Analysis of Fossil Fuel Subsidies, Negative Externalities and Subsidy Reform by Adam Sarwar July 22, 2013
Over the past few decades it has been widely accepted that fossil fuel subsidies are inefficient and wasteful, and that fossil fuel consumption pollutes the environment having a negative impact on climate change.
Studies also show that when fossil fuel energy is subsidized, it is consumed in larger quantities due to artificially lower costs, increasing the amount of pollution in the environment. There is a general consensus that reducing fossil fuel consumption will reduce it’s negative impact on the environment such as with decreased CO2 and greenhouse gases (GHGs) that are responsible for creating the warming effect on our planet’s weather.
The six case studies examined in The Effects of Fossil-Fuel Subsidy Reform: A review of modeling and empirical studies conclude that if fossil fuel subsidies are removed on a global level, then fossil fuel demand and consumption will decline along with damaging CO2 and greenhouse gases (Ellis, 2010.)
Therefore, if the impact of pollution on the environment from fossil fuels creates costly negative externalities, then inefficiently subsidizing oil companies that are making record profits should be discontinued so that less destructive, sustainable, and more efficient renewable energy sources and technologies can be utilized.
July 22nd, 2013
Analysis of Fossil Fuel Subsidies, Negative Externalities and Subsidy Reform
Energy subsidies are used around the world in order to help reduce costs for consumers or help producers be competitive within their industry, often leading to inefficient or wasteful consumption. This paper researches subsidy data revealing negative external costs associated with fossil fuel subsidies within the energy industry provided by the 1) U.S. Energy Information Administration’s (EIA’s) Annual Energy Outlook 2013, 2) The Joint Report by IEA, OPEC, OECD and World Bank on fossil-fuel and other energy subsidies (2010), and 3) The Global Subsidies Institute (GSI). It also reviews secondary data analysis provided by experts in the field such as Doug Koplow, Jennifer Ellis, Matthew Saunders and Karen Schneider in order to determine some of the effects of energy subsidies, specifically with regards to removing fossil fuel subsidies. This research explores the correlations between energy subsidies, production, consumption and negative externalities like pollution so recommendations can be made as to how to move forward with energy subsidy policies. I hypothesize that removing fossil fuel energy subsidies and supporting renewable energy will reduce market distortions in the fossil fuel energy industry allowing for more efficient energy sources and technologies to develop. Consequently, this will provide sustainable long-term energy and economic growth and development while also reducing negative externalities associated with fossil fuels.
As the world population increases along with higher energy demands, traditional fossil fuel energy sources like coal and oil are coming under greater scrutiny as the public grows increasingly concerned with the negative effects of pollution created from fossil fuels. Energy Subsidy Reform: Lessons and Implications, reports that the U.S. dominates in global annual fossil fuel subsidies paying around $502 billion, with China at $279 billion and Russia, at $116 billion (IMF 2013, 13.) The Big 5 Oil companies BP, Chevron, ConocoPhillips, ExxonMobil, and Shell earned a combined record profit of $112 billion dollars in 2012 while receiving massive subsidies and tax breaks (and tax loopholes) while taxpayers foot the bill of their energy subsidies (Taxpayers for Common Sense, 2013.) According to a report created by the Environmental Law Institute (ELI), the U.S. spent $72 billion dollars on subsidies for fossil fuels and $29 billion dollars on subsidies for renewable sources between 2002-2008, which clearly shows that U.S. government policies are focusing subsidy efforts on fossil fuels versus renewable energy (ELI, 2009.) The fossil fuel industry is making windfall profits and has been receiving favorable subsidies from the government while creating negative external costs (such as with environmental damage that are rarely accurately measured and taken into account) compared to the renewable energy market. Hence, it is illogical for the fossil fuel industry to continue benefiting from energy subsidies that make it more difficult for cleaner renewable energies and technologies to be competitive and affordable.
