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How Tax Breaks for Fossil Fuel Companies Inflated Profits for Oil and Gas Drilling

A new study estimates that tax breaks boosted the value of new oil and gas projects by up to $20 billion a year.

David McNew/Getty Images
A California oil field in 2014

During infrastructure negotiations, Republicans have been eager to frame any and all green spending as a wasteful add-on that picks winners and stifles competition. But the United States already picks winners—and a new report from the Stockholm Environmental Institute, a nonprofit think tank, provides one of the first-ever estimates for just how much these subsidies have been worth to one of the world’s most harmful industries. By boosting projected earnings by billions of dollars a year, government policy has been meddling in supposedly free markets—and driving up emissions—for years. Strikingly, the researchers estimate that these tax breaks are worth billions more to firms than the government itself admits.

“Subsidies are about what we as a society choose to support,” says study co-author Ploy Achakulwisut. “We’ve identified two major subsidies that are basically going to excess profits, or helping to create excess production from fields that wouldn’t otherwise be economically viable.” The problem, Achakulwisut and co-author Peter Erickson argue, isn’t the existence of these gargantuan subsidies so much as where they’re going. Redirecting the vast support already flowing to polluters could be an invaluable tool for scaling down drilling and building up zero-carbon power.

The study homes in on three long-standing producer-side subsidies, whose benefits accrue to drillers: a provision allowing them to expense so-called intangible drilling costs, or IDC, rather than depreciate them over many years; the accelerated amortization period for geological and geophysical expenses, allowing drillers more quickly to write off those expenses; and the percentage depletion allowance, a 15 percent deduction on gross revenue year after year. Just two of those—IDC expensing and the percentage depletion allowance—inflated the expected value of new oil and gas projects by up to $20 billion in a single year.

“Standard treatment in tax code is that you build some physical thing that makes your product, and you have to deduct that over the useful life of that thing,” Erickson says of IDC expensing. “Here, the special treatment that the oil industry gets is that the tax code says you can deduct that right away. That’s a big boost to the firm’s cash flow.”

To find out just how big a boost it was, Erickson and Achakulwisut used a financial model to reconstruct the decision-making of oil and gas developers from 1998 through 2019. They factored the expected value of those three subsidies into the projected profits for over 2,450 projects using data compiled by analysts at Rystad Energy on production and costs, including capital investment, and fuel prices at the time. That allowed them to get a picture of how much each new project would have been expected to make when it was being considered with subsidies in place, and compare that against projected earnings without subsidies.

What surprised them was just how far off their findings were from the government’s own estimate of how much these tax incentives are worth. In 2009, the U.S. estimated these subsidies were worth roughly $2 billion—less than one-tenth of what Erickson and Achakulwisut’s model shows. The difference, they explain, lies in the fact that these tax breaks are much less valuable to the U.S. than they are to companies, which use projected earnings to consider whether to go ahead with new projects. “It’s not that we’re doing it right and the government is doing it wrong,” Erickson says. “It’s a different perspective on how to value this benefit. One way to look at it is that the government has a very low discount rate for its own cash flow for taxes. They can get the taxes this year or next year and don’t really care that much either way,” he says. For companies, “the value comes from having cash sooner rather than later.”

The fossil fuel industry likes to argue that it doesn’t get any special treatment in the tax code, receiving only “ordinary deductions ensuring that companies are taxed only on real income.” But Erickson and Achakulwisut adopt a wide definition of industry-specific subsidies lifted from the World Trade Organization: “one that is only given to one company, or to a special group of companies.” In a 2015 self-assessment to the G20, the U.S. itself defined 16 tax benefits as producer-side fossil fuel subsidies, including those examined in the SEI report. The assessment finds that “like other oil and natural gas preferences,” allowing companies to expense intangible drilling costs “distorts markets by encouraging more investment in the oil and natural gas industry than would occur under a neutral tax system.” Even Pioneer Natural Resources—a major shale developer—noted in its 2012 annual report that eliminating the three subsidies Erickson and Achakulwisut consider could “defer planned capital expenditures if such changes accelerated the payment of taxes.” SEI estimates that those breaks could have boosted Pioneer’s expected project returns by $8 billion in a single decision-making year, mainly on projects in the Permian Basin.

Over the time period Erickson and Achakulwisut looked at, unconventional drilling came to dominate the sector. In the years since 2007, unconventional, capital-intensive methods like fracking account for most new projects, with overall spending averaging around $3 billion per field at the peak of the shale boom. “Because the average well cost was more, that meant [unconventional drillers] could have taken more advantage of the IDC subsidy,” Achakulwisut says, noting the inordinate benefits to high-cost production in shale fields in Texas and Appalachia. So while technological improvements certainly played a role, the fracking revolution owes no small part of its success to the serendipity of cheap credit—made possible by low interest rates—and extraordinarily generous fossil fuel subsidies that made it look like a more attractive prospect to investors with extra cash to throw around.

With precious little time left to get off fossil fuels, lawmakers will have to decide if tax breaks for polluters are worth keeping around. And given that credit remains cheap, the other question is whether legislators interested in building a burgeoning clean energy economy in the U.S. might consider directing the same level of state support to zero-carbon power that has historically flowed to fossil fuels. “Cheap, low-risk capital is the name of the game, and subsidies are all about what societal choices and priorities are,” Erickson says. “It’s not that subsidies themselves are bad. It’s about what the government is supporting. Clearly, the world and the U.S. need to get to a zero-carbon economy as fast as possible. More subsidies to renewable power should absolutely be on the table.”