California’s Proposition 87


I have intended to write this essay for a couple of months, but I have really struggled with what I wanted to write. Voters in California will decide on Proposition 87 in November. I have a number of friends and acquaintances who support this initiative, and even one who helped write the language of the initiative. Therefore, this essay is difficult to write, as it may offend some people whose friendship I value.

I have no doubt that this initiative will pass, but I have a lot of problems with the way this campaign is being run, and how oil companies are being vilified in order to win support for this measure. To be certain, oil companies are looking after their own best interests and those of their shareholders in opposing this measure. But I believe proponents are pumping out a steady stream of misinformation, even as they accuse the oil companies of doing so. I also think some of the proponents are very naïve if they don’t think this will increase gasoline prices in California. However, I would like to see gasoline prices go up to encourage conservation. Ultimately, my struggle is with whether the end justifies the means, and whether the money raised will be funneled into the most appropriate areas.


Proposition 87, commonly known as the Clean Alternative Energy Initiative, will impose a new wellhead tax on California oil producers. This is essentially what Hugo Chavez did in Venezuela – he decided he wanted a bigger slice of the petroleum pie and assessed additional taxes. At current prices, the new tax would amount to 6% of the value of a barrel of oil. If oil is selling for $75 a barrel, the tax on what the proponents call “excess profits” will amount to $4.50 per barrel. Proponents believe it will raise $4 billion in revenue from the oil companies, at no cost to consumers.

The initiative is being bankrolled by Vinod Khosla, and the proceeds will be directed primarily toward alternative energy, including Mr. Khosla’s ethanol interests. Mr. Khosla has said “just because I might benefit, doesn’t mean this isn’t a good idea.” True, but it creates a bit of a conflict of interest and gives rise to the potential that the funds raised will not be optimally deployed.

First, let me provide the links for the two opposing sides, so you can get more background information if you wish to do a bit of research:

Yes on 87

This is the website promoting the initiative, and they have lots of FAQs and background information. Opposing them, with their own set of FAQs is:

Californians Against Higher Taxes

Let me make it clear that I fully support alternative energy and conservation initiatives. However, not all alternative energy solutions are created equally. I have argued that corn ethanol, for instance, is undesirable for a number of reasons. Yet this initiative would funnel money toward corn ethanol, which is one reason I have a problem with it. It will help prop up an industry that already receives very generous government subsidies, while primarily just converting fossil fuels (natural gas, gasoline, diesel, coal) into ethanol. Corn ethanol promotes soil erosion, as well as herbicide and pesticide runoff into our waterways. On the other hand, the initiative would funnel money toward areas that I do support, like green electricity and biodiesel.

What Will Happen

I think the naïvety surrounding this initiative is stunning. Check out this passage from the Yes on Clean Energy site:

“Prop 87 would make oil companies — not consumers — pay their fair share for oil drilling, just like they do in Alaska, Louisiana, Oklahoma and even Texas. Oil prices will NOT increase. The California Attorney General has confirmed that Prop 87 makes it illegal for oil companies to pass the cost to consumers by spiking gas prices. And experts confirm the global markets won’t allow the oil companies to raise our gas prices either.”

This passage displays a stunning ignorance of how markets work, and how capital is allocated. Oil companies are going to be assessed $4 billion in new taxes, and consumers aren’t going to feel that? Please. Here is exactly what will happen. This is not speculation on my part; it is based on exactly how capital gets allocated.

When the initiative passes, oil companies will have a new tax to deal with in California. The returns on capital invested in California will drop, and it will be less profitable to extract oil in California. Each year oil companies determine where they will allocate capital to various refineries in the country based on expected returns on various projects. Refineries in various locations compete against each other for capital allocations, and now California will be at a bit of a disadvantage because they will be paying more for their crude. Not only will the returns from California be lower, but questions will arise as to when they might hold another initiative to increase the tax (ala Chavez). California refineries will get just a bit less of that capital, which over time will squeeze supplies. As gasoline capacity fails to keep up with demand, higher prices will result.

Now, pay attention to this next statement: One of the major proponents behind Prop 87 admitted to me that the scenario I laid out is likely, but he is counting on ethanol to step in and fill the gap. If you have followed my essays on ethanol, you know this is a great bit of wishful thinking. So, Californians will deal with higher gasoline prices. But guess what? I have no problem at all with that. It is the “truth in advertising” aspect of this that I have trouble with. And I also want to be able to say “I told you so.” The real irony of all of this, though, is that oil companies will be blamed for the higher prices and Prop 87 proponents will escape any accountability.

