Friday 28 October 2011

Oil Subsidies 101! by By Barryonenergy

It has been said that the “oil industry is the most heavily subsidized industry in the U.S. This is a rather grandiose statement, which sounds good but requires some validation. So in an attempt to dill down on the subject, no pun intended, this discussion takes a brief look at the tax codes in hopes of shedding some light on this claim.
To develop a common understanding of subsidies, a good rational is given by Gary Becker (University Professor Department of Economics and Sociology and Professor Graduate School of Business, The University of Chicago) and Richard Posner (Judge, United States Seventh Circuit Court of Appeals and Senior Lecturer, University of Chicago Law School). They state “a subsidy is defensible on economic grounds if it encourages the production of benefits that would be under-produced from an overall social-welfare standpoint were it not for subsidy.
For example, they indicate “That is the argument for allowing expenditures for research and development to be written off (deducted from taxable income) on an accelerated schedule; R&D is under-produced from an overall social-welfare standpoint because even with a patent system one firm’s R&D is quite likely to confer benefits on other firms for which the firm conducting the R&D will not be compensated; note in this connection that one requirement for a patent is that the applicant disclose the invention, and that disclosure may convey valuable information to competitors even though they cannot practice the patented invention without the patentee’s authorization.”
As a starting point, a review of the corporate income tax system gives a good indication of the relative level of taxation currently applies to capital income of the oil industry. The Congressional Budget Office Paper “Taxing Capital Income: Effective Rates and Approached to Reform” dated October 2005 shows:
• Petroleum and Natural-Gas Structures are subjected to a 9.2 % effective tax rate on capital income, the lowest of 49 categories. Computers and peripheral equipment have the highest tax rate at 36.9%
• Oil-field machinery is subjected to a 21.9% effective tax rate on capital income, ranking No 21 of the 49 categories.
These low tax rates may or may not be considered a direct subsidy. But in context to other assets types, such as educational building, which are taxed at 28.4%, the justification behind these favorable rates granted to the oil industry seems unbalanced.
Going a little bit deeper, Becker and Posner point out that the principal tax subsidies for the oil industry are:
• A “domestic manufacturing deduction” that allows oil and gas companies to deduct an extra 6 percent of their taxable income;
• A deduction for “intangible costs,” which are costs for investments in oil exploration or production that have no salvage value, such as clearing land to enable an oil well to be drilled—the oil companies are not required to amortize these costs over the entire expected life of the oil well.
• The companies are permitted to deduct royalties they pay to foreign government, on the ground that royalties paid to a government are really a tax.
They go on to say, “the aggregate value of these subsidies to the U.S. oil industry is approximately $5 billion a year, almost as much as the industry pays in federal income tax ($5.7 billion).  The industry’s total profits exceed $30 billion, so it would not be facing a crushing burden if the subsidies were to be eliminated; the Obama Administration proposes to eliminate only $2 billion of the subsidies.
Finally in a more qualitative way, David Kocieniewski article “Oil Companies Reap Billions From Subsidies,” which ran in the New York Times after the BP oil spill catastrophe suggests:
• “….. for many small and midsize oil companies, the tax on capital investments is so low that it is more than eliminated by various credits.”
• “ ….. (American producers) exploited tax laws by moving overseas to avoid paying taxes in the United States.”
• “….. many small and midsize oil companies based in the United States can claim deductions for the lost value of tapped oil fields far beyond the amount the companies actually paid for the oil rights.”
• “….. rigs, like Deepwater Horizon, are registered in Panama or in the Marshall Islands, where they are subject to lower taxes and less stringent safety and staff regulations.”
In closing, this discussion could not confirm the notion that the oil industry is the most highly subsided industry in the U.S. However, using Becker-Posner’s rationale, it is highly questionable that subsidies to the oil industry are defensible on economic grounds since it does not encourage the production of benefits that would be under-produced from an overall social-welfare standpoint were it not for subsidy. In fact the opposite is true.
Nevertheless, the discussion clearly shows a degree of disparity in favor of the oil industry from exploration to extraction. Eliminating these subsidies for the oil company and bringing their tax rates in line with other industries would bring additional revenue to the U.S. government. The real cause for concern lies in the economic impact of increased gasoline prices. How much would the price of gasoline increase to the consumer is anyone’s guess? Even a slight increase would be painful at a time of severe economic uncertainty and high unemployment. But sooner or later the oil industry must pay their fair share. You never know, relaxing subsidies may even help the bankability of renewable energy development projects.
Assuming the country does not fall into another deep recession, the net effect of the increase would be a reduction in consumption and a shift to cleaner fuels. A desired outcome if you care about the earth and our future.

