fossil fuel subsidies

Our article, Why Fossil Fuel Subsidies Matter, was published in the journal Nature yesterday.  The piece is part of what we hope is a continuing dialog on the importance of valuing and ultimately eliminating fossil fuel subsidies at a granular level; and of more systematically integrating data on fossil fuel subsidies into the modeling of energy systems, climate change, and industrial investment. 

The impetus for this piece was a 2018 study in Nature that used the results of integrated assessment models (IAMS) to infer that eliminating subsidies would yield “limited emission reductions…except in energy-exporting regions”, and described the emission reduction benefits as “small”.

Analysis of the early post-tax reform data from large public companies suggests that many profitable firms are paying no federal income taxes, and often getting refunds.  Firms involved with fossil fuels have been big winners.  An April paper by the Institute on Taxation and Economic Policy in Washington, DC reviewed data on Fortune 500 firms.  They found 60 that paid zero federal corporate income taxes despite having significant pretax income.  Indeed:

The report finds that in 2018, 60 of America’s biggest corporations zeroed out their federal income taxes on $79 billion in U.S. pretax income. Instead of paying $16.4 billion in taxes at the 21 percent statutory corporate tax rate, these companies enjoyed a net corporate tax rebate of $4.3 billion.

Goals versus political reality of tax reform

Good tax reform isn't supposed to do this.  In return for cutting tax rates on everybody to spur economic activity, properly-structured reforms are supposed to eliminate tax subsidies to everybody at the same time.  Lower rates, broader base.  Reforms should yield a lower tax burden on all economic activity while simultaneously removing politically-driven disparities between different sectors of the economy.  People keep more of what they make, market pricing signals are cleaner, and revenue impacts are reduced.

Or so goes the theory.  This ideal policy outcome for society as a whole is very different from what "winning" tax reform looks like at the firm level.  Industry lobbyists want to see rates cut on everybody, but cut even more for their sector.  And they would like for everybody else to lose their tax subsidies while somehow keeping their own. 

This type of political outcome flows only to the powerful.  In the massive Tax Reform Act of 1986, many tax subsidies were cut -- though most of those to oil and gas remained.  And despite lots of new windmills and solar cells popping up around the country, the fossil fuel industry remains powerful.

As the tax reform package was nearing a vote at the end of 2017, I noted this concern in my review:

A combination of key subsidies to fossil energy remaining untouched while core subsidies to renewables are repealed, along with significant use of tax‐favored corporate structures by oil and gas both suggest that were the current proposals to become law, they would materially benefit fossil fuel industries relative to other energy market participants.

Unfortunately, this seems to be how things are playing out.  The Tax Cuts and Jobs Act (TCJA) did greatly cut corporate rates across the board (from 35% to 21%).  But it also cut the overall tax burden (corporate plus personal) on Master Limited Partnerships used mostly by oil and gas firms even more.  For example, a special amendment by Senator Cornyn of Texas ensured that an ability to deduct 20% of income was not limited by the wage payments made by the partnership, a constraint applicable to most other partnerships under TCJA.1  

Capital equipment expensing was also broadly implemented, with the majority of the gains flowing to capital-intensive industries with long-lived capital assets, such as fossil fuels.  And those deductions can be taken on used assets too, not just new.  Here's the Oil & Gas Journal:2

Importantly, the Act allows the 100% deduction for capital expenditures used to acquire pre-existing (that is, used) property from unrelated persons. In the current oil and gas environment, where companies are shedding non-core assets, the 100% bonus depreciation regime provides an extra incentive for buyers of such assets to close deals in the next 5 years.

The Oil & Gas Journal review reported on modeling by long-time industry consultant Wood Mackenzie.  Wood Mack looked at how the TCJA affected asset values within the exploration and production sector of US oil and gas markets.  They indicated a post-tax increase of more than $190 billion.