In June of 2013 President Obama created a Presidential Climate Action Plan acknowledging the negative effects of fossil fuels on the environment, which have a direct impact on taxpayers through the healthcare costs and disaster relief costs that result in severe weather and disaster recovery. The plan also notes that extreme weather conditions such as droughts are putting farmers out of business and increasing food prices. His goal is to reduce dangerous greenhouse gas by 17% below 2005 levels by 2020, reducing the effects carbon pollution and therefore reducing the economic effects the climate has on the U.S. (The White House. 2013.) It is only logical to seriously address climate change, as there are both direct and indirect costs associated with damage resulting from pollution’s impact to the environment. 2012 had over $110 billion dollars in disaster recovery costs due to severe storms brought on by climate change such as with the devastating damages caused by superstorm Sandy, estimated at $65 billion. There is a general consensus that pollution negatively affects the climate and since the industrial revolution pollution has been increasing (and recently drastically) affecting global weather patterns such as with the recent super storms like Sandy and Katrina hitting U.S. coastlines. The President also made the pledge that the federal government will consume 20% of its electricity from renewable sources by 2020 compared to the current rate near 7.5% and his Climate Action Plan makes a clear connection with the negative impact fossil fuels have on our health and environment. During President Obama’s speech at Georgetown University in June 2013 he said, “The question now is whether we will have the courage to act before it’s too late.” Though this sounds great, one must follow the money trail of government subsidies analyzing how they affect the prices, production and consumption of fossil fuels and renewable energy to determine if this plan to help climate control by reducing pollution and greenhouse gasses is being effectively implemented.
The economic, environmental and healthcare costs associated with the effects of fossil fuel pollution are major negative externalities that must be addressed as we move into the future. Combine those externalities with the fact that there is a limited supply of fossil fuels available and a virtually unlimited supply of renewable energy through wind, solar, hydro and thermal, one must ask, “Have we really implemented the best energy subsidy policies possible geared towards sustainable growth and development?”
Scott Hodge, the president of the Tax Foundation references the International Energy Agency’s (IEA’s) 2010 G20 report citing “five general justifications for subsidizing energy: (1) alleviating energy poverty, (2) boosting domestic supply, (3) redistributing natural resources wealth, (4) protecting employment, and (5) environmental protection.” (Hodge 2010, 2.) Each government or economy ultimately operates for their own wellbeing but creating an optimal energy policy requires all parties to work together, communicate effectively and work towards the same goals. This does not appear to be the case with regards to the U.S.’ current energy subsidy position when looking at the substantial difference between fossil fuel and renewable energy subsidies. To avoid additional costs (or show that they are subsidizing a product) with producing pollution and getting taxed for it, the U.S. will also import goods from highly polluting countries that are energy intensive making it seem like the U.S. creates fewer negative externalities, typically within the manufacturing and transportation industry, which are energy intensive.
Subsidies are complicated tools available to the government depending on the objectives and goals desired. As just described, the way subsidies are used can help report ‘preferable’ numbers by the government with regards to import/exports numbers or with regards to employment statistics within subsidized industries for example. The complexity of subsidies makes it difficult to track and fully understand and there are no subsidy policies where ‘one solution fits all’. Each policy utilized is dealing with a different set of variables and circumstances such as the geography, economies, trade regulations or good and services being sold. As with many policies there are also shortcomings and factors that must be taken into consideration that can create uncertainty such as ensuring the accurate measurement of subsidies and or understanding the potential outcome of each policy. Understanding what gaps exist within current subsidy research is also important so further study can be more strategic with regards to the effective use of subsidies.
Common Forms of Government Intervention
Doug Koplow, the founder of Earth Track in Cambridge, Massachusetts’s lists a number of ways the government intervenes with energy markets in his paper Subsidies to the Energy Industry (2004.) The plethora of government intervention tools available and the effects of any changes within these policies can be difficult to measure making it problematic when trying to determine what policies will be most appropriate and effective. Changing one variable such as a price can have a ripple effect on many other variables, so influencing multiple variables while exercising an appropriate amount of control is challenging. Commonly used methods of intervention for energy are as follows: access to resources, direct spending, taxation, cap-trade, taxing, import/export restrictions, price controls, government ownership, risk, information, regulations, purchasing requirements and lending (Koplow, 2004.) Tracking the effects of all government intervention with a large number of variables is not an easy task. Some of these tools such as direct spending, taxation, lending and research & development have a more direct impact on taxpayers, as they are the ones that are inevitably footing the bill through paying taxes. One of the challenges with removing subsidies to cheap fossil fuels is that those with lower income will be adversely affected as small fluctuations in energy prices can have a large negative impact on those customers. In cases like this a ‘cross-subsidy’ might be used to help mitigate these effects on lower income housing such as if this incident took place in a remote region of a developing country for example. Maintaining a certain level of subsidization might be necessary, but at different level for different customers or regions. The government’s use of regulations, import/export restrictions, price controls and purchase requirements to influence markets do not require taxpayer money to pay for any inefficient pricing, but can create changes in price due to supply and demand or control of international business. If a government wants to support a growing industry or technology they might sponsor some of the research and development or lend money for such research to be done. For example, the U.S. government’s Defense Advanced Research Projects Agency (DARPA) has developed many cost prohibitive technologies such as with types of robotics, fiber optics or high-end computing and often companies working with these technologies can augment their technology with new research performed by DARPA.