Living without fuel subsidies an article by Jakata Post

Oil subsidies have become a serious topic for the government. Both the coordinating minister for the economy and finance minister do not hesitate to speak openly about a possible reduction of oil subsidies.

This is understandable because Indonesia’s status as a net oil importer since 2003 has stirred a panic every time world oil prices spike. The state of panic will be more severe if price volatility far exceeds the estimate used to draft the state budget.

While the government will not subsidize high-octane Pertamax and promises to improve the distribution of subsidized gasoline, Premium, the fear of turmoil in world oil prices continues.

This shows that the government is fully aware and more realistic about increasing oil consumption, while realizing that oil production is declining.

Based on the latest British Petroleum data released in 2010, Indonesia’s oil production fell by 3.5 percent while consumption increased by 3.2 percent annually over the last 10 years. Without fundamental changes, in the next 20 years fuel consumption will almost double, and more than 80 percent of this will be met through imports. Whoever governs this beloved republic will surrender to oil price shocks, except if Indonesia emerges as a wealthy nation.

Actually, there is nothing wrong with subsidies, as long as they are allocated to important things and reach the right parties. But in practice, Indonesia’s fuel subsidy is neither effective nor educative and is enjoyed mostly by the rich. According to Pertamina president director Karen Agustiawan, private cars consumed 46 percent of subsidized fuels, followed by motorbikes with 39 percent and public transports with 15 percent. From a geographical point of view, 59 percent of the subsidized fuels were distributed in Java and Bali.

There are at least three points we need to consider related to fuel subsidies. First, the subsidy is intended to secure economic stability rather than boost the grassroots economy. Second, due to the poor quality of public transport services, the ownership of private vehicles is on the rise. Third, the high dependence on fossil fuels indicates a low energy diversification.

There are energy efficiency (EE), energy diversification (DE) and renewable energy (RE) measures in place, but these have apparently been unsuccessful. Why?

First, in general, these programs are not running well due to lack of seriousness and focus. As a result, nothing is done. Everyone is busy only when the topic is hot. One of the victims is the Jatropha biodiesel program. Second, there is no adequate coordination and commitment between parties related to energy. This causes no sense of responsibility and belonging. Third, a lack of funds and mastery of technology stand between Indonesia and these programs.

EE, DE and RE programs require that the government formulate and implement appropriate solutions. To promote EE, public awareness of energy conservation should start now, using all public information and education tools, such as the media, schools, etc.

Then, the master plan for Mass Rapid Transportation (MRT) should be immediately executed, especially in big cities. Bureaucratic barriers to this plan must be cleared. In addition, the government should strictly restrict the use of older vehicles, which are more inefficient in terms of fuel consumption.

If necessary, the government should think of unusual ways to streamline economic activities without compromising growth, for example, by optimizing economic activities during weekdays. Germany’s experience in implementing business activities for 5.5 days a week should be considered. It needs a comprehensive study, particularly on its negative impacts on low-income people who work in the informal sector.

The government has to make full use of advancements in Information and Communication Technology (ICT) to reduce mobility. Business-based e-marketing and other types of work that can be done from home must be supported. This will significantly reduce fuel consumption.

For DE, the promotion of gas for vehicles should be supported, although it is not a long-term solution. The most important thing is to guarantee the availability of its distribution. Indonesia’s gas reserves can last for 44 years (BP, 2010), but they will quickly run out if explorations increases.

For RE, the development of biodiesel from Jatropha planted on degraded land is a step in the right direction. Of course, this will improve the people’s economy and reduce the burden on the city from the energy side. Furthermore, small and medium industrial vehicles that run on electricity need to be developed.

If Indonesia wants to avoid an energy crisis in the future, the long-term solution has to begin right now. Please do not hesitate to cut oil subsidies, but please invest more in the development of EE, DE, and RE.

The writer is a researcher at the Solar Energy Research Group, Vehicle Systems Engineering Department, School of Creative Engineering, Kanagawa Institute of Technology, Japan.

http://el-rufai.org/2011/10/the-nemesis-called-oil-and-gas-3-the-downstream-dilemma/The downstream parts of the oil and gas sector include all activities following the delivery of crude oil to processing plants for refining, conversion and value addition into gasoline, diesel, kerosene and petrochemicals, including transportation, storage, marketing of the finished products and associated services. The value chain entails the supply of crude oil to the refineries, primary distribution from refineries to terminals, secondary distribution to depots and distribution to retail outlets for marketing. In a country where nearly 80 percent of urban family incomes go towards food, rent and transportation costs, the prices of cooking gas, kerosene and gasoline constitute a lion share of the cost of living.

