How long would the fossil fuel economy last if we took it off life support?

Or to state the question more narrowly and less provocatively, what would happen if we removed existing subsidies to fossil fuel production?

Some fossil fuel producers are still highly profitable even without subsidies, of course. But a growing body of research shows that many new petroleum-extraction projects are economically marginal at best.

Since the global economy is addicted to energy-fueled growth, even a modest drop in fossil fuel supply – for example, the impact on global oil supplies if the US fracking industry were to crash – would have major consequences for the current economic order.

On the other hand, climate justice demands a rapid overall reduction to fossil fuel consumption, and from that standpoint subsidies aimed at maintaining current fossil fuel supply levels are counterproductive, to say the least.

As a 2015 review of subsidies put it:

“G20 country governments are providing $444 billion a year in subsidies for the production of fossil fuels. Their continued support for fossil fuel production marries bad economics with potentially disastrous consequences for the climate.” 1

This essay will consider the issue of fossil-fuel production subsidies from several angles:

Subsidies are becoming more important to fossil fuel producers as producers shift to unconventional oil production.

Many countries, including G20 countries, have paid lip service to the need to cut fossil fuel subsidies – but action has not followed.

Until recently most climate change mitigation policy has been focused on reducing demand, but a strong focus on reducing supply could be an important strategy for Green New Deal campaigners.

Ending subsidies to producers can play a key role in taking the fossil fuel economy off life support – or we can wait for the planet to take our civilization off life support.

Producer subsidies and the bottom line

A 2014 paper from the Oxford Centre for the Analysis of Resource Rich Economies takes a broad look at subsidization trends in many countries and over several decades. In “Into the Mire”2, Radoslav Stefanski aims to get around the problem of scarce or inconsistent data by, in his words, “a method of so-called revealed preference to back out subsidies.”

Stefanski does not focus specifically on subsidies to producers. Instead, he is concerned with inferring an overall net subsidy rate, which is the difference between subsidies aimed at either fossil fuel producers and consumers, and the taxes levied on fossil fuels at the production and consumption end.

He finds that “between 1980 and 2000 the world spent – on average – 268 billion USD (measured in 1990 PPP terms) a year on implicit fossil fuel subsidies.” Starting from the late 1990s, however – when it should have been clear that it was globally essential to begin the transition away from fossil-fuel dependence – the rate of subsidization grew rapidly in several regions.

In particular, Stefanski finds, “the vast majority of the increase comes from just two countries: China and the US.”

In North America, he says “until the 1990s the policy was fairly neutral with a slight tendency towards subsidization. Subsequently however, fossil fuel subsidies exploded and the region became the second highest subsidizing region after East Asia.”

Not only did the global price of oil see a rapid rise after 2000, but North American production saw a huge growth in production through two unconventional methods: hydraulic fracturing of oil-bearing shale, and mining of tar sands. These oil resources had been known for decades, but getting the oil out had always been too expensive for significant production.

A 2017 paper in Nature Energy shows how crucial subsidies have been in making such production increases possible.

Entitled “Effect of subsidies to fossil fuel companies on United States crude oil production”, the paper quantifies the importance of state and federal subsidies for new oil extraction projects.

The authors found that at then-current prices of about US$50 per barrel,

“tax preferences and other subsidies push nearly half of new, yet-to-be-developed oil investments into profitability, potentially increasing US oil production by 17 billion barrels over the next few decades.3”

The projects that would only be profitable if current subsidies continue include roughly half of those in the largest shale oil areas, and most of the deep-sea sites in the Gulf of Mexico – all areas which have been critical in the growth of a reputed new energy superpower often referred to triumphantly as “Saudi America”.

The authors also estimate the greenhouse gas emissions that will result from continuing these subsidies to otherwise-failing projects. In their tally, the additional carbon emissions coming from these projects would amount to 20% of the US carbon budget between now and 2050, given the widely accepted need to keep global warming to a limit of 2°C. In other words, the additional carbon emissions from US oil due to producer subsidies is far from trivial.

Extending this theme to other jurisdictions with high-cost oil – think Canada, for example – the authors of Empty Promises note “the highest cost fields that benefit most from subsidisation often have higher carbon intensity per unit of fuel produced.”4,5

The Nature Energy study is based on an oil price of US$50 per barrel, and says that subsidies may not be so important for profitability at substantially higher prices.

