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The Big Oil Discount

SOURCE: AP/Rick Bowmer

A man pumps gas into a vehicle in Portland, OR. Oil companies need to be held liable for the costs of their actions, and we need to cut the billions in unnecessary subsidies these profitable companies currently receive.

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See also: Eliminating Tax Subsidies for Oil Companies by Sima J. Gandhi

See sidebar: The liability cap for oil spills

The price tag for the Gulf Coast oil disaster could go as high as $14 billion. This includes cleanup expenses, which could cost as much as $7 billion, and related damages, such as losses to Louisiana’s fishing businesses of possibly $2.5 billion. British Petroleum, the company that operated the offshore drilling site that exploded, will pay for cleanup costs it directly incurs. But BP’s liability for economic damages inflicted on area residents and businesses is capped at $75 million under federal law (see sidebar, “The liability cap for oil spills”).

The mismatch between the amount BP will pay for cleanup and the costs the public will bear as a result of the spill is exacerbated by the many loopholes and subsidies the government provides oil companies. Oil companies need stronger incentives to act responsibly. That means holding them liable for the costs of their actions and cutting the billions in subsidies these profitable companies currently receive.

Sens. Robert Menendez (D-NJ), Frank Lautenberg (D-NJ), and Bill Nelson (D-FL) have introduced legislation that would expose BP to potential liability of well over $75 million. The Big Oil Bailout Prevention Act (S. 3305), their proposed legislation, would retroactively replace the $75 million liability cap with a $10 billion cap.

Policy recommendations that would push companies to internalize the costs of their actions:

  • Raise the liability cap on economic damages that result from oil company accidents
  • Eliminate the tax deduction that allows companies to avoid paying about 40 percent of any court-ordered punitive damages
  • Raise penalties for breaking safety regulations so there is a meaningful incentive to adopt preventive measures
  • Require oil companies to pay a reasonable rent for extracting resources from public waters
  • Eliminate nine tax expenditures for oil companies and save $45 billion over 10 years
  • Reform the “foreign tax credit” to ensure that oil companies pay U.S. tax when they don’t pay taxes abroad

Not only is liability capped on compensatory damages from oil spills, but payment of punitive damages is also tax deductible. Courts can impose punitive damages against a company when its actions cause harm. The tax code, however, lets companies write off their payment, which produces an after-tax savings worth about 40 percent.

Take the case of the Exxon Valdez, a tanker ship that ran aground and released nearly 11 million gallons of oil into Alaska’s Prince William Sound in 1989. Following this spill a court set punitive damages at $5 billion. Exxon litigated the decision for nearly 20 years until 2005 when the Supreme Court slashed the company’s punitive damages to $500 million. Of that, Exxon paid about $300 million after taking its tax deduction for punitive damages. Exxon’s profits that same year totaled $36.1 billion.

Higher fines and penalties for safety and regulatory infractions would also establish stronger economic incentives for companies to adopt precautionary steps. If fines are too low, companies may find it cheaper to break the rules and pay the fines than to actually fix the problem.

Offshore drilling accidents resulted in 41 deaths and 302 injuries between 2001 and 2007. BP’s accidental explosion, which allowed oil to flow from below the sea floor into the gulf, killed 11 workers. Yet according to ProPublica the average penalty paid by offshore drillers over the past 12 years was $45,000. This amount is a pittance compared to oil company profits—BP made about $62 million a day during the first quarter of 2010—offering little deterrence to risky behavior.

Indeed, early reports suggest BP may have compromised its ability to catch warning signs prior to the explosion. And the subsequent flow of oil into the sea may have been prevented had BP installed an extra precautionary switch that would remotely shut off the oil flow—a type of switch that is required in other countries like Brazil and Norway. This is not BP’s only lapse. The New York Times reports that between 1996 and 2009 BP-operated platforms spilled a total of about 7,000 barrels of oil—14 percent of the amount spilled in the gulf by any company.

The underlying problem, of course, is our reliance on oil. Reducing our reliance on oil would reduce the need for offshore drilling along with the risk of oil spills—not to mention other problems associated with oil consumption, such as global warming. Yet transitioning to alternative energy sources is challenging when highly profitable oil companies have a competitive boost—through receipt of billions in generous government subsidies—over start-up companies that offer safer, cleaner energy alternatives.