ITEP:  More than one-third of profitable firms in their review that paid no federal taxes in 2018 were oil and gas or utilities

ITEP periodically analyzes the effective tax rates of publicly traded companies.  Earlier this month, their analysts looked at Fortune 500 companies post tax reform and found that 60 of the profitable firms were paying zero in federal income tax.3   I sorted their data by industry to focus in on the sub-groups most directly linked to fossil fuels:  oil, gas & pipelines; and gas & electric utilities.  Twenty-two of the 60 firms paying no taxes were in these two sectors.  As shown below, they comprised 47% of the group's total pre-tax income and 41% of the net federal tax refunds.

ITEP notes that renewable production tax credits were one of the causes of low tax rates for the utility firms.  To assess the import of this factor, I included data on renewable PTCs claimed, as reported by ITEP; and assessed the share of tax underage from the new statutory rates that the renewable PTCs comprised. 

In a few cases, the benefits were significant:  renewable PTCs dominated the underage for one utility and were material in a second.  However, for most of the utilities (and all of the oil, gas and pipelines segment), other factors drove the results.  The utilities include renewable and nuclear infrastructure, but continue to be dominated by natural gas and coal in most cases. 

Table 1:  Many profitable firms in oil, gas, and utility sectors paying no federal tax under TCJA

Source:  ITEP (2019)

• 1James Chenoweth and David Sinak (2017). "Houston, We have New Tax Rates – Guiding Oil and Gas Companies Through Tax Reform," Gibson, Dunn & Crutcher, 21 December (accessed 4/23/2019).
• 2Conglin Zu, "US upstream and tax reform," Oil & Gas Journal, 2/26/2018.
• 3Matthew Garder, Steve Wamhoff, Mary Martellotta and Lorena Roque (2019). "Corporate Tax Avoidance Remains Rampant Under New Tax Law: 60 Profitable Fortune 500 Companies Avoided All Federal Income Taxes in 2018," (Washington, DC: ITEP), April.

PJM Interconnection LLC (PJM) has been worried that certain state subsidies harm the competitiveness of capacity auctions within its territory.  PJM serves as the grid operator for all or parts of Delaware, Indiana, Illinois, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.  Its service area spans nearly a quarter million square miles, and a population of 65 million -- roughly 20% of the country.  

In an April 9, 2018 filing submitted to the Federal Energy Regulatory Commission (FERC), PJM proposed two mutually exclusive options to protect capacity auctions from the impacts of these subsidies.1 Capacity repricing would increase the market clearing capacity price paid to all bidders that clear by adjusting bids to account for subsidies received by certain generators, though would not alter which specific bidders cleared. A second option, MOPR-Ex would adjust the bid price for subsidized resources prior to evaluating their competitiveness, changing the mix of facilities that would clear the capacity auction.  In part because of the scale of PJM's service area, and in part because of the precedential nature of the case, FERC's decision on this matter can be expected to have national implications on the relative competitiveness of different energy resources and the direction of future investment.

"Fixing" subsidies requires systematic capture of all mechanisms of support

Earth Track analyzed the details of the filing to evaluate potential gaps in how subsidies were defined and whether those gaps might have unequal impacts on different fuel cycles.  The review incorporated updated information on state-level supports to fossil fuels compiled by the OECD; state and local subsidies to local industry compiled by Good Jobs First, a DC-based organization; and other resources. 

Earth Track's summary report to Sierra Club can be accessed here.  The full comments by Sierra Club and others2 can be accessed here.  The full comments to FERC include not only the Earth Track report, but some interesting analysis on how generators might game the new capacity bidding structures in a manner that drives up costs and reduces pricing transparency. 

PJM’s proposal describes the types of subsidies that would be “actionable” under its proposals, including policy types, materiality, and exclusions. Their description of which subsidies are actionable initially seems broad enough to capture most types of potential subsidy. However, exclusions added just a few paragraphs later winnow down coverage in ways that are likely both material and unequal in how they affect different fuel cycles.