The downstream parts of the oil and gas sector include all activities following the delivery of crude oil to processing plants for refining, conversion and value addition into gasoline, diesel, kerosene and petrochemicals, including transportation, storage, marketing of the finished products and associated services. The value chain entails the supply of crude oil to the refineries, primary distribution from refineries to terminals, secondary distribution to depots and distribution to retail outlets for marketing.  In a country where nearly 80 percent of urban family incomes go towards food, rent and transportation costs, the prices of cooking gas, kerosene and gasoline constitute a lion share of the cost of living.
Unlike the upstream parts which are considered successful and relatively efficient, dominated by IOCs and private sector operations and mindset, the downstream sub-sector of the Nigerian oil industry is unanimously perceived to be unsuccessful, inefficient, and corrupt. Downstream operations also in sharp contrast with the upstream sub-sector are dominated by state-owned enterprises, government regulation and price control. On the whole, Nigeria has been the worse for it. It has not always been this way.
How did we get to where we are?  Why are we not refining 2 million bpd of our production and creating refining 25,000 jobs? Should the world’s 14th largest producer of crude oil be one of its largest importers of refined products? Is there a subsidy in the pricing of gasoline? Let us take a trip down memory lane and suggest some answers now and going forward.

Until 1966, the Nigerian economy was supplied with petroleum products through private sector imports by multinationals like Shell, Esso, BP and Total. Shell, BP and the three regional governments sponsored the first Port Harcourt refinery. It was commissioned in 1966 with a capacity of 35,000 barrels per day (bpd). This domestic production supplemented by imports served the nation until the early 1970s when demand outstripped supply and nationwide shortages developed.

In 1975, the Federal Military Government appointed the Oputa Panel of Inquiry to examine the root causes of the shortages of petroleum products. The panel’s main findings, which were accepted by the government were (1) national demand had outstripped domestic refining capability, and (2) local marketing companies lacked the financial resources to undertake the importation of substantial quantities of petroleum products required to augment domestic production, construct infrastructure and facilities to receive, market and distribute products to all consumption centers in the hinterland, and construct large capacity refineries to satisfy local demand.

The principal recommendations of Justice Oputa’s Panel, which were also accepted by the government were that government should take over the importation of petroleum products from the oil marketing companies, expand domestic refining capacity and the product importation and reception facilities as part of a nationwide system of pipelines to facilitate petroleum products’ distribution in the long run.
The following policies and actions were then implemented as a direct result of these decisions: (a) Legislation: The Petroleum Control Decree was passed to vest the Minister of Petroleum Resources the exclusive right to import and fix the price of petroleum products. The Petroleum Equalization Fund Decree was also enacted to ensure that prices of petroleum products are the same throughout the country. (b) Oil Marketers: The Government took over majority ownership of the major petroleum marketing companies (Shell, BP, Esso, Mobil and Total) during the implementation of the Indigenization programme of the 1970s. (c) Refineries: The Government through the NNPC then under Muhammadu Buhari’s leadership, expanded domestic refining capacity by contracting the building refineries in Kaduna (completed in 1980) and Warri (1978), and subsequently the expansion of Port Harcourt (1989) to a total national refining capacity of 445,000 bpd, spending about US$8 billion in the process.

A nationwide system of over 5,000 kilometers of crude oil and refined products pipeline transmission and distribution network and 23 depots were also constructed during the Babangida administration, with the first national fiber optic communications network laid contiguous with the pipelines. The NNPC also owns 9 LPG depots, which have been largely under-utilized since inception in 1995, due to the shortage of LPG from the refineries and logistic problems in the supply of imported LPG to the mostly upcountry depots.
The installed capacity of these refineries by 1989 was equal to about 140% of domestic demand. The intention of constructing the new Port Harcourt Refinery was mainly to export its output. This was achieved for only a short period. Thus, although Nigeria has an installed refining capacity of 445,000 bpd, only a maximum of about 240,000 bpd were being processed for domestic consumption since 1990.
The pricing of petroleum products moved from the market to the minister’s office. In 1992, a liter of petrol (PMS) cost just 70 kobo meaning the price has increased nearly tenfold in less than 10 years.  In 1994, the Abacha regime increased the price of PMS to N11 per liter but set up the Petroleum Special Trust Fund (PTF) to administer the proceeds under General Muhammadu Buhari’s chairmanship as its statement of sincerity. This was raised to N20 in 1999, N22 in 2000, N26 in 2002, N39.50 in 2003, N49 in 2004 and N65 in 2007, all by the Obasanjo administration. It is therefore understandable why Nigerians see the pricing of petroleum products as a slippery slope from which they seem to lose all the time.