Paying Their Fair Share

Proponents have painted this initiative as a way to finally make oil companies pay their fair share in California. From a FAQ on the campaign:

“California deserves its fair share. Currently, oil companies pay California almost nothing to drill, while they pay billions of dollars in drilling fees to every other oil producing state. Prop 87 will set California’s oil drilling fees at levels similar to those in Oklahoma, Alaska, and Texas at no cost to consumers and with no increase at the pump. The California Attorney General has confirmed that Prop 87 makes it illegal for oil companies to raise gas prices to pass the cost of the fee to consumers.”

Here’s what proponents aren’t telling you. From Gasoline Taxes by State:

Oklahoma – $0.17/gallon
Alaska – $0.08/gallon
Texas – $0.20/gallon
California – $0.32/gallon

California has the 3rd highest state gasoline tax in the nation, behind only Hawaii and Nevada. I think California is getting their “fair share”, only they chose to get it in a way different from the other states mentioned. I would argue that having such a high gasoline tax has helped spur conservation more than if California had the $0.17 gallon tax of Oklahoma. This of course means oil companies are already paying a price by selling less product than they would if gasoline taxes were lower. The net revenue is probably about the same whether you have low gasoline taxes and an oil extraction tax, or high gasoline taxes and no oil extraction tax. What Prop 87 will do is put an oil extraction tax on top of one of the highest gasoline taxes in the country. That’s something proponents aren’t telling you.

Learning from History

Of course the U.S. has experimented in the past with windfall profits taxes. From a 1990 Congressional Research Service report:

“The windfall profits tax reduced domestic oil production between 3 and 6 percent, and increased oil imports from between 8 and 16 percent. This made the U.S. more dependent upon imported oil.”

Of course in California’s case, it will reduce state oil production and increase imports from other states. It will make California more dependent on oil imports from other states. It will increase costs for California refiners. Even proponents have to understand that increasing the cost of oil produced in California is going to make importing oil into California more attractive.

Another article recently caught my eye. It deals with California’s many failed attempts at reducing petroleum dependence:

How California failed in efforts to curb oil addiction

Some interesting excerpts for those who are determined to repeat history:

“For a quarter century, California has pursued petroleum-free transportation more doggedly than any other place in the U.S. It has tried to jump-start alternative fuels ranging from methanol to natural gas to electricity to hydrogen. None has hit the road in any significant way. Today, the state that is the world’s sixth-largest economy finds itself in the same spot as most of the planet: With $75-a-barrel oil, and increasing concern about the role fossil fuels are playing in global warming, 99 percent of its cars and trucks still run on petroleum products.

Oil and auto companies say they’re justified in resisting government mandates to roll out alternative technologies when they’re not convinced consumers will buy them. Donald Paul, Chevron’s chief technology officer, says California regulators essentially tell industry officials, “We know what the answer is. You guys just spend the money and everything will work fine.” He adds, “History has not shown that that works very well.”

Proponents of oil alternatives are pressing ahead. An initiative set for California’s November ballot would hit oil companies with an “extraction fee” on every barrel of oil they pull out in California, a top oil-producing state. The fee would range from 1.5 percent to 6 percent of the oil’s value, depending on the prevailing per-barrel price. Backers say the measure would raise $4 billion, which would fund research into alternative-fuel technologies and incentives for consumers and fleets to buy alternative-fuel vehicles.

The initiative is bankrolled by entrepreneurs including Vinod Khosla, a Silicon Valley venture capitalist who has been investing in ethanol and other alternative-energy businesses.”

The final paragraphs of that story really tell the tale of why proponents want to funnel more money into ethanol. Despite all of the government subsidies that the ethanol industry currently enjoys:

“Today there’s just one E85 station in California that is open to the public. It sits beside a highway interchange in San Diego. It was opened three years ago by Pearson Ford, a San Diego Ford dealer that was convinced alternative fuels would be the next big thing. The station offers gasoline and diesel, natural gas, propane, electricity, biodiesel and E85.

What it sells, though, is mostly gasoline and diesel. On a recent morning, it was offering E85 for $3.10 a gallon, about 6 percent less than the $3.30 per gallon it was charging for regular gasoline. But, because a gallon of E85 contains about 25 percent less energy than a gallon of gasoline, the E85 actually cost more per mile. Only a handful of cars pulled up to the E85 pump.

