On the Incidence Pombo’s Proposed Subsidy for Oil Companies

Richard Pombo, who is a Republican Congressman from Stockton, wants to subsidize certain oil production:

Tucked into a massive energy bill that would open the outer continental shelf to oil drilling are provisions that would slash future royalties owed to the federal government by companies prospecting in Rocky Mountain oil shale deposits. Sponsored by Rep. Richard Pombo, R-Stockton, and passed by the House earlier this year, the bill would amend an existing requirement that the federal government receive a “fair return” from oil companies that hold oil shale leases on public lands. Instead, Pombo’s bill would reduce royalties from the customary 12.5 percent of annual revenue to 1 percent … The provision would benefit the energy industry, which is a heavy contributor to Pombo’s re-election campaign.

Hat tip to Duncan Black for discovering Pombo’s excuse:

Pombo stands by his provision, a spokesman said. “The chairman and the majority of the members of the [House Resources] committee feel that it is the right thing to do because it is such a massive resource that it could provide relief for consumers and strengthen our economy,” Pombo aide Brian Kennedy said.

The good news is that President Bush and certain Senate Republicans are not so sure that they wish to support Pombo’s proposal. But let’s discuss the economics of providing below market rates to government owned resources. Sure, it would tend to give a little more incentive to oil production. But don’t higher oil prices already give incentives to develop these resources? Pombo is pretending that the incidence of these subsidies will most accrue to consumers rather than suppliers. In other words, he is assuming that the elasticity of the supply curve exceeds the elasticity of the demand curve. But suppose that the elasticity of the supply curve is low – as depicted in the diagram drawn by James Hamilton. Arnold Kling provides a verbal discussion in his “Energy Policy for Idiots”:

Who would benefit from a short-term suspension of the 18.4-cent-per-gallon retail gasoline tax? Probably not the American consumer. The biggest beneficiary might be Iran. In the short run, the supply of gasoline is fairly inelastic. Current inventories of crude oil and refined products are fairly difficult to adjust, so that the supply of gasoline is what it is. That is why it is pretty certain that drivers face a “tough summer,” in the words of the President. If the supply of gasoline is what it is, then the price of gasoline will be whatever it takes to limit demand to meet the supply. If that means $3.00 a gallon, then consumers are going to end up paying $3.00 per gallon, no matter what the tax is on gasoline. (Note: this analysis applies only in the very short run. In the long run, supply is elastic, so that some of a tax cut would be passed through to consumers.) If the tax cut on gasoline will not be passed through to consumers, then where will it go? It will go to oil suppliers.

Subsidies are similar to reduction in tax rates. So what is Congressman’s Pombo’s evidence on the long-run elasticity for demand and for supply?