The boogeyman of oil and gas subsidies
The oil finder vs. the corporate economist
In the world of oil and gas, the proven oil finder is treated with special reverence. These are the rare geologists that have the ability to generate prospects that turn into discoveries. Within their cluttered offices you’ll find Soviet-era maps of central Asian geology, whiteboards crammed with sketches of continental rifting, and cabinets overflowing with old Schlumberger petrophysical manuals. The proven oil finder is allergic to corporate politics. They will often say things that offend middle management, and they definitely do not file their TPS reports on time. That big oil companies keep them around is testament to the difficulty of finding oil. The oil finder is able to challenge the normative understanding of a basin, to see opportunities through limited data, and to generate play-opening prospects.1
Identifying promising targets is only a piece of deciding where to drill for oil. International exploration teams will also be staffed with a business person, such as a corporate planner or economist, who scours labyrinthine government contracts to quantify the share of hydrocarbon revenue that will be taken by the host country—this share is known as “government take”. The differences in fiscal regime are incredibly impactful to the profitability—or lack thereof—of any given oil and gas development.
In 2018, the US Federal Government commissioned a comparative study of government take across different countries with significant offshore oil production. After costs are accounted for, the government would take a third of the revenue in the UK and US, half the revenue in Brazil, sixty percent in Australia, seventy percent in Mexico, and eighty five percent in Norway:2
The fiscal regime of the host government has a huge impact on oil and gas activity. Exploration for new fields is incredibly risky. In challenging drilling environments like the deepwater of the Gulf of Mexico, each individual well can cost hundreds of millions of dollars, and it may require drilling ten prospects to make a meaningful discovery. Full appraisal and development of a deepwater field can cost billions more before a single barrel of oil is sold. To justify that time, expenditure, and risk, the field must return significant profit.
At the start of my career, I worked in the international exploration unit of a large oil and gas company. I saw firsthand how government production taxes could deter investment in exploration and development. In countries with very high government take numbers, you would need to produce a huge field with very little risk.
I am bringing all this up because over the past couple years, I have heard an argument repeated many times. It goes something like this: oil and gas producers use their influence to secure huge amounts of subsidies, which keep the prices of oil and gas artificially low. This holds back the energy transition.
For an example of this train of thought, see this article in Nature: “Why fossil fuel subsidies are so hard to kill: Behind the struggle to stop governments propping up the coal, oil, and gas industries.” Reading something like that is a bit puzzling to me, as someone with knowledge of global oil and gas production taxes. I have read the contracts, I have seen the studies, and I have sat in rooms where fiscal regimes are actively considered. The reality is that oil and gas is one of the most heavily taxed industries in the world.
2022: a new record for oil and gas taxes!
This year, government oil and gas revenues are set to make a new record of $2.5 trillion, according to Norway’s Rystad Energy. For context, global GDP will be about $102 trillion. With high commodity prices, many governments are making over $50 per barrel produced:3
Alberta will be bringing in $28.1 billion CAD this year from oil and gas production. Norway estimates over $24,000 per person next year. The Texas state government will take in over $11 billion, not counting sales tax. Over 45% of Russia’s pre-war federal budget was funded by oil and gas revenues. These tax revenues dwarf oil and gas spending, which is estimated to come in a little over $1 trillion globally this year—and that includes both capital and operating expenses. In other words, for every dollar spent producing oil and gas, two dollars are paid in taxes to governments.
The boogeyman of oil and gas subsidies
Against $2 trillion in global taxes on oil and gas production, you would need, well, more than $2 trillion dollars in subsidies to be “propping up” fossil fuels. Oil and gas subsidies fall into a few common categories. First, there are consumption subsidies. These are payments from the government that reduce the cost of consumption of fossil fuels, such as subsidies for the cost of gasoline. Often these are not direct payments to consumers, but rather the government offering the fuel for below the international price: in Venezuela gasoline costs 10 cents a gallon, in Iran it’s 20 cents. The consumption subsidies tend to concentrate in fossil fuel-producing and poorer countries. The top six are Iran, China, India, Saudi Arabia, Russia, and Algeria:
Second, there are production subsidies. In contrast to the consumption subsidies, these tend to occur in countries with higher GDP and lower domestic oil production. These can include both direct support, such as for exploration wells, and indirect support in the form of tax write-offs. The intangible drilling cost deduction in the US amounts to around $1 billion in foregone tax revenue per year.4 This production support is usually justified to promote local jobs and energy independence, and to mitigate the inherent risk of drilling wells.
