fossil fuel subsidies

Master Limited Partnerships (MLPs) are a special corporate form, used primarily by natural resource industries.  They enable firms to both raise capital on public equity markets and to pay zero corporate income taxes.  MLPs deserve far more scrutiny as energy subsidies than they have received to date.   Although the US Energy Information Administration (EIA) excluded them from their most recent study of US energy subsidies on the grounds that other industries also benefit (so the subsidies are not "energy-specific"), EIA's logic is weak.  Based on data compiled by the National Association of Publicly Traded Partnerships in August 2012, roughly 87% of the total market capitalization of the MLP sector was associated with fossil-fuel related activity.  That's pretty focused. 

And the dollars look to be large -- between $5 and $15 billion/year in revenue losses, funds that either increase our deficit or have to be made up through higher taxes on other taxpayers.  More precise review of data on specific MLPs would be needed to tighten this range.  But even at the low end, tax subsidies through MLPs alone generate higher subsidies to fossil fuels than everything else that EIA counted combined.   Let's just say that the government's subsidy figures are highly sensitive to which policies they ignore. 

With enormous pressure on Congress to identify ways to boost revenues and reduce economic distortions from the tax code, stripping the tax exemption of MLPs seems a great place to look.  Of course the industry will lobby heavily to protect their subsidy; it always does.  But elimination is still good public policy.  In fact, were the industry to argue that the world will end if MLP tax treatment changes, we can point out that Canada has already traveled this path.  In 2006, Canada eliminated preferential tax treatment for their energy investment trusts, a corporate structure modeled on, and analogous to, MLPs.  And the oil and gas industry did not disappear.

The remainder of this blog is extracted  from a more detailed review  I did on subsidies that the Romney presidential campaign forgot when it discussed energy subsidies.  

Escaping corporation taxation entirely:  Master Limited Partnerships

With all of the talk this campaign season about reducing income tax burdens on small business, it is easy to forget that an ever higher percentage of small businesses (and many larger ones) are adopting corporate forms that escape corporate income taxes entirely.  This includes sub-S corporations, partnerships, and limited liability corporations.  As a result, the share of national income paid from corporate income taxes has dropped from nearly 30% in the 1950s to less than 11% for the period 2000-2009.^[1]  But one group of enterprises - those raising capital on public equity markets - must generally still use corporate forms that pay corporate taxes.   

One glaring exception is publicly-traded partnerships (PTPs), also known as Master Limited Partnerships (MLPs).  Under special rules, this group of companies can both raise capital on public markets and bypass corporate income taxes entirely.  Tax liabilities (and enterprise-related subsidies) pass directly out to the partners' individual tax returns.  MLPs don't make up a huge chunk of listed firms on the stock market.  But within the tax favored MLP universe, oil and gas companies dominate, including a new one focused on fracking sand. 

One other sector able to use the MLP approach is also relevant to this debate:  private equity firms.  If Bain Capital (the firm that Mr. Romney founded) wanted to go public so partners could cash in their built-up equity, they would likely become an MLP.  Blackstone and KKR, two large private equity firms, have already done so. 

 Table:  Avoided taxes on oil and gas MLPs alone exceed totals subsidies DOE attributed to the sector

[1] Chuck Marr and Brian Highsmith, "Six Tests for Corporate Tax Reform," Center for Budget and Policy Priorities, 24 February 2012.
[2] National Association of Publicly Traded Partnerships, "Master Limited Partnerships 101: Understanding MLPs," August 2012.
[3] Low-end assumes a yield of 6.7%, the average of fossil-fuel-related MLPs based on MLPs listed on the Yield Hunter website with additional data from Google Finance.  High-end estimate is from Telis Demos and Tom Lauricella, "Yield-Starved Investors Snap Up Riskier MLPs," Wall Street Journal, 16 September 2012.
[4] U.S. Energy Information Administration, Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2010, 2011, p. x.

Part 2 of my review of energy subsidies and the Romney campaign is a bit long for a blog posting.  Thus, it has been uploaded as a PDF instead, and can be accessed here.  Issues covered include conflicts between the private equity world view and good national policy; how appropriate adjustments to Romney's subsidy baseline alter the conclusions he drew from the figures, and a discussion of missing subsidies in a number of key areas:  tax-exempt oil and gas master limited partnerships, inadequate fuel taxes to pay for highways, huge losses on federal resource sales, and the funding of energy security.

My first posting on Romney's energy subsidy policy focused on data errors in his tabulation of subsidies to green energy.