“I would like nothing better than to turn all my pumps over to alternative fuels,” says Mike Lewis, the station’s co-owner. “But I’m not willing to carry the alternative-fuel flag into bankruptcy.”

Promoting Hatred

This is where I have the biggest problem with the initiative. Proponents are using very inflammatory language to work voters up into a frenzy. This is nothing but demagoguery. In fact, Mr. Khosla wrote the following essay for The Huffington Post:

Big Oil’s Big Profits, and the Big Lies They’re Telling to Maintain Them

Of course the title is inflammatory enough, but the hypocrisy is what bothers me. Big oil is vilified for “big profits”, yet ethanol companies – which Mr. Khosla promotes – have far higher profit margins. An excerpt from the essay:

“It’s kind of like the tobacco companies that for years claimed that smoking doesn’t cause cancer. The oil interests are willing to publish any myth, and put any amount of money behind anyone who will support their untenable position.”

Following that essay, he wrote another:

The Big Oil Companies Have Been Ripping Californians Off — And Not Just at the Pump

Another inflammatory title, and more inflammatory rhetoric. Some excerpts:

“You thought you were being ripped off at the pump. You are, but that is only half of the story — the rip-off goes far beyond that.

As I blogged here previously, many of the big oil companies are raising prices at the pump while standing in the way of progress on immediately viable alternative fuels (while pretending through their vast network of slick lobbyists, consultants, ad agencies, PR firms and token investments, to be committed to alternative fuels) to lessen our oil dependence.

If the money and inside-Sacramento power of the big oil companies is going to allow them to rip Californians off, then certainly we Californians have the right, if not the duty, to join together and stand up for ourselves. But more on how they buy California (and National) politicians in a future blog (yes, post or email me your favorite big oil stories at and I will feature them here).”

I honestly don’t believe there is any excuse for promoting this kind of animosity toward oil companies – even if you do stand to benefit financially from doing so. I am just waiting for the day that someone gets so wound up they decide to attack oil company employees on the way into work. It’s as if some people think that big oil companies are just a bunch of fat cats in an ivory tower plotting how to rip people off. In fact, oil companies are made of working men and women who sometimes give up their lives to make sure the gasoline keeps flowing. “Big Oil” is made up of the shareholders of oil companies, which span the gamut of backgrounds. So when hatred is spawned in the direction of “Big Oil”, these are the people who are the recipients of this hateful rhetoric. For the record, I have told Mr. Khosla that I disagree with these tactics. His response was “We will have to agree to disagree on this one.”


I don’t live in California, so I don’t have to vote on this initiative. There are some good aspects and some bad aspects, and forces on both sides are engaged in a pretty nasty campaign to win voters. The proponents needn’t worry. I think this initiative will comfortably pass because of the public animosity toward oil companies. I didn’t write this essay to influence undecided voters. I think the message of hope that Vinod Khosla is preaching is more readily accepted that anything the oil companies are saying. But my prediction is that after the tax is enacted, the gap between gas prices in California and the rest of the nation – already high – will increase a bit more. I am content with that outcome, but I have a feeling that a lot of Californians are going to feel like they have been ripped off.

25 thoughts on “California’s Proposition 87”

  1. I said straight out some time ago that if California wanted to reduce carbon emissions from vehicles, all they had to do was increase the gas tax by a dollar or three.  It would fix the state budget, too.

    Looks like Khosla has found a way to accomplish only a fraction as much, but profit from it much more.

  2. That’s one reason I struggle with the initiative. It accomplishes some things that are needed. Gasoline prices will go up (despite claims to the contrary) and this should spur conservation. But I really dislike the campaign that the proponents are running.

  3. I think Mr Khosla senses there is public backlash against higher oil prices and is capitalizing on that sentiment with short term political and economic measures irrespective of their long term damage. Thats unfortunately how our system creates billionaires. Either that or he really doesnt know that oil is fungible and energy capital allocation is too.

    The vilification of oil companies belies the fact that the first half of the planets oil reserves have been plundered. Its not the oil companies fault that we all like the freedom and convenience of driving cars. No one complains when Microsoft makes billions, but Exxons profits are unacceptable.

    Prop 87 is forward looking, but not forward enough.

