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.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.