Climate Action
Fueling the Distortion: How Oil Subsidies Skew Markets and Stifle Clean Energy
October 15, 2024
Oil subsidies may sound like a conspiracy theory far removed from your life, but the very real and vast funding that taxpayers pay to prop up the oil industry really is coming from your wallet. Billions of dollars each year are given to the very same companies that are largely responsible for climate change.
How Big Oil is Subsidized
Oil subsidies are tax breaks for oil companies. Many of these subsidies were established in the early twentieth century to attract investment when oil was considered a high-risk business due to the limited technology available to find oil reservoirs. You could strike it rich if you hit oil, or you could come up empty-handed. Since a country’s economic and political standing were interconnected with domestic fossil fuel production, the government could not afford to let the risky odds scare investors away. Promising to cover some of the costs was the best way to ensure investors would roll the dice.
One of the major subsidies oil companies can and do collect on is called Intangible Drilling Costs (IDC). IDC Deductions allow oil companies to immediately subtract most of their operating costs, including supplies, equipment repairs, fuel, and wages, from their income to lower their tax liability. When they report less, they pay less. Anywhere from 60 to 80 percent of drilling costs are covered by IDCs.
That’s not all because there is also the Percentage Depletion Allowance (PDA), which compensates oil companies for the decreasing production rate of oil drill sites over time. Up to 15 percent of an oil company’s gross income is tax-free because of these generous PDA deductions.
But perhaps the most insidious subsidy oil companies benefit from isn’t hidden in the Tax Code but in the absence of a federal carbon tax. The United States government is well aware of the negative impacts of drilling for and burning fossil fuels, including causing climate change, lowering air quality, and triggering a range of human health issues. So the U.S. government’s failure to implement a federal carbon tax on fossil fuel companies implicitly subsidizes these oil companies by allowing them to pollute without paying.
Oil companies are effectively allowed to also cash in on externalities.
A negative externality is an economic term that describes a situation in which a negative societal effect is not included in the price of a product. Take, for example, smoking cigarettes. Cigarette smoke lowers everyone’s air quality. To address this, the government adds taxes to ensure the price reflects the true cost on society. Internalizing an externality allows the market to accurately establish what the cost of a good should be — the same should be done for fossil fuels in the form of a carbon tax.
Without a national carbon tax, companies not only get a free pass to pollute, they have no economic incentive to attempt to reduce the emissions from oil production.
In contrast, Sweden maintains the highest carbon tax in the world at 126 USD per metric ton, which has successfully reduced carbon emissions by 27% while maintaining a growing GDP. With 46 other countries successfully putting a price on carbon, the United States is in danger of falling behind the international curve.
How Subsidies Skew the Market
Subsidies make a mess of the market. For it to function properly, the total cost of producing a good must be factored into the price. When it comes to fossil fuels, environmental harm is often neglected in this estimation, which disrupts the natural balance of supply and demand. The resulting market distortion allows oil companies to supply oil at a lower price and in greater quantities while still raking in a massive profit.
What’s worse is the extra profits from oil subsidies encourage companies to reinvest in fossil fuels. Exxon produces about 2.5 million barrels of oil a day and recently spent $60 billion acquiring another oil company in order to increase their daily output by 28%, or an additional 700,000 barrels a day. Subsidies are encouraging fossil fuel giants to double down on fossil fuels instead of investing in a transition to clean energy.
The Truth is That Oil Prices are is Deliberately Kept Low
The truth is not that fossil fuels are cheaper, but that they have 100 years of subsidies working in their favor. The market distortion is so severe that fossil fuels can dominate the market without actually being the cheaper or the superior option.
In fact, 40% of the oil from the Texas’s Permian Basin, the largest oil source in the United States, wouldn’t achieve profitability without subsidies. The common perception that fossil fuels are the cheaper energy source is an illusion that is holding back clean energy innovation.
Consumers will not push for clean energy alternatives if they believe their energy prices will rise as a result. Without a strong consumer interest in clean energy, investors have no reason to focus their money on new clean energy technologies.
BP is a stark example of this harmful trend; the company began investing in major renewable energy projects in 2020 but reversed course when they decided that further investment in fossil fuels seemed much more profitable in the short-term.
You might wonder why clean energy subsidies won’t ultimately have the same market manipulation tendencies. But here is the key difference, while oil harms society, clean energy benefits it.
When clean energy sources replace fossil fuels, they enhance air quality and human health, while mitigating climate change. Clean energy subsidies act as compensation for these benefits, which helps restore the market equilibrium. The Inflation Reduction Act includes subsidies for clean energy projects within the $369 billion allocated to ensuring energy security. Removing undeserved subsidies from oil companies and replacing them with subsidies for clean energy alternatives is essential to rebalancing the energy market.
Immovable Oil Subsidies
Even though the Biden Administration proposed a budget in March, 2024 that would eliminate oil subsidies, it is unlikely that this will be actualized. Fossil fuel companies are extremely effective at lobbying, spending $137 million on lobbying in 2023 alone, making it improbable that politicians will cut off Big Oil’s allowance. Their influence far outweighs grassroots efforts to eliminate oil subsidies and they know consumers will balk at higher gas prices as a result.
The reality is, investments in clean energy would actually boost economic growth and jobs; clean energy grew 4.2% in 2023, compared to a 6% drop in oil jobs. As many politicians continue to kick the oil can down the road, concerned more with their upcoming election prospects than with protecting our future, it’s harder for renewables to get the backing they deserve.
Creating Accountability
Removing oil subsidies is all about accountability. Oil companies have thrust us into a global crisis that will require trillions of dollars to mitigate. They need to start paying the full price for the destruction they have caused.
It is the responsibility of your representative to stand up for you against big corporations. How will you make sure they uphold their end of the bargain? It starts with voting. Your vote is your voice, which is why it is essential to research a candidate’s position on oil subsidies before you cast your ballot.
Want to take action today? Write your state lawmakers and ask them to invest in renewable energy for your community.