Objectives for Subsidies by Energy Type: Renewable, Fossil Fuels and Nuclear
Koplow points out that all subsidies are meant to stimulate and support economic growth, meet growing consumer and industry demand, and generate employee and social benefits (2004.) Subsidies aim to stimulate economic growth in some way, even if they end up generating negative external costs. Government subsidies policies are also in place to encourage national economic growth and development while trying to maintain an edge with competing economies. Having a diversified energy portfolio helps fortify U.S. national security through not being controlled by fluctuating imported energy (oil) costs and supply that may negatively affect the U.S. economy such as with the 1967 Oil Embargo.
Fossil fuels are low costs energy sources and when subsidized, it can help lower income citizens with their energy needs or helps energy intensive industries maintain a competitive edge with international markets through having lower energy costs. The economy can also be boosted in national and/or on a local level through lower subsidized energy costs (GSI 2011.) With coal being frowned upon for being a dirty energy, subsidies are given to spur development with natural gas (another fossil fuel) as the prices have equalized over time and there is a push towards cleaner energy.
Subsidy policies to nuclear and renewable energy are often created in order to protect the environment from drastic climate change and global warming brought on by increases in CO2 and greenhouse gases (GHGs). Renewable energy is widely seen as a clean and green with zero (or near zero) emissions, but nuclear energy is drawing criticism with the recent explosion of the Fukushima Daiichi Nuclear Power Plant in Japan. Adding a number of renewable energy sources through subsidization also helps with increasing energy access to consumers and realizing social benefits (GSI 2011.) Subsidizing renewable energy also stimulates cost reductions in renewable energy technologies such as with recent investments in wind and solar energy.
Job creation is another reason why some industries might be subsidized. It is ironic that Big Oil claims to be responsible for job creation and stirring the U.S. economy. However, it is shown that even with far less renewable energy being produced in American compared to fossil fuels, renewable energy industries are proving to be responsible for job creation with the Bureau of Labor Statistics (BLS) reporting a 12.5% increase in employment in the Green Goods & Services (GGS) Utilities sector in 2010 and 12.9% in 2011 (BLS, 2013.) As the renewable energy industry picks up, it will continue to add a number of job types that are more technical, increasing employment in the energy and technology sectors. Initially there may be a need to transition and train workers from other industries like oil as the oil industry has not been adding new capacity compared to that of renewable energy. In 2012 there have been ten times the number of job losses due to “extreme weather conditions” compared to that of “government regulations/intervention” which is another point to consider when thinking about employment rates and their correlations to energy and the impact that energy has on the environment.
Gaps in Existing Subsidy Studies
The Global Subsidies Initiative (GSI) reported on the gaps in existing studies providing a framework for developing more accurate and granular models and studies to improve on the understanding of energy subsidies. Research and development are a large part of making sure any policy is successful upon implementation. With regards to renewable and fossil fuel energy there are “few qualitative or quantitative analysis of subsidies to generating companies (OECD or non-OECD)” (GSI, 2011.) Renewable energy is also a relatively new energy source compared to fossil fuels so there will naturally be less data to review.
Fossil fuel subsidy studies are not capturing accurate numbers with regards to capital grants, lending based support mechanisms, tax incentives and mandates making it difficult to truly track, and potentially not accounting for many additional subsidies in use. An analysis of consumer studies to electricity is also limited to subsidies with price effects and non-OECD countries. The Organisation for Economic Co-operation and Development (OECD) is a group of 34 countries around the world working towards global development and a cleaner more sustainable future.