The "End Polluter Welfare Act (EPWA)," introduced by Sen. Bernie Sanders (I-Vt.) and Rep. Keith Ellison (D-Minn.) last week aims to strip away as many federal subsidies to fossil fuels as possible.  The bill reaches well beyond the short-list of most obvious subsidies that past reform efforts have targeted.  This elevated reach can be seen in the length of the subsidy list (four pages); in the estimated fiscal benefits of reform ($110 billion over ten years, roughly 2.5x the take of the narrower proposals, such as in President Obama's budget, or bills introduced by Sen. Robert Menendez (D-NJ)); and in the variety of groups supporting it (including the grass-roots powerhouse 350.org, run by Bill McKibben).  You can read the full text of the proposed legislation here.

Will Sanders and Ellison succeed where far more modest reform attempts quickly ran aground?  Perhaps not.  But that is hardly the only point of introducing something like this.  There is much to be gained simply by making a subsidy list that is far more comprehensive than the lists that have come before.

The bill takes the first step in undoing a big limitation of the prior, narrowly-cast legislative reform efforts.  Those initiatives focused only on a handful of the ways the feds have bolstered the fossil fuel industry for nearly 90 years.  As a result, they created the impression that the whole oil and gas subsidy trough wasn't really that large:  four billion or so per year and a handful of tax breaks -- end of story.  Such an impression was not accurate, of course.  But it has been quite useful to the lobby groups fighting to protect their fossil fuel pork.  With the number of targeted policies smaller, the lower fiscal savings from reform also led to more muted public outrage.  As a result, the lobbying job for industry to deter subsidy elimination was vastly simplified.

Enter EPWA.  By listing a much wider range of policies subsidizing oil, natural gas, and coal, the EPWA forces a more honest debate on the distortionary effects of federal policies on energy markets.  Though earlier reform efforts have primarily focused on stripping away tax breaks, the subsides to conventional fuels come in many guises.  There are below-market royalty rates, subsidies to fuel-related pollution controls, direct spending, caps on liability, and assorted subsidized credit for domestic power plants and exports of oil and gas-related goods and services.  There are subsidies to transporting bulk fuel, and to corporate structures particularly useful for natural resource extraction firms.  And there is subsidized oil security -- an area that despite it's large size was too political even for Sanders and Ellison to take on.  But other OECD countries with oil stockpiles to stave off supply disruptions (required of all member countries of the International Energy Agency) routinely recover the cost of these activities from oil markets rather than taxpayers.  The US should do the same.

Here are some of the subsidies I was particularly happy to see included in the EPW Act:

• Royalty relief.  Energy resources are a public endowment, and selling them for less than they are worth is foolish.  EPWA targets a number of these areas.  It increases the onshore royalty rate for production on public lands to equal the rate of offshore production.  It eliminates reduced royalties on all "special" types or locations of fossil extraction, recognizing that a variety of factors have changed:  market prices are higher, technical capabilities have improved, and high-cost "marginal" oil reserves ought to be viewed as competing not just against other oil, but against any other marginal energy resources.  The bill also includes language to claw back some value from a small "mistake" in the late 1990s that resulted in a huge amount of oil and gas from leases in the Gulf of Mexico being given away with no federal royalties at all.  Since the losses on this error are likely to exceed even Bernie Madoff's ponzi scheme, it would also be nice to see somebody prosecuted for this negligence.  I don't believe anybody has ever been called to task.

