Big Brother and the Oil Company

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In the midst of an election year, tied to a flurry of headlines about high prices for gasoline, there have been a lot of questions about the value and significance of government subsidies for the oil and gas industry. On a global scale, a closer look at the role of government subsidies reveals that they can be very much to blame for high oil prices.

The "S" word
Call them subsidies, or tax breaks, or credits, the question is not about semantics, it's about evaluating whether one of the most profitable industries in the world needs a government benefit. But if you look at this issue worldwide, the problem is much greater than the drama surrounding America's $4 billion payout.

The International Energy Agency estimates that in 2010, governments worldwide spent $409 billion subsidizing fossil fuels. In 2009, that number was $300 billion.

The IEA says that the single act of eliminating global fossil fuel subsidies would get the world nearly halfway to targeted greenhouse gas emissions reductions by 2020. In one fell swoop, the move would slash growing energy demand by 4.1%, and reduce oil demand by 3.7 million barrels per day. For comparison, that is equivalent to the rate of Canada's oil production in 2010.

That'll be the day
Though I'd love to see a worldwide elimination of subsidies and the ensuing drop in greenhouse gas emissions, I'm not holding my breath. Foreign governments not only heavily subsidize the oil and gas industry, they frequently own the oil companies outright, and use the proceeds from operations to wield power and influence over their citizenry.

The large subsidies by these governments lead to massive overconsumption. Surging demand drives up the price of oil, and though we can debate the peak oil theory until the cows come home, the commodity is proving to be more elusive, and more expensive to produce, than ever before.

This same high price of oil, however, is also what ends up refilling government coffers, allowing administrations to maintain subsidies and fund other, non-energy-related activities. Saudi Arabia, for example, needs the price of oil to sit above $90 in order to fund increased social spending at a time when unrest has shaken much of the Arab world. It is in the Saudi government's best interest to keep oil prices up and uprisings down, and OPEC is sympathetic to this need.

That is the problem with state-owned companies. Unlike independent operators, they are a means to many different ends, which often exclude efficient exploration and production operations, and a commitment to reserve replacement, the very things that increase supply and drive down the price of oil.

National oil companies
State-owned entities dominate the energy industry, making up close to a 67% share in emerging markets as of June 2011.  As of 2010, national oil companies, or NOCs, made up the top 10 of the largest oil and gas companies by reserves. ExxonMobil (NYSE: XOM  ) , in case you were wondering, is ranked 11th.


Oil Company

Proven Oil and Gas Reserves

1 National Iranian Oil Co. 310
2 Saudi Aramco 305
3 Petroleos de Venezuela 225
4 Kuwait Petroleum 110
5 Gazprom (Russia) 110
6 Qatar Petroleum 105
7 NOC, SOC, MOC (Iraq) 95
8 ADNOC (UAE) 75
9 Turkmengaz 49
10 Libya NOC 25

Source: The Economist. Reserves are in billion barrels of oil equivalent.

An incredible 73% of the world's reserves belong to state-owned entities such as the 10 listed here. And these 10 are just the beginning. Consider that many of the biggest "public companies" familiar to energy investors, PetroChina (NYSE: PTR  ) , Sinopec (NYSE: SHI  ) , Petrobras (NYSE: PBR  ) , and Statoil (NYSE: STO  ) , are really NOCs.

By taking a closer look at a government and its NOC, we can develop a better understanding of the effect of the relationship on production and demand.

Noble beginnings in Venezuela
This small South American country is a perfect example of what can go right, and oh so very wrong, with a state-owned oil company. Venezuela went through the process of nationalizing its oil company in the 1970s. For a while, things were going well.  With minimal government interference, Petroleos de Venezuela was one of the better operating NOCs, producing as much oil as Mexico's state-owned Pemex with one-third of the staff.

In the 1990s, the oil company decided to push the envelope and grow production to 6.5 million barrels per day. By increasing its own production, and encouraging foreign companies to develop its marginal fields (taking note of their superior technology), PDVSA set the stage for a successful future.

That all started to fall apart around 1998. PDVSA asked for government permission to increase investments in production. The government said no, and promptly slashed the oil company's budget to garner favor for an upcoming election. Production had reached 2.9 million barrels per day, but promptly fell and has not returned to that level since.

The story, naturally, gets worse
When Hugo Chavez came to power a year later, he cut the company's budget even further. Then he accused management of shady underhandedness, questioned its foreign expansion plans, and appointed top-level cronies to do his bidding. And then there was a strike!

Management and half of PDVSA's 40,000 employees stopped work for two months, devastating operations that required constant oversight. In a move that likely came up in a conversation that began "How can we make things worse?" Chavez fired all of the striking employees and filled the positions with a slew of incompetents.