These exclusions will likely impede PJM’s core objective of ensuring competitive, nondiscriminatory auctions in the wholesale capacity market. Because subsidies flow to all forms of generation, and nearly every upstream and downstream stage of each power-related fuel cycle as well, a comprehensive review process is needed if PJM is to address these subsidies in a neutral way.  Key findings of our analysis include:

• Blanket exclusion of federal and many state and local subsidies will reduce the accuracy of subsidy screening significantly. PJM excludes all federal subsidies, and any state or local support that is in place for regional economic development or to convince a plant to locate (or stay) in a particular region. Federal subsidies can be both large and highly targeted to an industrial facility. State and local subsidies excluded on the basis of their stated purpose can also be very large. They may represent multiple state programs, originating from more than one agency – some of which may be excluded and others not based on the PJM proposal. In all of these areas, it is the scale of support rather than the justification for granting it that will drive capacity market distortions.
   
• Revenue-based metrics for actionable subsidies need to be broadened to incorporate cost- and risk-reducing subsidies. Subsidies operate using three main levers: boosting revenues, reducing costs, and reducing the volatility of expected return by absorbing or capping credit, liability, or other business risks. The PJM proposal, as currently worded, focuses only on revenues and as a result will not treat different power sources equally. If a policy of mitigating subsidies is to be pursued, then the materiality test should shift from 1% of revenues to “a subsidy equal in magnitude to one percent of revenues” to incorporate the broad array of subsidy mechanisms.
   
• Purchase mandates are one technique of many that governments use to transfer value to the energy sector; subsidy screening needs to incorporate all of them. Not every form of electrical power has the same cost structure. Some are capital-intensive, rolling out new technologies, or face long or uncertain build times. Others require complex fuel supply chains, have risks of severe accidents, or significant and complex post-closure concerns. Still others have variability in their ability to produce electricity. As a result of these differences, the importance of particular types of subsidy support varies significantly across fuels, and rules that by definition or effect limit review to a small subset of subsidy approaches will materially disadvantage some energy resources over others.
   
• PJM’s current focus almost entirely on purchase mandates will understate the level of subsidies to other forms of energy. In addition, where interventions are focused on internalizing environmental or health externalities that are not being addressed in other ways, PJM needs to evaluate the impact on efficiency using more than just generator costs of operation.
   
• Large subsidies to upstream or downstream fuel cycle steps need to be addressed to determine when a subsidy should be actionable. These types of supports are most relevant regarding subsidies to coal and natural gas extraction and transport; coal mine land reclamation; large state support to ancillary infrastructure to move or process fuels; or state subsidy for high risk, long-term parts of the nuclear fuel cycle.
   
• Subsidy combinations matter. If there are multiple subsidies flowing to the same beneficiaries that in total exceed PJM’s action threshold of support equal to 1% of revenues, these should be reviewed as a group for action even if individually they don’t hit 1%. Subsidy “stacking” is common across the world, and it is the joint effect of multiple subsidies that will drive the distortions in market behavior.
   
• Test case illustrates the importance of a more systematic inclusion of subsidies as potentially subject to PJM action. A test case relating to tax exemptions for coal in the state of Pennsylvania indicates that more subsidies than just purchase mandates would exceed the PJM’s proposed revenue threshold. Additional analysis would likely illustrate a similar situation in multiple other parts of PJM, though this one example is useful in illustrating why a narrow focus on purchase mandates will be insufficient in addressing potential distortions.

• 1[1] PJM, Capacity Repricing or in the Alternative MOPR-Ex Proposal: Tariff Revisions to Address Impacts of State Public Policies on the PJM Capacity Market,” filing before the Federal Energy Regulatory Commission, April 9, 2018, pp. 1,2 citing ISO New England, Inc., 162 FERC ¶ 61,205 at P21 (2018) (“CASPR Order”).
• 2The filing was submitted by the Sustainable FERC Project, Sierra Club, Natural Resources Defense Council, and Environmental Defense Fund

The optimal position for your industry in any tax reform is to see general tax rates drop while also keeping all of your old subsidies.  The political lobbying on these bills is enormous, and given the scale of the energy sector in the US economy, and the need to transition towards lower carbon fuel sources, it seemed important to look at the tax reform proposals through the lens of energy.