Before I get any further, let me just pause to say: I believe that global warming is occurring, that the burning of fossil fuels is driving the warming, and that we need to transition over to alternative energies.
I feel the need to say that because, as you will see shortly, the reports about oil and gas subsidies produced by some prominent institutions are wildly inaccurate, if not intentionally misleading. I hope you will appreciate my genuine desire to figure out what is going on here, no matter the political valence of the facts.
With that said, let’s dive into a report from the International Monetary Fund titled “Still Not Getting Energy Prices Right: A Global and Country Update of Fossil Fuel Subsidies.”5 The headline number was that subsidies amounted to just under $6 trillion globally in 2020. The study was picked up by the press around the world:
So how does the IMF come up with $6 trillion in subsidies? By putting their finger on the scales, blatantly and repeatedly. Against this report, the WeWork IPO prospectus looks like a paragon of principled accounting. The authors of the IMF study use a straightforward methodology for calculating the “explicit” subsidy: they compare the supply cost of the product with the prices paid by users in the country, and multiply that by the total consumption of the product. If the international price of gasoline is $4/gallon, but the price locally is $2/gallon, the explicit subsidy would be $2/gallon times the total gallons of gasoline consumed in that country for that year.
OK! Seems like a pretty solid way to measure consistently across countries. What about the case where the international price of gasoline is $4/gallon but it is taxed domestically to $6/gallon? You would think that would be a negative subsidy, or a tax. But the authors zero out the tax:
Given the focus here on underpricing, if a user price exceeds the supply cost the explicit subsidy is counted as zero (rather than negative) and where the price exceeds the efficient level the total subsidy is counted as zero.
Imagine seeing a version of that quote in the footnotes in a tech company’s pitch deck: “Given the focus here is on revenues, costs are counted as zeroes (rather than negative).” If you zero out the costs, any business would look profitable. By the methodology of this report, fossil fuels would ALWAYS look underpriced, even if taxes outweighed subsidies 10:1.
Even with that blatantly misleading methodology, the authors would only be able to get to $450 billion of subsidies globally. To get to $6 trillion, the authors include “implicit subsidies”, which are often referred to as externalities. These capture the costs not reflected in the standard pricing, such as deaths due to air pollution.
Whether these externalities should be considered at the same level as direct subsidies is up for debate, and I will leave it to you to make your own decision about that. I will even grant that climate change-related externalities are worthy of study. But the inclusion of road travel-related externalities shows the flaws in the report’s methodology. These externalities include the costs of lost time due to congestion, traffic-related injuries, the wear and tear of roads, and other minor factors. In the analysis, these add up to 15% of the total explicit and implicit subsidies, coming in at around $900 billion in annual costs.
Ask yourself: wouldn’t vehicles powered by electric motors (or hydrogen, nuclear batteries, or animal spirits) have these same issues? Of course they would! The use of hydrocarbons for transportation also provides a number of positive externalities which fail to be considered by the authors: how much value is unlocked by long-haul trucking? How much lower would average worker productivity be if they couldn’t drive to work? What’s the benefit to the world economy of air travel?
Remember, by zeroing out benefits and counting only costs, this study’s methodology guarantees the finding of “underpricing”. Applying that rigged methodology to a huge, complex sector like transportation necessarily produces a huge “implicit subsidy.” Clearly, the aim of the study is not to actually estimate an efficient price, but rather to justify higher taxes for fossil fuels.
Comparing subsidies & taxes
When researching this piece, I spent a LOT of time looking for a comparative analysis that included production taxes along with subsidies to come up with a proper estimate of the relative government support or (or lack thereof) for fossil fuel industries. For whatever reason, all the big international agencies that collect global datasets seem only interested in writing ever-escalating reports on subsidies, so I have had to cobble it together myself.
First, let’s start with global fossil fuel production taxes. The World Bank provides datasets of global oil and gas earnings (they term these rents) for oil, gas, and coal.6 They give a figure of 77% of the earnings captured by governments, with the remaining 23% by private companies. The number rises and falls significantly with commodity prices, but it’s a lot of money. 2022 is not included in their data, but it will be higher than the rest here:
Second, the OECD and the International Institute for Sustainable Development track global fossil fuel subsidies that only includes the “explicit” ones (no externalities included, like in the IMF report).7 While, by their own admission, they use pretty broad criteria to include a subsidy, I will take their data at face value for the purposes of this comparison. The OECD report includes fossil fuel “consumption” subsidies data from the IEA8, which I have broken out separately from production subsidies for this analysis.