• Lease competitiveness.  Part of ensuring a proper return on mineral resources is making sure that leases are tendered competitively.  EPWA addresses this issue with respect to the Powder River Basin coal region, one of the most abundant coal deposits in the world.  Past problems with leasing in this area have been estimated to provide nearly $30 billion in subsidies to coal producers.
• Manufacturing deduction.  Special tax deductions are available for firms manufacturing products in the United States.  Including the endowment value of extracted minerals as though it is a "manufactured" value is problematic, as I've laid out here. 
• Subsidized pollution control.  One of the main benefits of many emerging clean energy resources is that they are, well, cleaner.  Because at present these newer technologies are often more expensive than coal or oil, it is critical that conventional energy resources not receive subsidies for investments in pollution controls.  The cost of compliance should be passed through to consumers.  EPWA takes on a number of ways we subsdize pollution control from the fossil fuel sector:  more rapid amortization of investments into pollution control equipment (heavily used by coal plants); the ability to expense costs associated with complying with EPA rules on sulfur pollution; deductions for environmental clean-up costs; and tax credits for CO2 sequestration.  The bill also requires that tar sands oil pay into the Oil Spill Liability Trust Fund just like other forms of oil transported across US territories, a simple and logical change given the growing levels of production, particularly imported from Canada.
• Bypass of corporate income taxes.  It turns out that multi-national fossil fuel firms have been extremely skilled at bypassing corporate income taxes.  Sanders and Ellison target the misuse of foreign tax credits where oil and gas companies characterize royalty payments (which are tax deductible) as foreign tax payments (on which they earn more valuable tax credits).  They also target the use of master limited partnerships by oil, gas, and coal companies to bypass corporate taxes entirely.  These structures, which are not available to clean energy firms, have been used disproportionately by the fossil fuel industry.  I reviewed treasury data on this issue (Table 6, page 42 in this report)  and found that for 2008, the sector comprised only 3.9% of total assets owned by pass-through entities (i.e., corporate structures for which all gains an losses pass through directly to partners), but 11.8% of net income.  These statistics include all sorts of corporate forms, such as LLCs that are used by a variety of sectors.  It is likely that the fossil fuel share of master limited partnerships alone would be much higher, and that the surge in fracking-related partnerships since 2008 would result in a higher oil and gas share as well.  Lest one believe killing these subsidies will bring ruin to the industry, it is useful to recognize that Energy Trusts, a similar structure used by Canadian firms, were eliminated due to the high revenue loss to the Canadian government.
• Transport infrastructure and transport. The United States is suddenly exporting large quantities of refined petroleum products.  Coal producers are itching to build huge new export terminals in the Pacific Northwest to move coal out to Asian markets.  These exports require massive infrastructure to move the bulk fuels to ports and load them on vessels.  Ramping up exports raises important environmental concerns about locking us in to many decades of higher carbon power once these facilities are built.  But these concerns are particularly acute where the port projects are not simply built because the returns are so high, but because the construction is subsidized by taxpayers.  Subsidies are quite common in port and pipeline projects.  EPWA would prohibit at least federal transportations funds for rail or port projects to transport and/or export fossil fuels.  It's a good start, but port subsidies also come through credit support as sub-national subsidies.  Those venues need to be targeted as well.

A simple Google search for "Jindal incentive," looking for descriptions of incentives the Louisiana Governor has put on the table for all sorts of groups, brings back 1.6 million hits.  There are so many subsidy announcements that it's hard to imagine even a McDonald's restroom can be built in the state without a subsidy, or that Jindal has time outside of his incentive announcements to actually run the state. 

Billions in gifts, but detailed data as well

But the volume of subsidies is only half the picture.  What I found so interesting about Louisiana that while it does seem to massively subsidize everything, its tracking of the support is quite good relative to what I've come across in other states.  The staff involved with these programs were forthright and responsive.  Queries were dealt with quickly and accurately, providing documents able to show in detail who was getting what from the state. 

This mixture is striking.  The state's biennial Tax Exemption Budget runs more than 400 pages, with details on each provision that lets this group or that out of paying into the state coffers.  Aggregate data for each tax base is presented (see page 6), showing both actual collections and how much the State estimates they've given away.  Corporate tax collections were $198m, for example -- compared with exemptions from corporate taxation of $1,459 million.  They calculate more than 88% of the tax base is exempt.  Thirty-six percent of the tax base for severance taxes (i.e., oil and gas) was exempted somehow.  And the total exemption is likely much higher:  one properly should not credit severance taxes (which are payments to the state for giving up valuable natural resources) if the proceeds are simply plowed back into support services for the same sector.

Without the level of transparency that Louisiana has on its subsidies, there would be no way to assess whether the policies make sense, or whether there are better ways to meet whatever job and development goals have been set forth as justifications for the giveaways.  But the magnitude of the subsidies, and their persistence over time, is a stark reminder that transparency alone is not sufficient for subsidy accountability and contestability. 

With so much documentation of the amount given away, Louisiana should do much more to assess the return it is getting on those "investments."  It's "hidden budget" is now as big as what the state is actually collecting in revenues.

Distribution of GO Zone Bonds is Skewed

There is another important lesson in Louisiana's data as well:  even "general" subsidies to job creation and investment tend to disproportionately favor the entrenched and powerful industries.  Louisiana's allocation for a special class of tax-exempt bonds, the Gulf Opportunity Zone Bonds (GO Zone), illustrates this. 

GO Zone Bonds were authorized by Congress in 2005 to help the states most hurt by Hurricane Katrina to rebuild.  Louisiana received the largest capacity of the Gulf states.  By the end of the program in December of 2011, it had used just about every bit of capacity (unused capacity by some accounts was less than 200 dollars) it had been granted.

