The producer benefits of implicit fossil fuel subsidies in the United States by Matthew J. Kotchen, April 6, 2021, PNAS, 118 (14) e2011969118
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There are real and substantial financial implications to fossil fuel producers of policies that seek to correct market failures brought about by climate change, adverse health effects from local pollution, and inefficient transportation. The producer benefits of the existing policy regime in the United States are estimated at $62 billion annually during normal economic conditions. This translates into large amounts for individual companies due to the relatively small number of fossil fuel producers. This paper provides company-specific estimates, and these numbers clarify why many in the fossil fuel industry oppose more efficient regulatory reform; they may also shape the way policymakers view the prospects for additional subsidies going forward.
This paper estimates the financial benefits accruing to fossil fuel producers (i.e., the producer incidence) that arise because of implicit fossil fuel subsidies in the United States. The analysis takes account of coal, natural gas, gasoline, and diesel, along with the implicit subsidies due to externalized environmental damages, public health effects, and transportation-related costs. The direct benefit to fossil fuel producers across all four fuels is estimated at $62 billion per year, a sum calculated due to the higher price that suppliers receive because of inefficient pricing compared to the counterfactual scenario where environmental and public health externalities are internalized. A significant portion of these benefits accrue to relatively few companies, and specific estimates are provided for companies with the largest production. The financial benefit because of unpriced costs borne by society is comparable to 18% of net income from continuing domestic operations for the median natural gas and oil producer in 2017–2018, and it exceeds net income for the majority of coal producers. The results clarify what the domestic fossil fuel industry has at stake financially when it comes to policies that seek to address climate change, adverse health effects from local pollution, and inefficient transportation.
Fossil fuels underlie much of the world’s economic activity, in addition to many of the greatest environmental and public health challenges. The sudden, unexpected, and significant fall in demand for energy brought about by the novel coronavirus has spurred policymakers to consider financial assistance to fossil fuel companies in order to mitigate damage to the industry. This comes at a time when there otherwise has been growing and more enduring concerns about fossil fuel subsidies around the world and a recognition of the benefits and challenges to phasing them out (1⇓⇓⇓–5). While the prospects and duration of any pandemic-induced bailouts remain uncertain, debates about fossil fuel subsidies and subsidy reform will continue—especially in light of their close connection to climate change, adverse health effects from local pollution, and transportation-related costs.
This paper’s findings inform debates about fossil fuel subsides along two dimensions. The first is a quantification of the financial benefits to fossil fuel producers of implicit subsidies already in place. Using data for the United States from 2010 to 2018, the estimates provide insight into the distributional consequences of implicit fossil fuel subsidies between producers and consumers during typical economic conditions. The analysis considers coal, natural gas, gasoline, and diesel, along with the implicit subsidies for each that arise because of the external costs borne by society due to environmental damages, public health effects, and traffic-related conditions.
The producer benefits of interest—i.e., the producer incidence (PI)—are based on the higher price that suppliers receive because of inefficient pricing compared to the counterfactual scenario where environmental and public health externalities are internalized. The direct financial benefit to fossil fuel producers of inefficient pricing across all four fuels is estimated at $62 billion per year on average, representing 11% of the total annual subsidy of $568 billion. The total subsidy is equivalent to an average of 3% of US Gross Domestic Product and equals the estimated value of the environmental, public health, and transportation-related externalities on an annual basis. To be clear, the focus here is not on direct subsidy payments that reduce the costs of fossil fuels, but rather on the implicit subsides that arise because of inefficient pricing that gives rise to social costs (1, 2, 6). While direct subsidy payments are common in many countries (7⇓–9), they are not in the United States.
The second set of findings are based on attribution of the subsidy benefits to specific fossil fuel companies. Because of high concentration in the supply of fossil fuels, the producer benefits accrue to a relatively small number of coal, gas, and oil companies. Many are found to benefit by hundreds of millions of dollars per year—with some exceeding one billion.
When compared to a company’s reported net income from continuing operations, the importance of these subsidies to company bottom lines becomes clear. The benefit exceeds net income for more than half of the coal companies over the most recent 2-y period, and in many cases by a wide margin. For natural gas and oil producers with the largest US production, the benefit constitutes a median of 18% of net income from domestic operations. The world’s largest, foreign oil producers are also found to benefit by hundreds of millions, or even billions, per year.
This paper also makes two methodological contributions to the literature on fossil fuel subsidies. First is a generalization and implementation of the standard International Monetary Fund (IMF) framework (1, 2, 6, 10) to separately estimate the PI and consumer incidence (CI). A key feature of existing studies—which focus on economic efficiency, environmental and health impacts, and government revenues—is the simplifying assumption of perfectly elastic supply (1, 6, 8⇓–10). This implicitly assumes away fundamental concerns about the extent to which the fossil fuel industry benefits from subsidies and may therefore seek to prevent reform. The approach taken here uses empirically based estimates of supply elasticities to examine distributional implications, with a focus on PI.
The second methodological contribution is rough estimates of cost pass-through rates along different stages of fossil fuel supply chains. The estimated ranges, combined with company-specific production data, enable a further partition of PI into the benefits accruing to a subset of individual fossil fuel companies. These estimates shed light on what fossil fuel companies have at stake with policies that seek to address climate change, protect public health through the control of local pollution, and promote more efficient transportation.
Along with greater recognition of explicit and implicit fossil fuel subsidies has come growing concern about their distributional consequences. Who benefits? Who bears the costs? And how might a better understanding of the distributional impacts affect the political economy and feasibility of proposed reforms? While existing studies have focused on distributional impacts of efficient pricing among households (22⇓⇓⇓⇓–27), questions about how distributional burdens are split between producers and consumers have gone unstudied. Indeed, as discussed previously, the existing literature on fossil fuel subsidies, which focuses primarily on environmental consequences and efficiency implications, sidesteps the issue completely by assuming perfectly elastic supply and therefore zero PI.
Estimates of the PI are nevertheless critical for understanding what the fossil fuel industry has at stake when it comes to the potential for subsidy reform. There are real and substantial financial implications to fossil fuel producers of policies that seek to correct market failures brought about by climate change, adverse health effects from local pollution, and inefficient transportation. The producer benefits of the existing policy regime in the United States are estimated at $62 billion annually during normal economic conditions. This translates into large amounts for individual companies due to the relatively small number of fossil fuel producers and high pass-through rates within fuel supply chains. These numbers clarify why many in the fossil fuel industry oppose more efficient regulatory reform; they may also shape the way policymakers view the prospects for additional subsidies going forward.