Today, PDSVA is known not for efficiency, but for deteriorating operations, secrecy, an intimate relationship with the government, and a production level that is hundreds of thousands of barrels short of what it was 14 years ago.

And worse, still
Now that we have established the negative effect of an NOC on the supply side, let's flip our greasy coin and look at demand. Herein lies a catastrophe.

As is common in many countries with state-owned oil companies, the Venezuelan government subsidizes gasoline -- at a rate of 90%. Ninety percent! The immediate problem is that it drives consumption through the roof. Though Chavez has talked about reducing consumption, there is an election coming up in October. So Hummers and old American muscle cars from the 1970s roll through the streets mocking fuel efficiency, as drivers fill their tanks with gas that costs $0.07 to $0.18 cents a gallon.

Birds of a feather?
Not all NOCs are as terribly operated as PDVSA. For example, Saudi Aramco is often touted as being incredibly efficient for an NOC. Regardless, Saudi Arabia also has a ridiculous gasoline subsidy policy. The country spends $13.3 billion a year on gas subsidies and $30 billion overall on fossil fuel subsidies. The price of gas in Saudi Arabia is about $0.48 per gallon. Mostly because of subsidies, oil producers in the Middle East will consume 1 million more barrels per day in 2015 than in 2010. If you think the oil market is tight now, just wait.

More importantly, as is clear in the case of Venezuela, well-run or not, today's efficiency is always subject to tomorrow's tyranny.

The way forward
Government commitment to subsidy programs quite often keeps production down and drives up consumption. This two-headed beast wreaks havoc on worldwide energy prices, and while it is absolutely crucial to develop alternative energy sources, an equal emphasis should be placed on decreasing demand and increasing energy conservation. It is the best way to reduce American dependency on foreign oil and pry ourselves free from the tangled mess of the global energy picture.

Fool contributor Aimee Duffy doesn't own shares of the companies mentioned in this article. If you have the energy, check out what she's keeping an eye on by following her on Twitter, where she goes by @TMFDuffy.

Motley Fool newsletter services have recommended buying shares of ExxonMobil, Statoil A, and Petroleo Brasileiro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 13, 2012, at 5:30 PM, xetn wrote:

    There should be no subsidies period. But another big reason for the increasing "price" of oil is the ongoing Fed QE programs in which the Fed is now the largest single holder of US debt and it has been buying that debt by creating new money out of thin air. The result of that is a continuing loss of purchasing power of the currency because oil prices are denominated in US dollars.

  • Report this Comment On March 13, 2012, at 5:54 PM, interdependent wrote:

    The real bottom line:

    The IEA says that the single act of eliminating global fossil fuel subsidies would get the world nearly halfway to targeted greenhouse gas emissions reductions by 2020.

    That's a truly good start. But halfway won't cut it.

    1980 was the year I started driving, a Ford Mustang, and buying gas. 2011 marked the last time I bought gas. In my driving-around-years we did quite a bit of damage. Some of that damage you can see from outer space:

    Oil profits won't be worth as much when the ice caps are gone.

  • Report this Comment On March 13, 2012, at 7:28 PM, aarondean wrote:

    It is foolishly sad when Americans consider an industry that keeps $4B of its own money as a payout. Nothing but Marxist rubbish. If I pay $100 dollars of taxes and receive $25 back after all of the accounting gimmickry has been done have I been given a payout?! Hardly. This method of thinking has led countries like Greece to utter ruin. But oh, we're America, it can't happen here. Keep taking from the producers to buy votes from the moochers. The oil industries receive no special subsidization that other companies receive for doing similar work. On top of that ask any economist who devotes his studies to the energy sector and he'll tell you the last spike in oil prices was just that, a spike. Nowadays its is structural. In other words, the price today is now more inline with what it costs to produce oil. Sure a market with that high of a demand can be driven by fear and appear skittish at times, look at what happened last week when Iran lied about an explosion along a Saudi Arabian pipeline in an attempt to drive the price of oil up just before the European oil embargo began.

    These things are only obvious to those paying attention folks (unlike the useless fools that worship at the alter of Pope Gore and the thoroughly debunked global warming hoax).

    Unfortunately America could use the extra revenues until we get our fiscal house in order. But $4B will only buy the government votes for about 8 hours. Then what?

    The only people that should be allowed to step up to comment on this are those that can differentiate between evil profits and a profit margin. XOM operates at about a 8.7% profit margin, while SBUX operates at around 10.5%. One provides you the means to get to work, the other makes you look trendy. Tough choice which horse to back here.

    Bottom line: stop demagoging an in industry simply because it makes a profit. Not sure if any of you have spent any time getting oil out of dirt, but its really, really hard. And they have to do it (thanks to Obama and his EPA) in places that don't like oil wells very much and consider them a target.

  • Report this Comment On March 13, 2012, at 7:57 PM, kmne68 wrote:

    Well, you have the right policy recommendation for the wrong reason.