Nuclear energy subsidy studies have not captured accurate and in-depth subsidy data and there are few attempts to do so on a national level. On top of that there are inconsistent methodologies for liability subsidy estimation (GSI 2011.)
Even when the same methodologies are used by agencies in order to obtain subsidy data such as with the commonly used Price-Gap Approach, results may vary and this goes to show how unreliable some of the data can be.
Common Methods of Measuring Energy Subsidies
Per GSI’s Subsidies and External Costs in Electric Power Generation: A comparative review of estimates (2011), there are three common approaches to measuring subsidies: 1) The Price-Gap Approach, 2) The Transfer Measurement Approach and 3) The Integrated Approach. The Price-Gap Approach, the most commonly used measuring tool for subsidies, measures the difference in observed price for versus a free market reference price that “should” be paid (Koplow, 2009.) The Transfer Measurement Approach relies on a bottom-up assessment to quantify the subsidy associated with a given program, regardless it’s effect on end price and requires substantial data to be effective. The Integrated Approach is where a framework applied by the OECD uses direct transfers as a result of government policy that reveal the value in transfers to and from Producer Support Estimates and Consumer Support Estimates (PSE-CSE) (Koplow, 2009.)
As mentioned earlier, the measuring the total value of subsidies is often incomplete so it is essential to review several case studies to learn about the effects they might have on economies or other specific factors such as CO2 and GHG emissions. When there is a trend amongst similar studies you can assume that there is a chance one may draw useful conclusions as a result.
Six Case Studies on Fossil Fuel Subsidy Removal by The Global Subsidies Initiative
An analysis of fossil fuel subsidy removal created by Dr. Jennifer Ellis shows positive outcomes reporting that, “All six of the multi-region, multi-fuel studies found overall increases in real income or GDP in both OECD and non-OECD countries” and decreases in CO2 and GHG emissions. Global increases in GDP ranged from 0.1 per cent in total by 2010 (Saunders and Schneider, 2000) to 0.7 per cent per year to 2050 (Burniaux et al., 1992)” (Ellis, 2010: 27, 29.) The Global Subsidies Initiative’s six case studies show a clear connection with removing fossil fuel subsidies and the positive outcome on GDP and the environment, a result of more efficient resource allocation.
Negative Externalities (external costs) and Cases
Koplow compares the negative external costs by energy types presented on Table 1 in order to determine which energy types have fewer negative external costs and measures this in terms of years of life lost, environmental damage costs and quantifiable external costs.
Table 1 – Overview of Externalities by Energy Resource
|Fuel||Years of life lost/TWh||Environmental damage costs (Euro-cents/kWh)||Quantifiable external costs (Euro-cents/kWh)|
|Coal, > 2000||113||4||3.4 (lignite)|
|Oil, > 2000||139||2.6|
|Gas, > 2000||29||1.7|
|Nuclear < 100 years||1||0||0.2|
|Nuclear > 100 years||8||0.2|
Source: (Koplow, 2004, 762) www.earthtrack.net/files/Energy%20Encyclopedia,%20wv.pdf
With renewables and nuclear environmental damage costs at or near zero compared to fossil fuels, Koplow concludes that coal, oil and gas are much more damaging to the environment compared to nuclear, and renewable sources like biomass, photovoltaic, wind, and hydro (2004.) One must note that renewable energy is relatively new compared to fossil fuels, which might skew results a little, but not enough to disprove the point being made. This research shows that subsidy policies affect the environment and negative external costs depending on what energy type being subsidized with fossil fuels have much higher negative external costs when compared to that of renewables.
Some of the costs with renewables are nearly zero with photovoltaic energy being 0.1-0.3 and biomass at an even smaller amount 0-0.8. In the case of Biomass, photovoltaic, wind and hydro, the environmental and external costs are nearly zero or zero. Considering this data is available along with other reports on negative external costs to fossil fuels, it would seem logical to find a way to reduce consumption of harmful energy sources that also affect the quality of life. Cheaper energy (fossil fuels) gives consumers in developing economies access to building a greater life and society, but at the risk of health costs and even death. Government programs would need to be in place to help reduce any shock to those of lower income when fossil fuel subsidies are removed and possibly target them with subsidy policies more so than other groups or regions.
