It included the coal industry but did not consider nuclear energy.  The second study, by Pfund and Healey (Ref. 1), covers subsidy programs in energy throughout the history of the U. S.  Since records of early subsidies for coal energy were difficult to assemble, they omitted coal from the analysis, whereas nuclear energy is included.  Pfund and Healey place considerable emphasis on the first fifteen years of subsidies in an energy sector regardless of its chronological occurrence.

Both studies arrived at very similar conclusions in spite of the great difference in their approaches to analyzing subsidy data.  ELI finds that in the seven years examined, subsidies for fossil fuels were about US$72 billion, while subsidies for renewables were about US$29 billion (over half of which benefited corn-based ethanol).  Thus, at a time not significantly removed from the present, fossil fuels were subsidized at a rate about 2.5 times as great as were renewable energy sources.

Pfund and Healey devised a creative analysis that enabled them to compare subsidies that were in effect at different historical times.  They find that in the first fifteen years of subsidizing a particular energy sector, subsidies supporting the nuclear industry, the oil and gas industry, and renewable energy were granted in the ratio of approximately 10:5:1, based on their portion of the federal budget at the respective times they occurred.  Thus at the stage in the development of the respective sector, when it is novel and worthy of public support for further development, the oil and gas industry received about five times as much support, adjusted for inflation, as the renewable energy sector.

Both reports point out that currently the oil and gas industry (and the fossil fuel industry in general) is mature and profitable, no longer in need of subsidies to promote further growth.  Renewable energy, on the other hand, is a nascent industry, which, among other factors, has not yet reached a point where economies of scale have been fully realized. In addition to the disparity in subsidy rates for the two sectors, Pfund and Healey point out that the oil and gas industry was able to expand into an uncluttered, newly created market for its products in the early years of the 20^th century.  Currently, however, renewable energy sources have to compete against, indeed have to displace, energy provided by fossil fuel sources—a much more challenging task. Renewable energy reduces the dependence of the U. S. on fossil fuels for its energy, especially the need to import oil from sources abroad whose reliability may be questionable.  Use of renewable energy mitigates the emission of greenhouse gases into the atmosphere, thus abating the increase in the long-term average worldwide average temperature.  These factors support the expansion of subsidies to be provided to renewable energy sources.  There is no longer a need in our energy policy for continued subsidization of the fossil fuel industry, while the need for expanding support for renewable energy sources is evident.

As noted above, in the mature energy economy of the U. S., renewable energy largely supplants, rather than complements, energy from fossil fuels.  It has been argued that renewable energy would lead to loss of jobs.  But this is not the case; our growing energy economy would continue to provide new job opportunities as renewable energy expands, both during construction and operation of renewable facilities (see this previous post for an analysis of jobs created by renewable energy). 

As pointed out by Pfund and Healey, the Congressional policy (or lack thereof) with regard to the Production Tax Credit for wind energy demonstrates the critical need for consistent long-term fiscal incentives in developing a new energy technology.  This lack of consistency also stands in contrast to those tax credits for oil and gas that are permanently enshrined in the federal tax code.  Permanence ensures consistency in long-term planning by private enterprises.  A more enduring subsidy policy should be considered for renewable energy sources.

Conclusion

Subsidies have played a positive role in developing energy throughout the history of the U. S.  Unfortunately, the rate of subsidizing renewable energy has fallen far short of the levels supporting other energy sectors over the years.  Developing and deploying renewable energy facilities is critical for our national security, freeing us from dependence on foreign sources of fossil fuel.  Thriving job opportunities would also result.  Renewable energy contributes significantly to abating man-made global warming arising from burning fossil fuels.  For these reasons the level of federal subsidy support for renewable energy sources should be expanded 3- to 5-fold.

References

1. “What Would Jefferson Do? The Historical Role of Federal Subsidies in Shaping America’s Energy Future”, by Nancy Pfund and Ben Healey, DBL Investors, September 2011; http://i.bnet.com/blogs/dbl_energy_subsidies_paper.pdf.   

2. “Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2010”, EIA, July 2011; http://www.eia.gov/analysis/requests/subsidy/pdf/subsidy.pdf. 

3. “Estimating U. S. Government Subsidies to Energy Sources: 2002-2008”, Environmental Law Institute, September 2009; http://www.elistore.org/Data/products/d19_07.pdf.

© 2012 Henry Auer