Rebuttal: Oil Subsidies—More Material for Climate Change Than You Might Think

This post is authored by Peter Erickson, a staff scientist at the Stockholm Environment Institute and a co-author of a new paper in Nature Energy that studies how much of U.S. oil reserves are economical to extract as a result of government subsidies that benefit the oil industry.

This post is a response to a previous post, by Varun Sivaram, arguing that federal tax breaks for the oil industry do not, in fact, cause a globally significant increase in greenhouse gas emissions, citing a recent CFR paper authored by Dr. Gilbert Metcalf at Tufts University. Dr. Sivaram’s short response to Mr. Erickson’s rebuttal is included at the bottom of the post.

As Congress moves towards tax reform, there is one industry that hasn’t yet come up: oil. While subsidies for renewable energy are often in the cross-hairs of tax discussions, the billions in federal tax subsidies for the oil industry rarely are; indeed, some subsidies are nearing their 100th birthday. And yet, removing oil subsidies would be good not only for taxpayers, but for the climate as well.

The lack of attention on petroleum subsidies is not for lack of analysis. Congress’ own Joint Committee on Taxation values the subsidies at more than $2 billion annually.  (Other researchers have put the total much higher.) Just in the last year, two major studies have assessed in detail how these subsidies affect investment returns in the US oil industry. The two analyses—one published by the Council on Foreign Relations (CFR) and the other in Nature Energy (which I coauthored)—both show the majority of subsidy value goes directly to profits, not to new investment.  

That inefficiency—both studies argue—is reason enough for Congress to end the subsidies to the oil industry.

But oil subsidies also have another strike against them: oil is a major contributor to climate change. The burning of gasoline, diesel, and other petroleum products is responsible for one-third of global CO2 emissions. That climate impact is one of the reasons the Obama Administration had committed, with other nations in the G7, to end these subsidies by 2025.

Both the CFR and Nature Energy analyses arrive at a similar figure as to the net climate impact. As CFR fellow Varun Sivaram notes in a previous post on this blog comparing the two studies, the CFR study finds that subsidy removal would reduce global oil consumption by about half a percent. Our analysis for the Nature Energy study also finds a reduction in global oil consumption of about half a percent. (You won’t find this result in our paper, but it is what our oil market model, described in the online Supplementary Information, implies.)

The most critical place where the studies—or rather, authors—differ is how they put this amount of oil in context. (Our study also addresses many more subsidies, and in much more detail, than the CFR study, but that is not the point I wish to address here.)

Sivaram refers to the half-percent decrease in global oil consumption as “measly…washed out by the ordinary volatility of oil prices and resulting changes in consumption…the nearly-undetectable change in global oil consumption means that the climate effects of U.S. tax breaks are negligible.”

I would argue that this assertion confuses the effect of subsidies on oil consumption with our ability to measure the change. But before I get into it further, let me first describe how much oil and CO2 we are talking about.

By the CFR paper’s estimates, removal of US oil subsidies would lead to a drop in global oil consumption of 300,000 to 500,000 barrels per day (corresponding to 0.3% to 0.5% of the global oil market). The sequential effects in their model are shown in the chart below, which I made based on their results. It shows their lower-end case, in which global oil consumption drops by 300,000 barrels per day (bpd). (This case is described in their paper as using EIA’s reference case oil price forecast and an upward-sloping OPEC supply curve.)  In their model, a drop of over 600,000 bpd in US supply from subsidy removal is partially replaced by other sources of U.S., OPEC, and other rest-of-world supply, yielding a net reduction in global consumption of roughly half as much (300,000 bpd, shown in the right column). (This ratio itself is also interesting and important. For each barrel of oil not developed because of subsidies, this case shows a drop in global oil consumption of 0.45 barrels. The CFR study’s other three cases show a drop of 0.51, 0.63, and 0.82 barrels of global consumption for each US barrel left undeveloped.)

Each barrel of oil yields, conservatively, about 400 kg of CO2 once burned, per IPCC figures. So, the range of impacts on oil consumption in the CFR study (again, reductions of 300-500k bpd or 110 million to 200 million bbl annually) implies a drop in global CO2 emissions of about 40-70 million tons of CO annually. (The actual emissions decrease from subsidy removal could well be greater, because this estimate doesn’t count other gases released in the course of extracting a barrel of oil, such as methane or other CO2 from energy used on-site).

From a policy perspective, 40 to 70 million tons of CO2 is not a trivial (measly) amount. Rather, it is comparable in scale to other U.S. government efforts to reduce greenhouse gas emissions. For example, President Obama’s Climate Action Plan contained a host of high-profile measures that, individually, would have reduced annual (domestic) greenhouse gas emissions by 5 million tons (limits on methane from oil and gas extraction on federal land), 60 million tons (efficiency standards for big trucks), and 200 million tons (efficiency standards for cars).