The problem began when our domestic refineries failed to produce at their design capacities – at ex-refinery costs determinable within Nigeria. As demand increased, we needed to import at import-parity costs determined outside our control. Hundreds of millions of dollars spent on turnaround maintenance between 1998 and 2006 have yielded no sustainable improvements in their output. The refineries now need about $400 million for revamp and retrofit to work! Why?

It appears that there are several built-in incentives to keep the refineries under-performing because that is an opportunity to sell the allocated but unprocessed crude for NNPC’s account, and an opening to import refined products to make up the shortfall in domestic production! Both situations present multi-million dollar arbitrage, patronage and pay-off opportunities for those in power. For instance in 2010, the refineries received a total of 33,633,907 barrels of dry crude oil and condensate and processed a bit more into various petroleum products. The combined average refining capacity in 2010 was less than 22 percent – with Warri having the highest capacity utilization (43%), Kaduna (20%) and Port Harcourt (9%). The highest capacity utilization ever achieved was 64% in 1990, compared with 80-95% the world over!
This means out of the 445,000 bpd allocated to NNPC for domestic refining – about 162 million barrels in 2010, about 128 million were allocated to privileged parties to sell on the open market. These privileged parties, the World Bank found in 2000, pocketed about $75 million as middlemen, marketing the most sought-after, light sweet crude oil in the whole world! The third source of pay-offs and patronage is the paperwork from marketers and NNPC to PPPRA and government to claim ‘the fuel subsidy’, or the price differential between what are imported product prices and the approved selling prices for PMS and Kerosene. The fourth and final source of pay-offs is the paperwork to reimburse ‘bridging costs’ – the cost payable to transporters to freight fuel from Atlas Cove, Mosimi, and the various depots to every nook and cranny of the country to ensure that elusive price equalization. The Nigerian citizen directly or indirectly bears the burdens of all these consequential inefficiencies, and some fat cats get paid for doing nothing even when the paperwork and audits show otherwise.

In 2010, the total production by the refineries was 4,404,360 tons of various petroleum products – and PPMC itself distributed 6,353,517,990,000 liters of PMS, 668,548,000 of kerosene (HHK), 205,546,720 of aviation fuel (ATK),  879,367,550 of diesel (AGO), and 272,699,100 of fuel oil (LPFO) – 0.747 million per day. This is inadequate to meet our national demand. Comparatively, we imported 5,031,288 tons of PMS in 2010, compared with the measly 747,776 tons our four refineries combined produced – in effect we imported nearly 87 percent of our gasoline needs last year.

The NNPC through its PPMC subsidiary evacuated 4,508,4934 tons of petroleum products from the refineries and received 6,639,752 tons of imported PMS and HHK for distribution. The total quantity of PMS sold in 2010 by the PPMC, the sole importer and distributor was 9,090,469,690 – about 25 million liters daily. It is estimated that the NNPC spent $5.5 billion in 2010 to import refined products. PPMC also sold a total of 13.75 billion liters of various grades of petroleum products through depots, bunkers and coastal lifting – about 38 million liters of various products daily. Last year, 945 million liters of other petroleum products – largely naphtha and LPFO – worth about N62 billion was exported. If our four refineries can operate at or slightly above the template capacity, we would not need to import more than a modest shortfall and strategic reserve that most countries keep – just in case.

Since the 1990s, what should have become a temporary measure to import has remained a permanent policy.  With the continuous depreciation of our national currency, the rising market price of crude oil, and consequential escalation of refined products prices from the markets we import, the shifting levels of imported fuel pricing has led to the contentious issue of fuel subsidy. The declared intention of the Jonathan administration to “withdraw the fuel subsidy” by decontrolling the pricing of gasoline (PMS) is the downstream dilemma facing both the citizens and the government that may have grave, even if unintended, consequences.

The arguments for and against subsidy have been well articulated by various commentators in this medium and others. There is a lot of waste and corruption around the current ‘subsidy’ system, and the Jonathan administration lacks the political will, executive capacity and even legitimacy to confront those benefitting from the patronage described above. After all, some of them allegedly financed Jonathan’s election. It is therefore easier to eliminate the whole arrangement via ‘deregulation’ thereby transferring the burden to every citizen through higher food, transportation and other costs.

For me, the most compelling case against the plan to take ‘N1.2 trillion subsidy’ from all of us (each man, woman and child will pay about N7,150 as contribution) next year is that the Federal Government in its medium term economic plan, has promised to target between 70 and 75 percent of the annual budget on recurrent expenditure till 2015 – that is more spending on the government itself and its employees rather than build more roads, power stations and enabling environment for job creation. We must resist this new tax on the Nigerian people that will go the way $200 billion was spent in the last 4 years – on nothing we can see or feel.