Third, the OECD PINE database (Policy INstruments for the Environment)9 catalogs global taxes related to environmental protection, which includes consumption taxes on fossil fuels, such as gasoline taxes.
With these data sources, we have enough to do a comparison of taxes and subsidies. Here’s a waterfall chart of the average 2010-2020 global values for each of these categories:
After netting out subsidies, fossil fuels have been taxed an average of $1.3 trillion dollars per year over the last ten years.
The headlines have it wrong: fossil fuels prop up governments, not the other way around. Now, oil, gas, and coal may still be mispriced with respect to externalities, but that is not something I will try to tackle. But to paint the fossil fuel industries as on life support, kept alive by governments, is simply not true.
The reality is this: oil and gas production is incredibly profitable10, and most of that profit is captured by host governments extracting rents from their natural resources. These governments have formed a cartel to keep production artificially low (you know this group as OPEC+). Outside of a few market-friendly jurisdictions, oil and gas development is highly restricted, heavily taxed, and subject to significant political risk. The marginal production comes from the US & Canada, where we produce some of the lowest-quality reservoirs in the world: heavy oil in Canada, and shale here in the US. This is only possible thanks to favorable fiscal & regulatory regimes that have endured for decades.
My intention in writing this piece is not to argue in favor or against any type of fuel, but rather to shine a light on commonly-ignored taxes on oil and gas. “Governments are subsidizing fossil fuels to the tune of $11 million per minute” makes for excellent clickbait, but we are deluding ourselves if we think there is some magic oil subsidy spigot that, if turned off, will usher us to renewable Valhalla.
Author’s note: if you have learned something in this piece, please do me a huge favor by hitting the like button or dropping a comment below. It helps others discover my writing through Substack’s recommendations network. Thank you for reading!
The proven oil finder goes by many names, including the “prospector.”
These numbers are for the case of a hundred million barrel field; there is significant variation based on field size, water depth, oil price, and other factors.
These numbers were generated earlier in the year when prices were higher, but are representative of government take in a “high price” year.
Note that many other industries have similar accounting rules for capital expenditures.
You can download the report here: https://www.imf.org/en/Publications/WP/Issues/2021/09/23/Still-Not-Getting-Energy-Prices-Right-A-Global-and-Country-Update-of-Fossil-Fuel-Subsidies-466004
Note that the report is listed on their website as a “working paper”, but somehow the IMF chief forgot to mention that in her speech to the U.N.
Data from data.worldbank.org as part of their Changing Wealth of Nations report: https://www.worldbank.org/en/publication/changing-wealth-of-nations . Here is an example set of data of global oil rents: https://data.worldbank.org/indicator/NY.GDP.PETR.RT.ZS?end=2020&start=1970&view=chart . 77% of oil rents were assigned to the government, following the World Bank’s comments. Also notable: that is not something the World Bank itself tracks, rather it uses data from Rystad and other sources. Why does no international agency want to track this data??
Data from https://fossilfuelsubsidytracker.org/ . This data is not natively split out according to production vs. consumption subsidy, but the consumption portion is from the IEA, which provides it in a separate database.
Data from https://www.iea.org/data-and-statistics/data-product/fossil-fuel-subsidies-database. It’s a nice database, thank you IEA.
Data from https://pinedatabase.oecd.org/ . Please note that I did not include taxes on electricity production, even though those are included in the subsidy studies, because I don’t have the data to assign it to fossil-based electricity production vs. alternative energies. These taxes also include things like water protection and mining taxes, but I removed anything non-fossil. Environment-protecting taxes on fossil fuels far outweigh other environment-protecting taxes by about 6:1. Finally, the PINE database differentiates taxes and fees/charges. I lump them all together here as “taxes.”
Oil is, by far, the most taxed and most subsidized of all the fossil fuels.
Great work Ted. Reposting. Cheers
Have a look at the Velkerri and Barney Creek shales, intracratonic basin preserved shales back closer to 2 billion years in age, and broadly correlative to the first significant oxygenation of the atmosphere. Literally the dawn of the modern earth to me.
As a shale...core looks like every other one you've seen less the trace fossils. Causes one to wonder whether the organic source is as well understood as we'd hope. This is pre type I or II, ancestral kerogen.