Federal Climate Policy Toolkit: Oil and Gas

Burning fossil fuels increases the concentration of greenhouse gases in the atmosphere and causes climate change. Minimizing our reliance on fossil fuels will slow down climate change. Federal policies that reduce the production and consumption of oil and gas—and that eliminate methane leaks—will help.

Eliminating Existing Tax Preferences for Oil, Gas, and Coal

The Basics

The tax code offers tax provisions and credits that benefit the fossil fuel industry specifically and encourage the production of fossil fuels. Policymakers can reduce emissions by eliminating some of these provisions, thereby reducing incentives for oil and gas production. Many provisions and credits favor oil and gas producers; the major ones are listed here:

• Accelerated tax deduction for intangible drilling expenses
• Accelerated tax deduction for resource depletion (“percentage depletion”)
• Tax credits for enhanced oil recovery
• Tax credits for marginal oil and gas wells (wells producing fewer than 25 barrels of oil equivalent per day)

Together, these credits and preferences cost the government between $3 billion and $7 billion each year. Eliminating some or all of these tax breaks can lead to increased government revenue and decreased emissions.

Benefits

• Increases government revenue by several billion dollars annually.
• Can reduce emissions by reducing oil and gas production.

Challenges

• Slightly increased energy prices, due to reduced supply of oil and gas. However, research finds that the effect on global oil production—and, accordingly, emissions and prices—would be modest.

Key Considerations

• Which tax credits and preferences to eliminate and which to keep.
• The accounting mechanisms that policymakers deem to be appropriate for the types of capital expenses incurred by oil and gas developers. This is in part a technical accounting question and in part a subjective determination about what type of tax treatment is deemed fair.

Past, Current, and Proposed Policies to Eliminate Tax Credits

Proposed bills from the 116th Congress that would eliminate these preferences include S. 4887, H.R. 7781, and H.R. 8411. All three bills would eliminate all the oil and gas tax preferences discussed above; the first two also would eliminate the refined coal credit.

Upstream or Midstream Carbon Tax

The Basics

Carbon taxes require companies to pay for each ton of GHG emissions they are responsible for, creating a financial incentive for companies and individuals to reduce their emissions. When implementing a carbon tax, policymakers must choose where in the economy to impose it—essentially determining who directly pays the tax. Policymakers can levy carbon taxes at any of the following points:

• Downstream, where the emissions occur, such as at a power plant or a gasoline pump when filling your fuel tank
• Upstream, at the point of production of fossil fuels, such as at a coal mine or oil well
• Midstream, somewhere in between, such as at an oil refinery

A midstream or upstream tax would apply to the “embodied emissions” in the oil or gas—that is, the emissions that eventually are produced when the fuel is burned. The cost of the tax would be paid directly by the taxed entity, but may be passed on to other entities, as well. For instance, some of the increased cost of an upstream tax would be borne by oil and gas producers, reducing production; however, to the extent that producers can raise their prices to cover additional expenses, some of the tax would be passed on to refineries (midstream) and utilities and consumers (downstream), reducing consumption. Reduced production and consumption alike lead to reduced emissions.

Benefits

• An upstream or midstream carbon tax encourages cost-effective emissions reductions in the covered sector, generally similar to an economy-wide carbon tax.

Challenges

• Emissions leakage. Leakage occurs when production shifts from an area with a tax to an area without the tax, or when consumers import fuels from foreign suppliers that are not subject to the tax. Leakage makes the tax less efficient and less effective at reducing emissions.

Key Considerations

• Leakage can be combated by imposing a border adjustment (import tax or export rebate) on the carbon content of imported (or exported) products, including oil and gas, so that domestic and foreign sources are treated equally. Imposing a border adjustment raises concerns, however, about ensuring that the adjustment comprehensively covers all related goods. For example, if the import tax applies only to crude oil but not to gasoline (which is made from crude oil), consumers may import the untaxed gasoline.
• Administrative ease. The structure of the supply chain may make it easiest to measure and apply a tax at a particular point. For example, the United States contains nearly one million operating oil and gas wells owned by thousands of companies (upstream), more than 100,000 gas stations (downstream), but only about 100 refineries (midstream). It may be easier to apply the tax at the level with the fewest entities, which in the case of oil is the midstream refineries.
• The preferred point of regulation may vary by fuel type; for example, scholars have argued that natural gas is best taxed downstream, because a large share of gas does not go through midstream processing, so would be missed by a midstream tax.

Past, Current, and Proposed Upstream or Midstream Carbon Taxes

Where carbon pricing has been implemented, it typically has been applied downstream for fossil fuels used at large stationary sources (like power plants) and midstream for oil refineries.

Reforming Federal Oil, Gas, and Coal Leasing Policy

The Basics

The federal government owns about 28 percent of US land and leases the right to extract fossil fuel from those lands to private developers. The emissions associated with the extraction and use of fossil fuels from federal lands are equivalent to about one quarter of US emissions annually.

Three policy reforms on this issue have received the most attention from policymakers: a ban on all new fossil fuel leasing, imposing “carbon adders” (akin to a carbon tax) on federal lands, and adjusting royalty rates (the share of fossil fuel revenues that the federal government receives).

Benefits

• All three of the aforementioned policies would reduce emissions, with the amount of reductions depending on the stringency of the policy.
• Imposing higher royalties would generate new revenues for the government. These revenues historically have been shared with the producing states and could help support communities that depend on fossil fuels for their livelihoods, as the economy transitions away from fossil fuels.

Challenges

• Because the policies would affect only the production from federal lands—not all US production—emissions leakage may occur; in other words, reduced federal production and emissions may be partially offset by increased production and emissions on nonfederal land within the United States and in other countries.

