Obama's Energy Tax Proposals: Wind vs. Oil and Gas

“Governor Romney may have figured out that you can’t drive a car with a windmill on it, but he doesn’t seem to know that America now has enough wind turbines installed to generate enough electricity from wind to power nearly 13 million homes with clean energy.”

…

“I want to stop giving $4 billion in taxpayer subsidies each year to big oil companies that are making huge profits and have been subsidized for a hundred years, and let’s keep on investing in the new homegrown energy that’s creating jobs right here in Iowa.” President Obama, Des Moines Register, August 14, 2012[i]

There are a number of problems in President Obama’s statements made recently on the campaign trail in Iowa regarding his Administration’s push for renewable energy and extending the production tax credit for wind power. First, wind power cannot provide enough electricity to “power nearly 13 million homes with clean energy.” The reason is that wind does not blow all the time, so it must have back-up power, typically coal-fired or natural gas-fired power plants that can provide power when demanded. That means that we are essentially paying twice for new generating capacity, i.e. the wind turbines that generate the wind power and the natural gas- or coal-fired power that provides the back-up electricity when the wind isn’t blowing. Further, wind power is the greatest when we least need it–at night and during the very early morning when we least demand electricity.

The “$4 billion in taxpayer subsidies each year to big oil companies” message is also in error since the $4 billion are tax deductions that are mainly targeted to the small independent oil and natural gas producers, rather than the major integrated oil companies usually described as “big oil.”. One of the tax deductions is provided to all U.S. manufacturing firms, not just oil and gas producers, while the others are for typical business deductions in the tax code. Removing these tax deductions will result in the big oil companies taking capital abroad to make their investments and the small independent companies going out of business, reducing U.S. oil production and tax revenues and getting less production from this form of our own “home grown energy”.  Given that oil and gas production-related employment on non-federal lands in the United States is one of the few bright spots in the worst economic recovery since the Great Depression; such a result would simply undermine job creation.

Let’s take a better look at wind energy and what it is providing us and what the $4 billion in oil and gas industry tax deductions are providing us.

Wind Energy

Wind power is not a new technology. It has been around for centuries. But only recently has there been a push to develop it widely. The United States attempted to develop a wind industry in the 1970s beginning in California (e.g. in the Altamont Pass and in other areas), only to later see its stagnation. But now, the wind industry believes that its wind turbines are better constructed, more efficient, and less costly. And, the wind industry incentives are much greater as well.

The laws of about half of our states require a certain percentage of electricity to come from qualified renewable energy sources (generally wind and solar technologies) and federal laws give large subsidies to the industry. In fact, according to the Energy Information Administration (EIA), federal subsidies for wind energy increased 10-fold between fiscal year 2007 and fiscal year 2010—a three year period. Between 2007 and 2010, wind generation increased 175 percent, increasing from a 0.8 percent share of generation in 2007 to 2.3 percent in 2010. But to get there, the government had to spend  $5 billion in subsidies in fiscal year 2010 alone. For every megawatt hour of wind energy generated, the taxpayer paid $56, compared to 64 cents for coal-fired and natural gas-fired generation. According to EIA, 97 percent of the $5 billion in subsidies to the wind industry in fiscal year 2010 was due to the stimulus (the American Recovery and Reinvestment Act of 2009).

Wind energy is not without its problems. It generates electricity only when the wind is blowing, regardless of whether electricity demand is high or low. This means that wind does not have capacity value because it cannot be dispatched on an as-needed basis as coal and natural gas-fired technologies can. Thus, wind gets preferential treatment when it is available so that state mandates can be met and the industry can receive its production tax credit.

The production tax credit provides a tax credit of 2.2 cents per each kilowatt hour of wind energy produced over the next 10 years for wind units put in service before the end of the year. According to the Joint Committee on Taxation, the wind industry has received over $1 billion a year from the production tax credit. Arguments against extending the production tax credit are found here.

Through 2011, the wind industry had the option of a 30 percent investment tax credit that could be received as up-front cash grants. Most of these grants, however, have supported foreign industries rather than U.S. industries. Of the most recent $1 billion in wind energy grants provided by the government, 85 percent or $849 million supported foreign wind turbine companies, such as Germany’s Siemens, Spain’s Gamesa, India’s Suzlon and Denmark’s Vestas. Spanish utility company Iberdrola S.A. collected $545 million in recent years.[ii]

In 2008, Presidential Candidate Obama promised to create 5 million green energy jobs over 10 years by investing in solar, wind and other renewable energy sources. Yet by 2010, according to the White House, only 225,000 green jobs had resulted from the stimulus program although his 2009 economic-stimulus plan spent a record $90 billion on clean energy.[iii] President Obama is touting that the wind industry is supporting 75,000 jobs (direct and indirect), but that 37,000 jobs in the wind industry will be lost if the production tax credit is not extended. That contrasts with a study by energy consultant Wood MacKenzie that found that new U.S. oil and gas production could create an additional one million U.S. jobs by 2018 if the right policies were put into place.