    Forget global warming (everyone else has), if it is happening, it is not the basis for an energy policy. Sound economics is. If we want to wean our economy off of petroleum, we have to let the true cost of petroleum based energy be seen in the marketplace. That means ending government subsidies which make it artificially cheap. In ending subsidies, not only do we free the market to advance presumably cleaner alternatives, but we also save governments (and consequently taxpayers) billions of dollars.

    By the same reasoning, tax breaks for "green energy" are just as bad. For green energy to be viable, it must be sufficiently attractive in the market to support its own development. We have been throwing government money into that pit since the 1970s. Only when petroleum is sufficiently expensive will "green" alternatives get sufficiently "cheap".

  • Report this Comment On March 13, 2012, at 8:19 PM, Beery1 wrote:

    Yes, and no private oil company ever took a government subsidy, right?

    I'll worry about Venezuela's oil industry subsidies when I live in Venezuela. Same with all the other countries that subsidize nationalized industries. Right now I'm more concerned with my subsidizing of private companies here in the US.

  • Report this Comment On March 13, 2012, at 11:12 PM, CaptainWidget wrote:

    OH no!? You mean....subsidizing a behavior produces more of it!?!

    What will you tell me next? That taxing a behavior produces less of it???


  • Report this Comment On March 14, 2012, at 4:07 PM, DJDynamicNC wrote:

    "If I pay $100 dollars of taxes and receive $25 back after all of the accounting gimmickry has been done have I been given a payout?"

    If you pay $100 in taxes and in exchange you get America, I think you've made yourself a pretty good deal.

    I see value in sharing the wealth I create, I see value in requiring contributions from everyone who benefits from the stable framework of state, and because this is a representative democracy, I am within my rights to fight for those ideas and see them implemented. And it is clear that we as a people agree that we are in this together and must all contribute to the greater good and to the care of one another.

    I would argue that living in the United States is itself a payout.

  • Report this Comment On March 14, 2012, at 5:02 PM, SolarInvestor wrote:

    What would the price of gas be without (1) subsidies to the oil companies and (2) taxes on gasoline? I really don't know.

  • Report this Comment On March 14, 2012, at 5:50 PM, sailrmac wrote:

    Though it doesn't tout any particular party, this article is mostly political. It's message is think green.

    I personally would prefer the site stick to investments.

    But if the fool wants to be just another Yahoo message board, so be it.

  • Report this Comment On March 15, 2012, at 10:01 AM, Smithrob999 wrote:

    It's my understanding that subsidies for "big oil" ended in 1976. The so called subsidies are depreciation for smaller wildcat drillers.

  • Report this Comment On March 15, 2012, at 10:02 AM, Smithrob999 wrote:

    Here are a few of the items which are being incorrectly identified as “subsidies” inside the beltway:

    Intangible Drilling Costs – Companies which engage purely in energy exploration and discovery can recover their costs related to exploration at tax time at a rate of 100%. This lessens the burden on energy providers for the number of “dry holes” which may be found in the process. Integrated companies (i.e. “big oil”) can recover these exploration costs at 70%. Not a subsidy.

    Domestic Manufacturer’s Deduction (Section 199) – A deduction (not a credit) equal to 9% of income earned from manufacturing, producing, growing or extracting in the United States, is available to every single taxpayer who qualifies in the U.S. The oil and gas industry, and only the oil and gas industry, is limited to a 6% deduction.

    Percentage Depletion – The percentage depletion deduction is a cost recovery method that allows taxpayers to recover their lease investment in a mineral interest through a percentage of gross income from a well. This depletion method is not available to companies that produce oil as well as refine and market it (i.e. “Big Oil”.) This is available to all extractive industries (gold, iron, clay, etc) in the US and is in no way unique to the oil and gas industry.

  • Report this Comment On March 15, 2012, at 11:50 AM, DJDynamicNC wrote:

    Not sure why transferring wealth from taxpayers to oil companies doesn't count as a subsidy.

    I don't have a problem with subsidies, but I would like to see the ones we pay to the oil companies removed (I feel that once a company achieves the status of "most profitible company in human history," as Exxon did until recently, then subsidies are no longer justifiable).

  • Report this Comment On March 15, 2012, at 11:51 AM, Greygus wrote:

    I discount the opinions I read when I see them refer to global warming as "thoroughly debunked" or other non-sense. If they're that uninformed and entrenched in an outdated opinion (the debunk has been debunked, a long time ago, actually), then what else have they wrong? I can't help but wonder.

    As to the article, I believe subsidies are a tool with a specific use, particularly to foster fledgling industries that are perhaps the future or that struggle against unfair global competition, however we must exercise careful control so that, as with the case of Big Oil, the temporary gift we've all agreed should be given isn't taken by them to in time be their soverign right.

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