Key Considerations

• Policymakers must weigh key trade-offs, including emissions and revenues, given that fossil fuel leasing on public lands generates billions of dollars annually in royalty revenues for the federal government and the producing states.

Past, Current, and Proposed Leasing Reforms

The Obama administration issued a temporary moratorium on offshore oil and gas leasing, following the Deepwater Horizon oil spill, and later imposed a moratorium on federal coal leasing while it considered imposing carbon adders on new coal leases, potentially based on the social cost of carbon. In January 2021, the Biden administration took an analogous approach with respect to oil and gas leasing.

Methane Policy: Leakage, Venting, and Flaring Regulations

The Basics

The primary component of natural gas is methane, a GHG about 30–90 times as potent as CO₂. Methane can leak into the atmosphere at multiple points in the oil and gas supply chain, such as through leaky pipes and valves. Additionally, methane sometimes is intentionally released (vented) or burned (flared) as part of the production process, both of which contribute to atmospheric GHG concentrations and waste natural gas. Though methane theoretically could be captured and used, it’s often more practical for producers to dispose of the gas, because transporting gas to market can be difficult.

Benefits

• Regulating methane emissions can reduce GHG emissions while ensuring that less natural gas is wasted.
• Capturing more gas for delivery to market means more royalty revenues for the owners of the resource, which includes both private landowners and the federal government.

Challenges

• Although gas has value, the private value lost from flaring falls far below the social cost of emitting methane—in other words, companies have insufficient private incentive to capture the gas.
• Capturing excess gas is not always economical: many oil-heavy regions are in remote areas with limited gas pipeline capacity, so capturing the gas and delivering to market would require building new pipelines. The costly, unpopular alternative would be to shut the wells down completely and cease drilling, which would mean less energy production.
• Monitoring leaks at scale is costly and difficult. Methane leaks largely come from so-called “super-emitters”—infrequent but massive leaks; thus, the costs to install improved infrastructure may yield negligible benefits in emissions reductions at many wells that are not leaking to begin with, while the emissions reductions from other wells may be very large. Targeting heavily leaking wells in a timely way is difficult with existing technology.

Key Considerations

• Enforcing policies that penalize methane leaks requires those leaks to be tracked accurately. This means that regionally widespread yet accurate monitoring technology is necessary, but the most common monitoring technology is a handheld infrared camera, which is difficult to deploy at the necessary scale. Satellites increasingly are being deployed to improve monitoring; other approaches involve sensors on aircrafts or drones. Flaring is easier to detect, because the light produced by flaring is visible by existing satellites, but those data have not yet been explicitly incorporated into regulatory action.

Past, Current, and Proposed Methane Regulations

Many states have rules that limit the venting and flaring of methane, and the stringency of these rules varies from state to state and over time. At the federal level, the Obama administration issued regulations that restricted methane and other emissions from all new oil and gas wells, along with a Methane Waste Prevention Rule that limited venting and flaring from wells on federal lands and charged royalties on any such lost gas. These rules were rolled back by the Trump administration. Recent congressional proposals would reinstate Obama-era restrictions on new wells. In addition, the Methane Waste Prevention Act of 2021, proposed by Representative Diana DeGette (D-CO), would codify the Obama-era rule of the same name.

“Green” Gas Certification, Standards, and Markets

The Basics

By reducing methane leaks and taking other actions, gas producers can reduce emissions associated with the gas they sell. Creating certification programs to validate this low-methane-emissions gas, standards to mandate low-methane gas, and markets for “greener” gas can lead to emissions reductions without reducing the amount of gas that is produced and used.

“Green” gas standards would work by certifying gas that has relatively low emissions associated with it. Producers would get a certificate or credit that can be used to comply with the standards or sold to other companies that have more methane-intensive gas supply chains. This system could mirror a clean energy standard or renewable portfolio standard, as seen in the power sector.

Benefits

• Creates incentives for operators to reduce their emissions and provides a standardized way to measure the methane intensity of different gas sources.

Challenges

• Unclear whether sufficient market demand exists. If consumers are not willing to pay extra for green gas, operators will have little incentive to pursue certification.
• If certification is voluntary, only operators that are already low methane likely will opt in to claim credit, resulting in little to no reduction in emissions.

Key Considerations

• Designing a program to certify green gas requires widespread yet accurate measurement of emissions associated with gas production. However, methane monitoring is not straightforward. Improved satellite- or aircraft-based monitoring technology could facilitate this measurement.
• How frequently producers need to recertify. Because a single large leak can have a major effect on the overall “greenness” of a gas supplier, somewhat frequent certification may be necessary.
• Who designs and implements the green gas certification program. While standards would be set by the government (state, federal, or international), certification could be led by an industry coalition, nonprofits, or other stakeholders, and each option has different merits.

Past, Current, and Proposed “Green” Gas Policies

No federal standards for green gas exist yet, although some in the industry have begun voluntary efforts, such as ONE Future. Many other products have analogous certifications (e.g., fair trade coffee, Energy Star appliances). The US Environmental Protection Agency has used voluntary programs to reduce methane emissions, such as the Obama-era Methane Challenge Program and the Natural Gas Star Program (akin to Energy Star).

Some existing natural gas policies could be built upon to create a green gas standard or program. The Sustainability Accounting Standards Board requires member companies to disclose methane leaks in their US Securities and Exchange Commission filings. Finally, the Clean Energy Innovation and Deployment Act would encourage gas-fired power plants to demonstrate that their gas supply chain is clean, by providing credits for reducing emissions (i.e., provide greater financial incentives to produce clean energy) under a clean energy standard in the power sector.

This article is available as a published RFF explainer titled “Federal Climate Policy 108: The Oil and Gas Industry.”