The Obama administration is pushing the installation of wind and solar units on federal lands. As part of President Obama’s “We Can’t Wait” initiative, two large wind farms with a combined capacity of over 3.4 gigawatts are being fast tracked on federal lands. The Mohave wind energy project in Arizona, a 425 megawatt project, will have federal permit and review decisions completed by January 2013. The second project, the largest proposed wind farm in North America, is the Chokecherry and Sierra Madre project, in Carbon County, Wyoming. This 3-gigawatt wind project is expected to get final permitting decisions by October 2014, beginning with a land-use plan decision in October 2012, followed by review of right- of-way applications in 2014.[iv]

Besides cost and reliability, other wind problems include noise pollution, the need for large amounts of land, and the destruction of bats and birds that come within the path of the turbine blades. Additionally, most favorable wind production areas are remotely located far from consumers, and therefore require expensive and inefficient energy transmission systems to be built (and paid for by consumers). Wind production, like the production of all types of energy, has both positives and negatives.

Oil and Gas Industry Tax Deductions

Obama’s plan would slash two tax deductions that are primarily for small, independent producers, companies with less than 20 employees. These incentives exist to encourage small companies to produce oil from marginal wells that become somewhat profitable with the tax breaks, but are uneconomic without them. These marginal wells are old or small wells that do not produce much oil individually, but in total produce a great deal of oil. According to the Independent Petroleum Association of America, independents produce 68 percent of our domestic oil and 82 percent of our domestic natural gas.

The two tax deductions that primarily affect the small independent producers are the percentage depletion allowance and expensing of intangible drilling costs. As the oil and gas in a well is depleted, independent producers are allowed a percentage depletion allowance to be deducted from their taxes.  While the percentage depletion allowance sounds complicated, it is similar to the treatment given other businesses for depreciation of an asset.  The tax code essentially treats the value of a well as it does the value of a newly constructed factory, allowing a percentage of the value to be depreciated each year. This allowance was first instituted in 1926 to compensate for the decreasing value of the resource, and was eliminated for major oil companies in 1975. It saves the independent oil and gas producers about $1 billion in taxes per year.

Independent producers are also allowed to count certain costs associated with the drilling and development of wells as business expenses. The law allows the small producers to expense the full value of these costs, known as intangible drilling costs, every year to encourage them to explore for new oil. The major companies get a portion of this deduction—they can expense a third of intangible drilling costs, but they must spread the deductions across a five-year period.[v]  This tax treatment is also similar to that of other businesses for such investments as research and development.

President Obama would also like to do away with the Domestic Manufacturing tax deduction, whose purpose is to get companies to continue to do business in America. The United States now has the highest tax rate in the world among developed countries, and due to those high tax rates, companies have been making investments overseas.  The Domestic Manufacturing tax deduction allows all industries and businesses (not just oil companies) to deduct a certain percentage of their profits—for the oil and gas industry, it is 6 percent, for all other industries (software developers, video game developers, the motion picture industry, among others), it is a 9 percent deduction. It saves the oil and gas industry (mostly independent producers) about $1.7 billion in taxes per year.[vi]

Repealing these tax deductions would result in less domestic production, more imports of oil and refined products and less tax revenues from oil and gas production as well as fuel and petrochemical production.  A study by Wood McKenzie[vii] estimates the loss to be 0.7 million barrels per day of domestic oil production by 2020, with an additional 1.7 million barrels per day at increased risk due to unprofitable project economics. Ending the tax deductions that support the small independent producers would make many wells unprofitable, decreasing production here and increasing imports. Importing an incremental 0.7 million barrels per day would increase our trade deficit by over $60 million per day or $22 billion per year. Thus, the nation is reducing taxes by $4 billion in order to produce $22 billion in economic activity.  Government revenue losses are estimated at $6 billion in 2020 with an additional $8 billion put at increased risk, and an estimated $10 billion in 2025 with additional $8 billion put at increased risk.[viii]

Politicians—and President Obama is no exception—like to complain about the earnings of the oil and gas companies. However, the oil and natural gas industry must make large investments in new technology, new production, and environment and product quality improvements to meet future U.S. energy needs. These investments are not only in the oil and gas sector but in alternate forms of energy (e.g. biofuels) as well. For example, an Ernst & Young study shows the five major oil companies had $765 billion of new investment between 1992 and 2006, compared to net income of $662 billion during the same period. The 57 largest U.S. oil and natural gas companies had new investments of $1.25 trillion over the same period, compared to net income of $900 billion and cash flows of $1.77 trillion. In a more recent Ernst and Young report, the 50 largest oil and gas companies spent over $106 billion in exploration and development costs in 2011, an increase of 38 percent over those capital investments in 2010. Without these investments, the U.S. oil and industry would not be able to make the strides in increased oil and gas production that they have made recently in this country.[ix]  The earnings allow companies to reinvest in facilities, infrastructure and new technologies, and if those investments are in the United States, it means many more jobs, directly and indirectly.

Conclusion

The Obama Administration is pushing for an extension of the production tax credit for wind and the repeal of tax deductions for the oil and gas industry. But the advantages and disadvantages of these incentives vary greatly in terms of benefits—revenues to the government, employment, and energy contribution.  But the scariest comparison is the dependability of the energy produced. For example, Britain is a world leader in wind generation installations, but its program continues to falter. When temperatures plunged to below freezing this past winter and electric power demand soared, electricity production at Britain’s 3,100 wind turbines fell from an average of 8.6 percent of Britain’s electricity mix to 1.8 percent. Jeremy Nicholson, director of the U.K. Energy Intensive Users Group, said, “We can cope at the moment because there is still not that much power generated by wind. What happens when we are dependent on wind turbines for more of our power, and there is suddenly a period when the wind does not blow and there is high demand?”[x]

That is a question that President Obama and other supporters of more subsidies for intermittent power sources need to answer, too.