When the Joint Committee on Taxation assesses the cost to Treasury from the proposal, they are focused on the new rules or repealed line items a particular bill may put forward.  But the economic impacts of a new tax regime is affected by three major threads:  whether general changes in tax rules disproportionately affect some energy resources relative to others; energy-specific line items being repealed, changed, or added; and whether political power among particular industry-subsectors has enabled them to have their cake and eat it too by keeping their old subsidies while also getting lower top tax rates.

This working paper is a first cut at doing this.  I've no illusions I've captured everything, or mapped out all of the interactions.  But even the first order effort to combine these three main threads is important in gauging winners and losers under the proposals.  This is a discussion draft, so email your comments, concerns or corrections if you've got them. 

To better see patterns, the tax line items have been grouped into three general energy categories:  conventional energy (mainly fossil); emerging resources; and mixed (which includes the grid and transport policy).  Both new and (apparently) surviving tax expenditures are included.

There's a great deal of detail in the full summary, but my key takeaways are below:

PJM Interconnection is a regional transmission operator (RTO) serving more than 60 million customers in 13 states and the District of Columbia.  The service region is centered in the mid-Atlantic region of the United States. Incumbent base load generators within PJM have complained that subsidies to renewable resources have been cutting their ability to win capacity market auctions, stripping them of revenue, and harming them competitively. They have been proposing adjustment factors that would improve their competitive position by adjusting bid prices to exclude the subsidy.

These proposals have been contentious, and PJM established the Capacity Construct/Senior Policy Task Force to work through them. From my perspective, two features of conventional generators are problematic for their case. The first is that while renewables play a growing role in energy markets, they are still quite small in capacity markets. Competitive pressures, such as from new gas plants, have been much more significant.

The second is that government subsidies to energy -- at all levels of government -- have been around for a very long time.  Indeed, many of these very same conventional energy resources have also received significant subsidies for their entire operating lives. For some, subsidies helped them to reduce plant construction costs. Others have reduced their cost of input fuels, a significant cost factor in fossil plants. Still others have shifted the long-term costs of fuel extraction or refining, accident risks, or managing toxic wastes from the power plant to taxpayers or plant neighbors.  Risk shifting is particularly important with regards to coal and nuclear.

To demonstrate the complexity of the situation, working with the Natural Resources Defense Council, I assembled an initial listing of state-level subsidies to conventional energy within PJM states. Data compiled by the OECD in Paris, and by Good Jobs First, an NGO, were extremely helpful inputs.

Although the timeline was short and it was impossible to capture everything, the listing is nonetheless long. The figures are sometimes quite big as well.  The unfunded cost to remediate abandoned coal mine sites within PJM states, for example, exceeds $8 billion and the region comprises nearly 80% of the national total.

The list is available here or on the PJM website (file in Excel).  If you know of big ones we are missing, please email me.

For more on the general issues before PJM, Jennifer Chen of NRDC has a blog post and statement before FERC that summarizes it well.  A recent paper by Amory Lovins at the Rocky Mountain Institute challenges some of the claims by coal and nuclear plants that they deserve special subsidies because of their provision of baseload dispatchable power. 

The PJM task force has proposed a structure to identify relevant subsidies to power markets in the region.  Since the most important subsidies to particular forms of energy can vary tremendously, unless one captures all categories the results can be highly skewed.  Part of the work for NRDC was to evaluate potential areas where PJM might miss important policies.  The results were summarized in the table below.

1) Earth Track congressional testimony.  Read Earth Track's testimony to the Subcommittee on Energy of the Committee on Energy and Commerce, U.S. House of Representatives: Federal Energy-Related Tax Policy and its Effects on Markets, Prices, and Consumers. 

2) New work on subsidies:  US public lands, European coal, Asian fossil fuels. 

• A review of subsidies to fossil fuel extraction on public lands released by Oil Change International.
• Coal subsidies in ten European countries released by the Overseas Development Institute.
• IEA's review of subsidies within APEC:  Tracking fossil fuel subsidies in APEC economies: toward a sustained subsidy reform

3)  Exelon fails to clear latest capacity auction with two of its reactors.  Exelon's Three Island Mile and Quad Cities nuclear facilities failed to clear the latest PJM auction.  Trade publication Utility Dive noted that Exelon said the loss "stemmed from 'the lack of federal or Pennsylvania energy policies that value zero-emissions nuclear energy,' and, in the case of Quad Cities, not falling under Illinois ZECs program." 