When BP had it’s recent oil-rig explosion with the Event Horizon, they used dangerous chemicals like Corexit to disperse the oil making it form small droplets falling to the bottom of the ocean floor, which parts of are now covered in oil killing life it touches such as with the coral reefs and creating mutations to new life in the area. People who live in the area have been reported very sick. Even with some of these stories being reported on the news, the government has not tried to stop BP from using these toxic chemicals in the clean up process, and not all the oil has been cleaned up. “Corexit is not only toxic to marine life on its own, but when combined with crude oil, the mixture becomes several times more toxic than oil or dispersant alone” (Kirby, 2013.) If the government does not help those who are affected by these negative externalities than those costs are not even being taken into consideration and instead neglected. This is often the case with environmental disasters. Total clean up and recovery claims to BP to date may be up towards $90 billion, and that does not mean the oceans will actually be clean, or unpolluted from the spill (Chazan, 2013.)
Take the case of China with regards to their acknowledgement of car emissions effect on their environment. China has acknowledged that the environmental and healthcare costs of pollution is having a negative effect on their country leading to higher costs in healthcare and shorter life spans. As a result they have already successfully implemented laws (target subsidy) to reduce sulfur dioxide from automotive emissions in order to make a positive change in healthcare costs due to emissions pollution (Remais, 2011.) China is rushing to tackle some of their energy issues not only as they grow as a country and demands increase, but also because the environmental impact has economic costs that must be considered in order to truly have sustainable growth and development. China is now the global leader in clean energy investment, as of 2009 they had invested in $34.6 billion dollars while the U.S. had only invested $18.6 billion (Remais, 2011.) In this case, China sets an example to take environmental issues created by fossil fuels seriously.
Fossil fuels are the leading source of pollution caused by energy production with a costly impact on the environment and the world, one that is not even fully understood at this time. The Joint Report by IEA, OPEC, OECD and World Bank on fossil-fuel and other energy subsidies makes a statement taking their stance against inefficient and wasteful subsidies that create or encourage negative externalities, which increase the overall costs of energy, including the negative external costs.
Inefficient fossil fuel subsidies that encourage wasteful consumption are economically costly to taxpayers, can damage the environment through increased emissions of greenhouse gases and other air pollutants, and by distorting the energy mix. Several studies have also found that subsidies to fossil-fuel use tend to benefit high-income households more than the poor, due to the former’s higher per capita consumption levels (World Bank IEG, 2008). According to the IEG study, the bottom 40% of the population in terms of income distribution received only 15-20% of the fuel subsidies in developing countries. However, a reform of inefficient fossil-fuel subsidies that encourage wasteful consumption may require some safety net to protect low-income households and other vulnerable populations that would otherwise benefit from such measures.
(G20 2011, 7 www.oecd.org/site/tadffss/49006998.pdf)
Benefits of fossil fuels subsidies include making energy cheap to produce and consume making it easier for developing countries and their citizens to afford basic power needs, which lead to further economic growth and development. However, as indicated above, subsidies to fossil fuels tend to benefit higher income households over lower income households and removing such subsidies can also have a larger impact on low-income consumers. Oil and coal are in abundant supply making it easy to extract and transport, though the transportation alone of these forms of energy also have intensive oil requirements.
Trends in Energy Consumption, Production and Oil profits
The U.S. Department of Energy’s Energy Information Administration (EIA) forecasts a leveling of coal use, which is hazardous to the environment and a steady increase in renewable energies, mainly from solar and wind. Because of the ease of collecting coal and oil and the amount still available, these forms of energy creation will still be an important part of the global energy portfolio, but not an environmentally friendly option. Over time pollution reduction technologies will help mitigate the negative effects on the environment. As a result of current cost prohibitive technologies and permit requirements, there is no movement on building new energy generators using fossil fuels.
Despite fossil fuel’s favorable subsidized energy policies, you can see that energy consumption is changing in the U.S. as Table 2 shows from the DOE’s Energy Information Administration (EIA) indicates with the trends in U.S. energy consumption from 1776-2012 by fuel type.
Table 2 – History of energy consumption in the United States (1776-2012)
Table 2 shows consumption of energy from petroleum is taking a dip along with coal taking a major dip as it becomes replaced by natural gas. Renewable energy only provides a small fraction of total energy consumption within the U.S. but those rates are climbing with hydro (which is a form of renewable energy) and nuclear energy remaining stagnant. This graph does not show a detailed account of the changes, but a further look into this data through the EIA’s Annual Energy Outlook 2013 reveals these statements to be consistent.
