The Easy Truth About Oil That “Deficit Hawks” Don’t Want To Hear

Tax breaks and other subsidies for oil companies have been getting a lot of attention lately, to the extent that cutting them has even made it into an actual Congressional proposal. The issue has been around forever, but I like to flatter myself by thinking that the Environmental Law Institute’s report on fossil subsidies that I consulted on has something to do with it. Wishful thinking, perhaps. But if the Democrats can dream that they may actually eliminate some of these things, then I can dream that I had a hand in it.

The driver for all of this, the good work of ELI not withstanding, is the deficit, of course. Everyone is looking for ways to try to balance the budget. As crises like these so often do, the current budget crisis has created some amusing dynamics. One of my favorites is self-proclaimed “deficit hawks” pushing back against the idea of cutting subsidies for oil companies. Apparently,  their desperation to close the budget gap doesn’t extend to the roughly $44 billion in oil subsidies the Administration would like to eliminate. (See also: “With Oil Prices High, Taking Aim at Industry Tax Breaks“)

The justification, of course, is that cutting oil subsidies would lead to higher gasoline prices, which would be bad for the economy.

I actually tend to agree with the general principle that a recession is a lousy time to raise taxes or cut tax incentives. With household budgets suffering and business slumping, the last thing you want to do is to increase the price of an essential household product like gasoline. (Of course, by the same token, the other last thing you want to do in the middle of a recession is to cut spending on government support that goes to propping up family budgets, but anyone who expects consistency from elected leaders has never seen or heard an elected leader.)

But here’s the catch: Cutting subsidies to oil companies won’t increase gas prices.

As I’ve said here before oil is a global commodity, and oil prices are set on a global market. For any given grade of crude, the price in the U.S. is the same as the price in Japan or Europe, or anywhere else.

Imagine a giant oil barrel sitting in the middle of the ocean somewhere. All the world’s oil suppliers dump their oil into the top of the barrel, and all the buyers take it out of a spigot at the bottom. If seller thinks the price of oil is too low, he won’t put his oil in the top. If a buyer thinks the price is too high, she won’t take any out of the bottom. But if she does, it could come from the U.S., the Middle East, or anywhere else, or from a combination of places.

The price of oil is determined by what’s going on inside the barrel. If more is coming out than is going in, prices rise. If the level of oil is rising toward the top, the price falls. Global oil prices go up and down to make sure that the barrel is never empty and never overflows.

Notice what the price of oil does not depend on: Costs. In Saudi Arabia, for example, it costs somewhere around $6 to extract a barrel of oil from the ground. On a deepwater rig, it’s closer to $30. But in the big oil barrel in the middle of the ocean, it all sells for the same price.

What does this mean for oil subsidies? Simply put, if the price of oil is indifferent to the cost of producing it, then cutting subsidies won’t make prices go up. Since the U.S. only produces about 10% of global oil supplies, even huge swings in the cost of extracting oil here have little to no impact on global prices. U.S. companies can’t demand that oil consumers pay more for oil just because they lost some tax benefits. They just don’t have the market power to make it happen.

But let’s pretend that they do and grab our calculators: The Administration’s budget proposed to cut about $44 billion in subsidies over ten years. At current production rates, this comes out to about $1.40 per barrel of American oil, which in turn is about 1.5% of the price of oil. This means that the price of about 10% of global oil supplies would go up by about 1.5%, which means that prices at the big barrel in the ocean would rise by somewhere between about 15 and 17 cents a barrel, or a whopping 0.4 cents per gallon of gasoline. Even to cash strapped families, this is small potatoes, but to oil companies, it’s still $44 billion.  Which is why I’m so skeptical that we’ll ever close these loopholes.

In the real world, this 0.4 cent per gallon apocalypse would never happen. And if our elected leaders didn’t know it before, they know it now: The Library of Congress just put out a report telling them so.

Politicians who claim that ending tax breaks for oil companies will lead to higher gasoline prices are just pretending that they don’t know any better and hoping that you don’t either.

Now that we’re all in on the big secret, can we please stop pretending that defending oil subsidies is about anything more than defending oil subsidies?