The CFR authors don’t quantify their findings in CO2 terms, however, and Sivaram refers to oil market volatility as a way to discount CFR’s findings on reduced oil consumption, concluding that the effects are “undetectable” and “negligible.” The argument is essentially that because other changes in the oil market are bigger, and can mask the independent effect of subsidy removal, that subsidy removal has no effect on climate change.

This line of argument conflates causality, scale and likelihood of impact (which in this case are either all known, or can be estimated) with ability to monitor, detect and attribute changes (which is rarely possible in any case, even for more traditional policies focused on oil consumption). By this logic, almost any climate policy could also be discounted as immaterial, because it is rare to be able to directly observe with confidence both the intended result of a policy and the counterfactual – what would have happened otherwise. 

Rather, I would argue that if we are to meet the challenge of global climate change, we’ll need these 40 to 70 million tons of avoided CO2, and many more, even if there is uncertainty about exactly how big the impact will be. Concluding an action represents a small fraction of the climate problem is less a statement about that action than it is about the massive scale of the climate challenge. Indeed, as the Obama White House Council on Environmental Quality stated, such a comparison is “not an appropriate method for characterizing the potential impacts associated with a proposed action… because…[it] does not reveal anything beyond the nature of the climate change challenge itself.”

So, I argue that subsidy removal is indeed material for the climate, even by the CFR report’s own math. And as Sivaram also notes, the CO2 emission reductions would multiply as other countries also phase out their subsidies.

Lastly, I need to disagree with Sivaram’s statement that our study is “written in a misleading way”. He asserts this because in the Nature Energy article we focus on the entire CO2 emissions from each barrel, rather than apply an oil market economic model as described above that counts only the net, or incremental, global CO2. But the incremental analysis method above is not the only way to describe CO2 emissions. Indeed, comparing the possible CO2 emissions from a particular source to the global remaining carbon budget is a simple and established way to gauge magnitudes, and nicely complements the incremental analysis enabled by oil market models.  

As another noted subsidy expert—Ron Steenblik of the OECD—commented separately in Nature Energy, our analytical approach provides an important advance because it enables “researchers to look at the combined effect of many individual subsidies flowing to specific projects and to use project-specific data to gauge eligibility and uptake.” Similar assessments of other countries, and other fossil fuels, would provide an important window on the distortionary impacts of these subsidies and their perverse impacts on global efforts to contain climate change.

Sivaram Response to Erickson Rebuttal

First of all, I am grateful to Peter Erickson for responding in this way to a blog post I wrote that was critical of his conclusions. His response was graceful and sophisticated—I think I largely agree with it, and he’s pointed out some holes in my post that I want to acknowledge. However, I do still stand by my headline, “No, Tax Breaks for U.S. Oil and Gas Companies Probably Don’t Materially Affect Climate Change.” In fact, I think the Erickson rebuttal above reinforces just that point.

Tackling the overall thesis first: in his rebuttal, Erickson is willing to accept that a reasonable estimate for the carbon impact of U.S. tax breaks for oil and gas companies is 40–70 million tons of carbon dioxide emissions annually (there may be other greenhouse gas emissions, such as methane, that increase the climate impact). Erickson even compares the magnitude of this negative climate impact with the positive impact of President Obama’s efficiency standards for big trucks.

I am absolutely willing to accept that removing U.S. tax breaks for oil companies would be about as big a deal, in terms of direct emissions reduction, as setting domestic efficiency standards for big trucks. Importantly, this direct impact is trivial on a global scale, which is the point that I made in my original post, reinforcing Dr. Metcalf’s conclusion in his CFR paper.

I am, however, sympathetic to Erickson’s argument that the world needs a rollback of tax breaks, efficiency standards for big trucks, and a whole suite of other policies in the United States and other major economies to combat climate change. And there is certainly symbolic value to the United States rolling back its oil industry tax breaks, possibly making it easier to persuade other countries to follow suit.

I also want to concede that Erickson very rightly called me out on unclearly discussing the relationship between oil price volatility and the effect on oil prices of removing tax breaks. We definitely know which direction removing subsidies would move prices (up) and global consumption (down). I should have been clearer that my comparison of the frequent swings in oil prices to the tiny price impact of removing subsidies was merely to provide a sense of magnitude, NOT to imply that measurement error washes out our ability to forecast the magnitude of tax reform’s price impact, ceteris paribus.

Finally, Erickson took issue to my characterization of his paper as “misleading.” Indeed, I never meant to imply that he and his co-authors intended to mislead anybody. I still, however, stand by what I meant: that the paper might lead a casual reader to take away an erroneous conclusion by relegating the global oil market model to an appendix and only citing the increase in U.S. emissions in the main body. In my opinion, readers need to know that industry tax breaks have a very small effect on global greenhouse gas emissions, but there are other very important reasons to remove them. And yes, the United States absolutely should remove its tax breaks, as should other countries remove their fossil fuel subsidies. On that count, Erickson and I are in complete agreement.