America's Most Obvious Tax Reform Idea: Kill the Oil and Gas Subsidies

In a world where $100-a-barrel oil is here to stay, there's no need to pad the industry's bottom line.
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(Reuters)

When Saudi Arabia's longtime oil minister, Ali Al-Naimi, opens his mouth, the world listens. Yesterday, during a speech in Hong Kong, he delivered a message that U.S. policy makers in particular would do well to take note of. The days of $100-a-barrel crude, he told the crowd, are here "for the foreseeable future."

If he's right, one thing that shouldn't be around for the foreseeable future are the outdated tax credits that protect oil and gas companies, which will be plenty profitable in a world of $100-a-barrel oil. If Democrats and Republicans are looking for safe ground to set up camp for the budget negotiations, let's start with these $7 billion-a-year subsidies. 

Why Big Oil Doesn't Need Uncle Sam's Help
The oil industry's lobbyists like to argue that its array of tax write-offs (which allow companies to deduct everything from drilling costs to the declining value of their wells) aren't any different than other deductions for less publicly reviled companies. Cutting them will discourage new exploration and put jobs at risk, they claim.

Yet, some of the breaks are anachronisms that date back almost to the days of John D. Rockefeller. And in a world of permanently high crude prices, there's very little rationale for subsidizing the bottom lines of companies like ExxonMobil and BP.   

Make no mistake, either: Those profits are perfectly healthy. Between drilling and refining, Exxon's U.S. operations alone earned $7.5 billion after taxes in 2012. California-based Occidental Petroleum Corporation, one of the so-called "independent" oil companies and the top oil driller in Texas, raked in $7.1 billion via its oil and gas division. 

There are plenty of reasons, far beyond the word of a single middle-eastern oil man, to expect that those profits will stay high. Oil prices have continued to hover around the $100 mark in part because of instability in the Middle East, but also because, even in our sluggish global economy, demand is still relatively tight. As things improve, demand -- and prices -- will only increase. So if you think China's best days are still ahead of it, and that Europe will eventually pull out of its funk, you should expect prices to keep floating skyward. The Energy Information Administration, for one, believes the cost of a barrel will most likely increase to around $162 by 2040 (as shown on the blue line below). 

EIA_Oil_Price_Predictions.JPG


The oil-filled shale formations in states like North Dakota and Texas that have powered the U.S. energy boom are notoriously expensive to drill. But if predictions like the EIA's come even close to true, then they should remain profitable plays for the industry for years to come. One might argue that without subsidies, they won't be quite profitable enough -- that by nixing the tax breaks that support domestic drilling and refining, we might encourage companies to put their money to do something else with their money. But as Harvard's Joseph Aldy has noted, independent analysts forecast that cutting the subsidy cord would have at most a minimal effect on U.S. drilling activity, possibly reducing it by as little as 26,000 barrels-a-day. Since 2009, he notes, production has been growing each month by 30,000 barrels a day.* 

If there's money to be made sucking oil out of the ground, in the end, somebody is likely to do it. 

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Jordan Weissmann is a senior associate editor at The Atlantic.

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