Another recent look at the fracking boom, however, reveals that the US fracking boom – particularly fracking for crude oil as opposed to natural gas – has been financially marginal even when prices hovered near $100 per barrel.

Bethany McLean’s book Saudi America6 is a breezy look at the US fracking industry from its origins up to 2018. Her focus is mostly financial: the profitability (or not) of the fracking industry as a whole, for individual companies, and for the financial institutions which have backed it. Her major conclusion is “The biggest reason to doubt the most breathless predictions about America’s future as an oil and gas colossus has more to do with Wall Street than with geopolitics or geology. The fracking of oil, in particular, rests on a financial foundation that is far less secure than most people realize.” (Saudi America, page 17)

Citing the work of investment analyst David Einhorn, she writes

“Einhorn found that from 2006 to 2014, the fracking firms had spent $80 billion more than they had received from selling oil and gas. Even when oil was at $100 a barrel, none of them generated excess cash flow—in fact, in 2014, when oil was at $100 for part of the year, the group burned through $20 billion.” (Saudi America, page 54-55)

It seems sensible to think that if firms can stay solvent when their product sells for $50 per barrel, surely they must make huge profits at $100 per barrel. But it’s not that simple, McLean explains, because of the non-constant pricing of the many services that go into fracking a well.

“Service costs are cyclical, meaning that as the price of oil rises and demand for services increases, the costs rise too. As the price of oil falls and demand dwindles, service companies slash to the bone in an effort to retain what meager business there is.” (Saudi America, page 90)

In the long run, clearly, the fracking industry is not financially sustainable unless each of the essential services that make up the industry are financially sustainable. That must include, of course, the financial services that make this capital-intensive business possible.

“If it weren’t for historically low interest rates, it’s not clear there would even have been a fracking boom,” McLean writes, adding that “The fracking boom has been fueled mostly by overheated investment capital, not by cash flow.”7

These low interest rates represent opportunity to cash-strapped drillers, and they represent a huge challenge for many financial interests:

“low interest rates haven’t just meant lower borrowing costs for debt-laden companies. The lack of return elsewhere also led pension funds, which need to be able to pay retirees, to invest massive amounts of money with hedge funds that invest in high yield debt, like that of energy firms, and with private equity firms—which, in turn, shoveled money into shale companies, because in a world devoid of growth, shale at least was growing.” (Saudi America, page 91)

But if the industry as a whole is cash-flow negative, then it can’t end well for either drillers or investors, and the whole enterprise may only be able to stay afloat – even in the short term – due to producer subsidies.

Supply and demand

Many regulatory and fiscal policies designed to reduce carbon emissions have focused on reducing demand. The excellent and wide-ranging book Designing Climate Solutions by Hal Harvey et al. (reviewed here) is almost exclusively devoted to measures that will reduce fossil fuel demand – though the authors state in passing that it is important to eliminate all fossil fuel subsidies.

The authors of the Nature Energy paper on US producer subsidies note that

“How subsidies to consumers affect energy decision-making is relatively well studied, in part because these subsidies have comparatively clear impacts on price …. The impact of subsidies to fossil fuel producers on decision-making is much less well understood ….” 8

Nevertheless there has been a strong trend in climate activism to stop the expansion of fossil fuels on the supply side – think of the fossil fuel divestment movement and the movement to prevent the construction of new pipelines.

A 2018 paper in the journal Climatic Change says that policymakers too are taking another look at the importance of supply-side measures: “A key insight driving these new approaches is that the political and economic interests and institutions that underpin fossil fuel production help to perpetuate fossil fuel use and even to increase it.”9

The issue of “lock-in” is an obvious reason to stop fossil fuel production subsidies – and an obvious reason that large fossil fuel interests, including associated lending agencies and governments, work behind the scenes to retain such subsidies.

Producer subsidies create perverse incentives that will tend to maintain the market position of otherwise uneconomic fossil fuel sources. Subsidies help keep frackers alive and producing rather than filing for bankruptcy. Subsidies help finance the huge upfront costs of bringing new tar sands extraction projects on line, and then with the “sunk costs” already invested these projects are incentivized to keep pumping out oil even when they are selling it at a loss. Subsidy-enabled production can contribute to overproduction, lowering the costs of fossil fuels and making it more difficult for renewable energy technologies to compete. And subsidy-enabled production increases the “carbon entanglement” of financial services which are invested in such projects and thus have strong incentive to keep extraction going rather than leaving fossil fuel in the ground.

