A typical economic analysis of any sort of government subsidy shows that the costs exceed the benefits (exceptions to this rule accepted in the comments section ;-), unless the subsidies encourage an activity that generates a positive externality. So let's assume that encouraging U.S. energy production helps relieve our dependence on Middle East oil and improves national security. In today's NYTimes we find that government subsidies to the U.S. energy sector don't do much to improve national security, but they do alot for the oil industry's profits (Incentives on Oil Barely Hurt U.S., Study Suggests):
The United States offers some of the most lucrative incentives in the world to companies that drill for oil in publicly owned coastal waters, but a newly released study suggests that the government is getting very little for its money.
Details below. Plus, as a holiday bonus, I insert my own radically mainstream* economic and other thoughts after each paragraph (from the section of the long article that I found most interesting)! I repeat: after each and every paragraph. Wow.
The new study, prepared under contract to the Minerals Management Service of the Interior Department by Innovation and Information Consultants of Concord, Mass., is one of the few attempts to assess the impact through a rigorous econometric analysis.
This is the first time I've ever read "econometric" in the newspapers. I need to get out more often.
The report estimates that the current incentives would have a tiny impact that is far exceeded by swings in market prices.
When oil prices double the incentive to drill is already there, the subsidy becomes gravy on top of the mashed potato(e) profits.
The report predicted that the current incentives would lead to the discovery of only 1.1 percent more reserves than if there had been no incentives at all. Total oil production from 2003 to 2042 would be about 300 million barrels more, or less than 1 percent, than it would have been anyway. Natural gas production would be 0.6 percent greater than it would have been otherwise.
1.1% and 0.6% increases won't reduce prices much boy-o.
But the cost of those royalty incentives would be high: about $48 billion less in royalty payments over the 40-year period. That loss would be offset by a slight increase in the prices that companies pay when bidding for leases in government auctions, but analysts said the net cost would still be above $40 billion.
$1 billion a year.
The Interior Department, in a written response to questions, said the actual cost of its incentives would be much lower than $40 billion because most leases in the Gulf of Mexico include an escape clause that requires companies to pay full royalties if prices are above $34 a barrel.
Institutionalizing the price effect!
But officials conceded that oil companies are still poised to escape billions of dollars in royalties in the next five years alone.
Now, I'm a little confused. The annual cost from above is $1 billion a year. So, the most they could be poised to escape is $5 billion. When the writer says "billions" I'm thinking more than 5 in 5 years.
Dozens of companies signed leases in the late 1990’s under a Clinton administration program that offered highly generous incentives and, apparently because of a bureaucratic error, omitted the escape clause. The government has estimated that it would have received as much as $10 billion more over the next five years if the mistake had not been made. It is trying to renegotiate the terms.
Shouldn't "bureaucratic error" be in quotes?
But as much as half of that money is out of reach. The Bush administration also endorsed a new royalty holiday for “deep gas” drilling in shallow waters even if natural gas prices climb above today’s levels. According to internal budget estimates last year, the deep gas incentives account for half of the $10 billion that the government stands to lose.
Pet peeve timeout: I'm always quesy when we use language such as the last four words above. It would make more sense to me to say "$10 billion that the government would no longer gain." Just my preference that the generator of the economic activity has property rights to the economic gain. Then the government, i.e., the people, might rightly claim their fair share. Continuing the theme, that's why I don't like to read about a tax cut being a "subsidy." A subsidy is when the government gives something away. It can vary in magnitude. A tax is when the government extracts something. It can also vary in magnitude.
To be sure, the newly released study found that the extra incentives prompted companies to pay more money upfront when bidding on offshore drilling leases and predicted that they would lead to a small increase in exploration and production.
A "small increase" considering high oil prices have already heavily encouraged exploration and production?
The actual impact of the incentives depends on what happens to oil prices. But under any of the projections, the cost ended up exceeding the market price for oil.
Confused: The cost of the subsidy exceeds the market price for oil? Is that price per barrel? Then, $1 billion/year is surely much greater than $62/barrel. We need to make the units explicit before we can compare subsidy costs and prices (or, oil revenues).
Analysts said the meager impact of royalty incentives was not surprising: for oil and gas companies deciding whether to drill in deep water, the potential money involved in royalty incentives is small compared with the money at stake in changes of market prices.
I was way ahead of that line (see above). Of course, I read ahead before I inserted comments. If I had cut off the extract from the NYTimes article before this sentence I could have appeared much more intelligent than I actually am. I could even have added a neo- to my mainstream.*
Eliminating royalties on oil or gas will save a company 12 to 16 percent on some of its production. But those savings are minuscule compared with the nearly fourfold increase in oil prices from $15 a barrel in 1999 to more than $70 this summer.
Above I said "doubled" oil prices. From the bottom to the top they've increase by more than four times. But going from the bottom to the top is cherry picking, right?
At today’s prices, even the risk of a $100 million dry hole is not so daunting.
Only if the one dry hole is part of a portfolio that includes several profitable oily holes.
Wasn't that fun? Sort of like The Gift of the Magi:
The moral of the story is that physical possessions, however valuable they may be, are of little value in the grand scheme of things. The true unselfish love ... is greater than ... possessions.
*Note: only the really smart and innovative economists are able to deviate from the mainstream and become Libertarians and Marxists. The very smartest can add "neo."
