Considerations of a Temporary Oil Import Tax

Considerations of a Temporary Oil Import Tax

A Temporary Oil Import Tax

A Purple Proposal for the Highway Trust Fund

January 18, 2016

Wes Chapman

Gusher

 

We are enjoying excess production worldwide – how to best capture that value?

Over the last 24 months we have seen the price of crude oil in the US fall from over $100 per Bbl. to under $30 today. Today the US is back to being the largest oil producer on earth (almost 14 MM Bbl. per day). While this would have been greeted with unmitigated jubilation in my youth, the resulting precipitous decline in prices is a mixed blessing, with significant dislocations in credit quality, the stock market and employment. The increase in production is due largely to a technology called fracking, which uses hydraulic and mechanical means to open up previously unrecoverable oil and gas. The increase in production has vastly outstripped demand growth, and the result has been the rapid decline in price shown below.

Normally, when prices drop, commodity production does as well, and the problem self corrects – at a price satisfactory to the marginal producer; but this is not a normal market at the moment. The vagaries of fracking make it quite difficult to shut these wells down, and much of the world’s oil production is now controlled directly by sovereign governments – particularly Saudi Arabia – which needs to maintain production to promote political stability.

Additionally, there is a bit of good, old fashion predatory pricing at work here – old John D. Rockefeller would be proud of the Saudis and their pricing strategies. In any event, lower prices don’t seem to be having the normal self-correcting effects on production, and the results have led to significant disruptions in the financial credit and labor markets.

WTI prices last 2 years

Supply goes up – price comes down

World supply .Demand

Price – more volatile than supply

Fracking is very capital intensive, and has required enormous investment over the last few years – about $300 billion annually over the last 5 years in the US. A large amount of this financing has come from debt financing – directly or indirectly – and resulting bust has dramatically increased defaults in the junk bond market, put increased pressure on banks and caused havoc in the stock market. Since the price slide began in earnest, about 90,000 jobs have been lost, with an estimated 150,000 more to come in the next year.

If you happen to be running for political office, this is a fairly ugly backdrop to your campaign. Nobody wants to explain why our best allies in the US are trying to bankrupt our most successful fledgling effort at energy independence – it wasn’t supposed to look like this.

In the US, about 70% of total petroleum use is in transportation, and there was enormous economic pressure to increase fuel efficiency as oil prices began their “moonshot” in 2003. As shown in the chart below, fuel economy has more than doubled since the ‘70s, with the average passenger vehicle hitting almost 24 MPG last year. The truth is that cars are now very long lived assets – the average car on the road in the US is now 11 years old – and we will have to drive a lot of miles in new SUVs to use up all that new oil.

Fuel Efficiency

Better performance means less CO2, and less oil demand

One of the unintended consequences of improved fuel efficiency has been the serious depletion of funding for highway construction and repair in the Highway Trust Fund of the Federal Government. This fund, originally established in 1956 as part of the Interstate Highway program, receives a tax of 18.4 cents per gallon of Gasoline, and 24.4 cents per gallon of diesel. Not too surprisingly, as mileage as improved, receipts have fallen sharply. The normal wear & tear on our infrastructure seriously threaten to bankrupt the Trust Fund this year without heroic outside funding (see chart below). Stopping maintenance and repair programs are a bad plan from a safety perspective, and a disaster politically. Collapsing infrastructure is a poor backdrop to assertions of domestic prosperity and voter appeal.

HTF-Cash-Flow-Summary-through-10-16-15_Weekly-Ticker

Headed for a wreck

Highway fund balance

Collections are bad and getting worse

I believe that there is a happy solution to the twin problems of collapsing oil prices and the bankrupt highway trust fund. I propose a tax on imported oil of $ 20/Bbl., with the proceeds used to resupply the Highway Trust Fund. From a political perspective, it would be unwise to tax Mexican and Canadian imports, so the tax would be applied to about 5 million Bbl./day, producing around $ 36 billion a year – an amount sufficient to restore the Trust Fund to good health. It would also help protect around 250,000 jobs – which in the oil industry generate around $25 billion in GDP per year.

This would doubtlessly immediately increase domestic oil prices, thereby alleviating the worst of the dislocations caused by foreign predatory pricing, and would further reduce prices on the world market – something clearly beneficial to our G8 allies; and would put more pressure on Saudi Arabia to get serious about rational pricing.