Using data provided to us by the Louisiana State Bond Commission, we grouped recipients by industry.  Fossil fuel-related recipients included pipelines and fossil fuel storage, fossil-fueled power plants, extractive operations or firms supplying those operations, and chemical production reliant on fossil fuel feedstocks.  In some cases, a recipient project would related to other sectors as well as fossil fuels; these were included in a split category.  Some key findings from this exercise:

• Fossil fuel-related recipients received 57% of the $7.8 billion in bond capacity issued.  Once joint projects are included, this jumps to 65%.  This fossil fuel sub-group also had a higher success rate than other sectors, with 53% of the applications being allocated capacity (versus 32% for all applicants) and 76% of the allocated capacity ultimately being issued (versus 48% for all sectors).
• Two fossil fuel-related projects received the right to issue $1 billion in bonds each -- a Marathon Oil Corp. refinery and a Lake Charles Petroleum Coke Gasification Project.  Many other projects received tax exempt capacity in the hundreds of millions of dollars. 
• The program was highly popular, with applications for all projects three-times the level of available funding.  About half of the capacity that received an initial allocation under the program did not end up being able to issue bonds, however.
• Applications by plant-based biofuels firms were $1.5 billion, of which about $1.2 was allocated.  Yet, the sector ended up getting nothing (though a sugar facility and animal-fats biofuels project did receive GO Zone capacity).

The table below summarizes this key data.  A full listing of the applications, sorted by industry, can be found here.

Summary of GO Zone Applications and Issuance by Sector

With so much focus on the US federal budget deficit, it is easy to forget that the directed legislation, subsidies, and political bias plaguing our national government exist at the state and local levels as well.  While this certainly complicates the process of trying to figure out who is getting what, Pennsyvlania Fossil Fuel Subsidies: An Overview, written by Christine Simeone at PennFuture, highlights that greater transparency is possible everywhere.

The report documents some of the long-lived biases in state tax codes that favor fossil fuel production and consumption.  For example, though nearly all goods and services have to pay a sales tax, fuel purchases don't.  This is clearly a subsidy that encourages more consumption.  Industry sometimes argues that fuels already pay too much relative to other industries.  Too often, however, those comparisons overlook the fact that many of the fuel taxes are not for general revenue purposes, but rather to pay for fuel-related infrastructure (e.g., roads), problems (mine reclamation or fuel tank cleanups), or in some cases even resource rents on the fuel being extracted. 

PennFuture's findings on taxes are generally in line with multi-state work done in the early 1990s by Joe Loper, then with the Alliance to Save Energy.   Loper's analysis is still among the best work I've seen on state-level energy subsidies.  He estimated that reductions or exemptions for energy from state sales taxes alone was worth $18 billion (1992$) per year.  At the time, rate reductions were highest for the residential and industrial sectors, and for gasoline.

There is probably room for dialogue on how to treat various tax exemptions in the subsidy tallies.  For example, if a particular fuel charge is earmarked entirely for roads, I wouldn't view agricultural exemptions as a subsidy so long as the vehicles using the fuel are used only on private roads.  In contrast, agricultural exemptions from fuel charges linked to general revenues or amelioration of fuel-ralated problems such as tanks would be a subsidy.  Another interesting issue involves governments exempting themselves from fuel taxes or charges, something the PennFuture report calls attention to.  The issue of "self-charging" comes in many forms:  not paying rent for space in public buildings or for services provided by other government agencies; getting discounted power from municipal utilities (an issue in my town); or not paying fuel taxes on energy used during government business. 

While at first blush instituting full cost recovery seems like a complicated way simply to have government pay itself, that view misses the core value of price signals.  Because governments compete with others (including other parts of the government) for space, energy, or other resources, charging full price is a necessary part of proper cost accounting and decision-making for government managers and for the taxpayers who fund them.  Full prices ensure governments see the proper incentives to invest in demand-reduction options (be it smaller offices or more efficient appliances), and that they contribute their fair share of public spending on energy-related clean-up or infrastructure.  It's useful to remember that corporations routinely charge different parts of their organization full price on required inputs for quite similar reasons.

What is striking about Simeone's listing of subsidies (see table below) is not just that a single state could potentially have tax subsidies favoring the use of conventional fuels of close to $3 billion per year, but also that PennFuture didn't do much to identify and quantify the many other non-tax subsidy mechanisms that exist in the state.  Pennsyvlania, for example, allows the use of waste coal to qualify under its renewable portfolio standards (albeit at a lower tier, and called "alternative" instead of "renewable").  PA is also an old coal state, and studies of TN, WV, and KY have found subsidies to coal roads and mine cleanup were large and continuing sources of government support to the fossil fuel sector -- spending that in some situations actually resulted in net losses to the state on coal operations.  Looking in more depth at some of these additional forms of support would seem a useful task for subsequent work.