Reliability is the main selling point of baseload nukes facing increasing operating and maintenance costs.  Thus, it is notable that while nuclear blames renewables for its heartache, non-hydro renewables comprise a tiny portion of the PJM capacity market. 

A cynical view of the politics of nuclear power leads one to at least consider that perhaps Exelon is playing a bigger game.  The only way for the firm to extract multi-billion dollar subsidies to keep its aging fleet open is to present as realistic a case of distress as they possibly can.  Strategic losses in capacity auctions could be part of this.  Indeed, the firm's management may well decide that its highest return "new" line of business is extracting subsidies from taxpayers to prop up their old plants.  Here's Crain's, which has long tracked the political strategy of Exelon:

Fresh from winning subsidies in New York and Illinois, Exelon wants ratepayers in other states to pony up more to keep nuclear plants open... In an email, Exelon says only that it "continually evaluates strategic opportunities to add value for our shareholders and customers." Speaking generally of its desire to subsidize nuclear power beyond Illinois and New York, Exelon says, "Right now, active discussions on the economic and environmental advantages of nuclear power are occurring in Connecticut, Ohio, New Jersey and Pennsylvania."

And their strategy seems to be working.  According to Crain's:  "Exelon's stock has risen 36 percent since the Dec. 1 agreement in Illinois, well above the 20 percent increase for the Standard & Poor's 500 Utilities Index."  UPENN's Kleinman Center for Energy Policy noted in a recent blog post that it is quite difficult to ensure the subsidies flowing to old nuclear reactors (which are often part of a complicated corporate network) are actually needed rather than simply juicing corporate returns. 

4)  Sounds of silence: G7 and fossil fuel subsidy reform.  The G7's 2016 pledge to end harmful subsidies to fossil fuels by 2025 was not re-affirmed in their most recent meeting in Italy.  While it was agreed to in April, the issue was not included in the formal ministerial communique in May, an omission bleakly noted by fuel subsidy research NGO, Oil Change International.  These things aren't particularly binding, so the inability even to make clear statements of direction is troubling.

5)  The persistent areas of overlap between civilian and military nukes.  A sobering review of Japan's plutonium stockpile, its civilian origin, and the weapons proliferation risks going forward.

6)  Westinghouse bankruptcy: about that $8.3 billion they owe Uncle Sam...  Turns out the last sliver of the "nuclear renaissance" in the US is at risk due to poor management, fiscal distress, and the bankruptcy of one of the key vendors, Westinghouse.  Gee, if only somebody could have seen something like this coming.  In one of the finest moments of pretend finance in recent years, DOE flagged the risk of these massive loans (roughly sixteen Solyndra's) at zero. 

The bankruptcy affects nuclear projects in both SC and GA, though only the GA project (Plant Vogtle) is receiving federal subsidized loans.  The big question is how much of the DOE loans will end up in the lap of taxpayers.  As of now, Vogtle hobbles on, with Southern Company -- the largest investor in the project -- taking over the lead from Westinghouse.  Whether or not the Vogtle reactors are completed, there are billions in costs to be covered by some combination of customers, taxpayers, and utilities.  Here's the Atlanta Journal-Constitution's summary:

The Plant Vogtle project was backed by $8.3 billion in loan guarantees from the U.S. Department of Energy – during the Obama administration...[T]he Congressional Research Service noted that those loan guarantees came with this price: “If the Vogtle project is terminated, the borrowers must repay the entire outstanding loan amount in five years.”

But the CRS also said that the secretary of energy has the power “to modify the loan agreement terms and take other steps upon a default.”

This battle will not be resolved soon.  Good thing Southern Company CEO Thomas Fanning sold most of his shares in the company back on 2014.

Update, June 3rd:  a key deadline in the continued financing of Vogtle has been missed, and analysts predict litigation.