Congress passed legislation in 1995—when oil prices were low—that provides royalty relief for oil companies that drill in certain federal waters off the Gulf of Mexico. Royalties are generally paid to governments for the right to use resources like oil and gas located on land that is owned by the public. Oil companies take advantage of the legislation’s ambiguity to improperly enjoy relief from royalty payments even when oil prices are high. Government Accountability Office testimony suggests that forgone royalties from leases issued during 1996 to 2000 could be as high as $80 billion. Congress should change the law so that oil companies pay a reasonable rent for extracting resources from these public waters.

Oil companies also receive large subsidies through tax expenditures—special deductions, credits, exclusions, rates, exemptions, and deferrals that are delivered through the tax code. President Barack Obama’s fiscal year 2011 budget proposes cutting nine tax expenditures that primarily benefit oil companies (listed here), which would save about $45 billion over the next 10 years. These include the “percentage depletion allowance,” which provides oil companies a subsidy—at a cost of $10 billion over the next 10 years—to pump oil out of existing wells. And the tax expenditure for “intangible drilling costs” gives companies a subsidy worth $8 billion over the next 10 years to drill new oil wells.

The “foreign tax credit” provides another way for oil companies to avoid paying their taxes. This credit is intended to prevent the double taxation of corporate income that is taxed abroad but is also subject to tax in the United States. Companies have managed to exploit this subsidy even when they don’t pay income taxes abroad. Oil companies particularly abuse this tax expenditure. In total, companies will avoid about $8.5 billion in taxes over a 10-year period as a result.

We cannot afford to provide these subsidies. The nation’s current and long-range fiscal challenges demand that we get maximum value out of every taxpayer dollar spent. Oil companies are highly profitable—they don’t need these subsidies. Nor does it make sense to subsidize oil companies for producing oil as we are trying to move to cleaner, safer forms of energy.

As long as these subsidies are in place the market will be distorted to the oil companies’ competitive advantage. And oil companies will not have to pay the full costs of the health, safety, and environmental damages they cause. Congress should act to change these distortions. It’s time for oil companies to pay their fair share.

Sima J. Gandhi is a Senior Policy Analyst with the economic policy team.

For more on this topic please see:

The liability cap for oil spills

Federal law caps BP’s liability for economic damages caused by the Gulf Coast oil disaster at $75 million. Cleanup costs directly incurred by BP are not subject to this cap.

Oil companies currently pay an 8-cent tax on barrels of oil imported or produced in the United States. Revenues are placed in the Oil Spill Liability Trust Fund, or OSLTF, which was created in the aftermath of the Exxon Valdez spill. The Coast Guard and other government parties draw from this fund to pay the costs of cleaning up oil spills when the polluting party cannot be identified or does not have the funds to pay.

If economic damages—such as lost wages, costs of environmental restoration, and drops in business revenue—exceed the company’s liability cap parties that suffered losses can recover funds from the OSLTF. The OSLTF is also an important source of annual appropriations to various federal agencies responsible for administering and enforcing a wide range of oil pollution prevention and response programs.

The liability cap varies depending on the type of spill and expected clean-up cost. The higher the expected cleanup cost, the higher the liability cap. The $75 million liability cap affecting BP applies to operators of deepwater facilities. Liability for oil discharges from ships such as fishing vessels or tankers is subject to a $10 million cap because cleaning up those spills often costs less. Spills from onshore facilities, on the other hand, are subject to a $350 million liability cap because damages onshore can be high.

As Congress reconsiders the OSLTF, it should also investigate whether the $10 million and $350 million liability caps are high enough. A Coast Guard report, for example, recommended raising the liability cap for ships whose spills drain the most from the fund.

For any given incident, a maximum of $1 billion can be drawn from the OSLTF to pay for related cleanup costs and economic damages. This limit has not been an issue until now. Prior to the Gulf Coast disaster, the most expensive incident was the Athos I tanker spill in 2004, with costs of $300 million. Expected cleanup costs from the BP disaster could reach $12 billion.

The Big Oil Bailout Prevention Act (S. 3305) has been proposed in the Senate and would replace the $75 million liability cap for economic damages with a $10 billion cap. It would also eliminate the $1 billion per incident payout limit from the OSLTF. These changes make sense since companies that make the most expensive messes can generally afford to pay for them and should be on the hook for more. The bill also would leave more in the OSLTF for funding preventative programs and cleanup expenses from smaller spills like fishing vessels.

Even with the higher cap, however, the OSLTF will likely run out of money. It earned about $250 million from the 8-cent per barrel tax between October of last year and the end of April, but this tax expires in 2017 or when the OSLTF hits $2.7 billion dollars (whichever comes first). Congress should eliminate the sunset from the tax to ensure the fund can replenish itself.

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