I know – at this point you are saying dream on; this is an election year and this would never get through Congress. Perhaps, but most of the oil producing states are solidly Republican, and should be willing to do almost anything to get this mess with oil prices fixed. While a tax increase in an election year would normally be considered anathema for Republicans, I wonder how Ted Cruz would respond. This is a bread-and-butter issue in Texas, and he ultimately must answer to those folks first and foremost. I’m quite sure that it would be strongly supported by most of the Mountain States, and that should be enough to do the trick in the Senate – where the matter would ultimately be decided.

Finally, I submit that this is a prudent thing to do – at least for a year or two. There is no question that our entire fiscal system is a jerry-rigged mess, and this will only do a little to make it worse. It will have the strongly counterbalancing position that it will ultimately mitigate the impact of the decline in oil prices, as well as fund infrastructure repair – which certainly transcends the political shenanigans of a Presidential election year.

I 35 bridge 8.1.07 Minneapolis

Underfunded Highway repair – I35 in Minneapolis

Sources: CNNMoney (New York)First published October 6, 2015: 3:37 PM ET: https://www.washingtonpost.com/news/wonk/wp/2013/12/13/cars-in-the-u-s-are-more-fuel-efficient-than-ever-heres-how-it-happened/: http://www.api.org/~/media/Files/Policy/SOAE-2013/SOAE-Report-2013.pdf: www.api.org/~/…/SOAE-Report-2013.pdf: http://www.eia.gov/tools/faqs/faq.cfm?id=727&t=6: https://www.cbo.gov/topics/budget: Federal Highway Administration Office of Policy Development

 

Wes Chapman
Written by Wes Chapman

4 Comment responses

  1. Avatar
    January 19, 2016

    Well done, Wes. But I have concerns. With Iranian oil exports soon adding to the worldwide supply, the pricing problem will be exacerbated. The Saudis can no longer control pricing. Smaller producing nations (eg. Nigeria, Venezuela) risk collapse. Will your proposal help to insulate the US artificially, protecting US producers, while throwing the larger world economy into a tailspin? What does the correction look like within the “year or two” span for the proposed tax?

    Reply

    • Avatar
      January 19, 2016

      Hoss, you are right – it could lead to the collapse of Nigeria and/or Venezuela (Russia?), but that may be OK. It will prevent the collapse of the oil industry in the US, and help fund the chronically underfunded Highway Trust, which are highly desirable outcomes. Ultimately, we need to come to terms with predatory pricing and dumping – both for manufactured products and commodities. Finally, I would hope that we could fix the overall tax code in the next 2-3 years in a much more pro-growth fashion, rendering the long-term issue mute.

      Reply

  2. Avatar
    January 19, 2016

    A lot of baggage; among countless others:
    –Regressive tax inconsistent with appeal to middle class;
    –Saudi behavior more rational in political context — major producers (U.S., Russia, Iran) not on the friends list; unclear how Saudis play this;
    –Our old favorite — role of dollar instability — would this be further enabling?

    2 points for this to have a chance:
    –Keep it simple — addresses underfunded trust fund which will is pro jobs;
    –Get the trust fund back to its intended purpose — fix highway infrastructure and stop allocating pork to dubious ancillary uses

    Reply

  3. Avatar
    January 19, 2016

    Thanks, Wes. Three comments: 1) do you think, even if Congress followed your suggestions, that Congress would unravel the $20/barrel tax after a year or two? That suggestion may fly in the face of the old and true but seldom spoken (at least publicly) rule that once Congress (controlled by either party) gets its hands on the money, it keeps it. 2) with regard to the Saudis, I think they may have less flexibility than generally known. S. Arabia has a huge number of “guest workers” and if the Saudi economy goes south because oil revenues drop off, those workers, presumably then unemployed, could create substantial public unrest. In addition, I understand that a very large part of Saudi government revenues go to support the Royal Family – which I recall that about 15 years ago numbered over 60k – and if you walk around London or European vacation spots, you know members of the Royal Family don’t believe in budgets. 3) If your plan is viable, would Congress and the Pres go along with this in an election year?

    Reply

<