The U.S. has a portfolio of energy sources based on costs, geography, politics and the willingness of citizens to pick where they want to buy their energy from. Some of these energies are more sustainable than others, but not all energy types are subsidized the same. In some cases, the purpose of subsidies work against each other such as when tax credits are given to fossil fuel producers and are allowed to pollute without any fines on a federal level and then given tax credits (direct payments from tax payer dollars) if they pollute less. These industries are still polluting which has a direct environmental impact and cost, as these costs to taxpayers are not taken into account. In the end taxpayers are paying through inefficient subsidizing, paying the tax credit and for the cost of environmental and healthcare costs. These negative are an example of a wasteful policy creating inefficient consumption as the tax dollars are given to an energy producer that is incurring additional costs through environmental damage.
Oil continues to make massive profits, while producing less oil and increasing
their prices along the way even when taxpayers are paying their government
subsidies that help destroy the environment and reduce the quality of life. Table 3 on the next page show massive profits
for the five Big Oil companies, also displaying oil and gas prices with gas
being artificially lower than oil. Clear
evidence that subsidies to oil are wasteful and inefficient, especially when
production is lower by 3% in aggregate for all 5 companies over the past
year. Table 4 compares oil production
with gas prices since January 2001 indicating that even with oil production
remaining steady, gas prices are climbing steeply.
Table 3 – Big oil vs. prices for oil and gasoline
Table 4 – Oil production vs. gas prices
If oil companies are making record profits while producing less and still obtaining steep subsidies through taxpayers, doesn’t it make sense to adjust or remove their subsidies? Being some of the most profitable companies in the world, they certainly do not need financial assistance. Big Oil likes to claim that they are responsible for America’s economic growth, but there is plenty of evidence that can show that is not the case such as with the new technologies creating clean energy, which do not have a negative effect on the environment.
Research conducted by major economies and institutions around the world show that a transparent and globally unified approach must be taken to reduce and remove fossil fuel subsidies that create harmful and costly global warming effects. Instead, move towards a sustainable clean energy production mix such as with solar and wind renewable energies and subsidize those technologies instead to speed up the process of technological innovation bringing reduced prices in energy and increased efficiency. More granular and robust studies on subsidy removal and measurement are needed in order to have more effective policies. Once an industry starts receiving subsidies it can be hard to discontinue them even if they are inefficient and wasteful such as in the case with oil subsidies. Though numerous studies are conducted, there has not been a consensus on the best portfolio of energy subsidies that should be used. Many studies are not perfect as there are variables that may not always be accounted for, as one change in a price, tax, subsidy and so on has a ripple effect on production, consumption, the environment, healthcare costs and negative external costs.
My recommendations would be to phase out fossil fuels in such a way that it has as little negative effect possible on the many variables associated with it, but making sure that the negative costs to the environment are made a priority. There is no research that can claim when the globe’s ecosystem could collapse due to pollution from fossil fuel energy. This is not an easy task, otherwise it would most likely already have been done. The U.S. government’s holding the hands of Big Oil is part of the problem and though the U.S. and other countries and organizations are in talks of creating a more sustainable future, they must tackle the issues of inefficient and wasteful government subsidies, especially pertaining to polluting fossil fuels. As technological advances increase, computer modulations and simulations may be able to help economists around the world with creating formulas and measuring the impacts of changes to any variables that affect energy, pricing, production, consumption, social effects, healthcare costs and environmental effects and so on. Another suggestion is educating the US (and global) population on energy and the environment giving them information to make educated decisions so that everyone can be involved in creating a less polluted, more efficient energy system. If one does not know the true costs associated with energy from coal, then they may not care to consider using a new solar panel they can get subsidies for or tax rebates on.
I conclude that over time, more evidence will present itself and general populations will make clearer connections between their energy usage and the negative impact it has on the environment. With this information, subsidy and energy policies will be reviewed, removing wasteful subsidies and encouraging sustainable economic and energy growth and development.
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Fracking is an increasingly popular method of collecting natural gas from the ground, also releasing Methane gas (a negative externality), which is 20 times more toxic than CO2 emissions.
The methane released from fracking is not properly mentioned in the news or many reports on natural gas and their harmful effects as the government backs them up.