At $50 a barrel, the low price of crude oil has slowed some of the oil production in the US, especially in regions that are costly to develop, like the Arctic. But US oil producers aren't bearing the whole brunt of low prices, because federal and state governments provide tax breaks that stimulate oil production despite low prices.

The tax situation isn’t unique to the US—China, the EU, and India also offer a variety of flavors of tax breaks to fossil fuel producers, despite their recognition of the need to address climate change. Although the US has signaled its intent to withdraw from the Paris Agreement, tax breaks that fund more fossil fuel production don't help the rest of the globe to limit warming to 2 degrees Celsius.

The latest research offers some hard numbers on just how much tax policy is supporting extra CO 2 emissions. “Federal tax subsidies to the oil and gas industry alone cost US taxpayers at least US$2 billion each year,” write researchers from the Stockholm Environment Institute and Earth Track in a recent Nature Energy article. That $2 billion in uncollected taxes is helping some oil fields go from "unprofitable" to "profitable," increasing the amount of oil that's available for consumption. (The researchers broadly used the term "subsidies" to indicate different types of tax-based support that "confer a financial benefit from government to oil producer.")

Doing the numbers

The authors of the paper focused on 12 federal and state subsidies in an attempt to quantify how much the oil industry benefits from lenient tax policy. The results are significant—at the current price of around $50 per barrel, nearly half of discovered-but-not-yet-developed crude oil fields become profitable where they otherwise would not be. When those fields are made profitable, they get developed, and the CO 2 derived from crude oil use is liberated.

With current government assistance, an additional 17 billion barrels of oil will be realized over the next several decades, resulting in an additional 6 billion tonnes of CO 2 emitted that would otherwise not be if the subsidies didn't exist.

“Our analysis suggests that oil resources may be much more dependent on subsidies than previously thought, at least at prices near US$50 per barrel,” the authors wrote.

The researchers were able to make this determination by taking data from Rystad Energy’s UCube database, which estimates “capital investment, operating costs, taxes, and production profiles for each oil field in the US." From there, the authors identified more than 800 onshore and offshore discovered-but-not-yet-developed fields. For each field, they determined the point at which each site would become profitable with a 10-percent minimum return. If a site was profitable without any federal and state subsidies available to it, then the site will likely be developed anyway. But if the site requires a little government assistance to reach a good return on investment, then it was counted as moving from uneconomic to economic with subsidies.

Overall, tax assistance moved the rate of return for all of the studied oil fields up by a median three percentage points. Most of the fields that went from uneconomic to economic were found in Texas’ Permian Basin. (This may be due to the fact that several of the subsidies studied by the researchers were Texas-based, so they were applied to fields in Texas and not applied to out-of-state fields). In Texas specifically, the researchers estimated that “about 40 percent of the economic oil resource is subsidy-dependent.”

On the other hand, fewer of the offshore oil projects were subsidy-dependent. The researchers suspect that this is because there are fewer operations offshore to begin with, and the large corporations that can afford such expensive extraction don’t qualify for the most generous subsidies.

How to reform the system?

In the course of their research, the authors identified the three tax loopholes that had the greatest impact on oil production. All three were federal tax breaks. The most economically important of the three "allows oil producers to deduct many drilling and field development costs associated with domestic oil wells.” The second, called the "percentage depletion allowance," allows oil producers to deduct a portion of their operation’s gross value rather than limiting deductions to invested capital. And the third is the “domestic manufacturer’s deduction,” which allows oil producers to “deduct a percentage of ‘gross income’ from taxable income.”

The authors also noted that there's a potential feedback loop from removing subsidies. If fewer oil fields are perceived to be profitable, then less crude oil is produced. The reduced supply could drive the price of oil back up, which would suggest that more US oil fields on the fence between profitability and unprofitability would end up on the profitable side. But the authors ran the numbers on that, finding it only leads to global crude prices climbing an extra $1 per barrel (if today’s $50-per-barrel price is assumed to be the starting point). “This increase would not have a substantial effect on our findings: some additional oil fields would be profitable (containing an estimated 1 billion barrels), reducing the proportion of fields depending on subsidies from 47 percent to about 44 percent,” the paper noted.

So what does all this have to do with climate change? Ultimately, an additional 6 billion tonnes of CO 2 create a big problem for our prospects of limiting warming. Estimates from the Intergovernmental Panel on Climate Change (IPCC) suggest that as of 2016, the world can only emit about 840 billion tonnes of CO 2 over the next 84 years to have a two-thirds chance of limiting global warming to 2 degrees Celsius. The 6 billion tonnes of government-subsidized CO 2 emissions will constitute nearly one percent of that—an amount that’s hardly inconsequential when we’re faced with a world that can use all the emissions-reduction help it can get.

Nature Energy, 2017. DOI: 10.1038/s41560-017-0009-8 (About DOIs).