Carbon-entangled governments tend to be just as closely tied to big banks as they are to fossil fuel companies. Sadly, it comes as no surprise that in 2018 the G7 Fossil Fuels Subsidy Scorecard noted that “not a single G7 government has ended fiscal support or public finance to oil and gas production, with Canada providing the highest levels of support (per unit of GDP).”10

Fossil fuel producer subsidies and the Green New Deal

Major international climate change conferences have long agreed that fossil fuel subsidies must be phased out, ASAP, but little progress has been made.

The first step in getting out of a deep hole is to stop digging, and at this point in our climate crisis it seems crazy or criminal to keep digging the hole of fossil fuel lock-in by subsidizing new extraction projects.

Many major fossil fuel corporations have expressed their support for carbon taxes as a preferred method of addressing the climate change challenge. I am not aware, however, of such corporate leaders advocating the simpler and more obvious approach of removing all fossil fuel subsidies.

Perhaps this is because they know that carbon taxes almost always start out too small to make much difference, and that every attempt to raise them will stir intense opposition from lower- and middle-income consumers who feel the bite of such taxes most directly.

The costs of producer subsidies, on the other hand, are spread across the entire population, while the benefits are concentrated very effectively among fossil fuel corporations and their financial backers. And by boosting the supply of fossil fuels, especially oil, to a level that could not be maintained under “free market” requirements for profitability, these subsidies maintain the hope of continuous economic growth based on supposedly cheap energy.

The sudden popularity of “Green New Deal” ideas in several countries raises essential questions about political strategy. There is no single silver bullet, and a range of political and economic changes will need to be made. Though one major goal – eliminate most fossil fuel use by about 2030 and the rest by 2050 – is simple and clear, there are many means to move towards that goal, not all of them equally effective or equally feasible.

A swift elimination of producer subsidies, and a redirection of those funds to employment retraining and rehiring in renewable energy projects, strikes me as a potential political winner. Major fossil fuel interests, including big investment firms, can be counted on to oppose such a shift, of course – but they have shown themselves to be determined lobbyists for the preservation of the fossil fuel economy anyway.

Among the overwhelming majority of voters without big financial portfolios, the cessation of handouts to corporations strikes me as an easier sell than carbon taxes levied directly and regressively on consumers.



Photo at top: port of IJmuiden, Netherlands, September 2018.

Footnotes

1 Empty Promises: G20 subsidies to oil, gas and coal production, published by Overseas Development Institute and Oilchange International, 2015, page 11

2 “Into the Mire: A closer look at fossil fuel subsidies”, by Radoslav Stefanski, 2014.

3 Peter Erickson, Adrian Down, Michael Lazarus and Doug Koplow, “Effect of subsidies to fossil fuel companies on United States crude oil production”, Nature Energy 2, pages 891-898 (2017).

4 Empty Promises: G20 subsidies to oil, gas and coal production, published by Overseas Development Institute and Oilchange International, 2015, page 17

5 The same hurdles to unsubsidized profitability apparently apply outside of North America. See, for example, this article detailing how major fracking ventures in Argentina are likely to stall or fail due to declining subsidies: “IEEFA report: Argentina’s Vaca Muerta Patagonia fracking plan is financially risky, fiscally perilous”, March 21, 2019

6 Saudi America: The Truth About Fracking and How It’s Changing the World, by Bethany McLean. Columbia Global Reports, 2018.

7 McLean’s reading echoes the analysis in the 2017 book Oil and the Western Economic Crisis, by Cambridge University economist Helen Thompson.

8 Peter Erickson, Adrian Down, Michael Lazarus and Doug Koplow, “Effect of subsidies to fossil fuel companies on United States crude oil production”, Nature Energy 2, pages 891-898 (2017).

9 Michael Lazarus and Harro van Asselt, “Fossil fuel supply and climate policy: exploring the road less taken,” Climatic Change, August 2018, page 1

10 G7 Fossil Fuels Subsidy Scorecard, Overseas Development Institute, Oilchange International, NRDC, IISD, June 2018, page 9