  4. Thanks for this, Robert. I live in California and will vote “no” on 87. This will come as a surprise to most people I know, and I will refer them to your insightful comments.

    I fully agree that raising gas prices is essential, but to then give the money to a fraud like Khosla makes no sense.

    By the way, have you ever looked into the Argonne GREET model that Khosla uses to justify his bizarre claims for the EROEI of ethanol?

  5. By the way, have you ever looked into the Argonne GREET model that Khosla uses to justify his bizarre claims for the EROEI of ethanol?

    I actually have a copy of the GREET model. I could write an essay on the problems with the model.

  6. Thanks RR. Based on your essay I will vote against 87 and cross my fingers. I don’t really care if gas prices go up here, heck I’d be happy to see a $2.00 gallon tax nationwide to encourage efficiency and get the guzzlers off the roads. But I am worried that oil companies might stop investing in producing crude here – your analysis didn’t really touch on that, yet wouldn’t that be the activity that’s impacted by the new tax, not refineries? We definitely don’t want to discourage oil companies from producing more domestic supplies – gack!

  7. But I am worried that oil companies might stop investing in producing crude here – your analysis didn’t really touch on that, yet wouldn’t that be the activity that’s impacted by the new tax, not refineries?

    That’s why I said California will be importing more oil. Yes, it will impact investments into oil production. If you believe the proponents, ethanol will slide right in and make up the shortfall. If you are skeptical that ethanol can fill the shortfall, then increased imports into CA will fill the shortfall.

  8. I actually have a copy of the GREET model. I could write an essay on the problems with the model.

    Robert, may I suggest that you do so? Khosla ends all discussion of EROEI by invoking GREET. I found it on the web, but it appears to be a “black box” program that is not easy to analyze.


  9. We definitely don’t want to discourage oil companies from producing more domestic supplies – gack!

    Wouldn’t it be better to leave our oil in the ground until it’s more needed, rather than blowing it on our current profligate lifestyle?

    This point makes me rethink my “no on 87” vote. Leaving American oil in the ground for as long as possible seems like a good idea to me.

  10. Has anyone done an independent validation of the model? The Argonne documents don’t appear to discuss validation. Putting “GREET and model” yields severa hits but none appear to address validation.

    People appear to be using it for policy decisions. For example: Z AMEL N, LI XG. Life cycle analysis of vehicles powered by a fuel cell and by internal combustion engine for Canada. JOURNAL OF POWER SOURCES
    155 (2): 297-310 APR 21 2006.

    So a sound external validation of the model (that is, published in a refereed journal) would be an important contribution to the debate.

  11. Oops. That sentence in my post above should have read “Putting ‘GREET and model’ into the ISI Web of Science bibliographic database . . .”.

    One of the hits does include a reference on validation. And much grey literature is cited, which means that it is outside the scientific anonymous peer review process.

  12. Wouldn’t it be better to leave our oil in the ground until it’s more needed, rather than blowing it on our current profligate lifestyle?

    Avo, I think the die is cast there. Just a little north of here, say between $4 and $5 per gallon, and there will be a hue and cry for drilling absolutely everything, that’s how spoiled we are.

    I’d rather keep coal in the ground until it’s needed. If drilling is closed as an option, make no mistake, we will ramp up CTL technology and damn the consequences.

    Some drilling now would help because increasing supply would ease pricing of the marginal (last 1-2 million bpd) oil, and that would bring down the cost of everything else. It would provide a double benefit to our balance of trade. It would have to be coupled with a big gas tax so that the savings go to the government to fund energy alternatives, instead of into giant SUVs. I realise I’m dreaming here…

  13. Robert, do you have data on the total petroleum tax, i.e. wellhead, gasoline, and whatever else there is at the state level? You pointed out that the states with high wellhead taxes have lower gas taxes, but didn’t mention the wellhead rates. Actually, though, I’m not sure these two taxes are directly comparable, in that one is paid by the producer and the other by the consumer. If gasoline taxes have an effect on capital allocation, we should see some correlation in the price of gasoline (ex-tax) in different states. Is this observed?

    Regarding thelastsasquatch’s comment that no one minds MSFT profits… There are millions of people who hate MSFT. MSFT has a long history of suppressing innovation and selling shoddy products. And MSFT has NEVER had a year like XOM just had!

  14. You pointed out that the states with high wellhead taxes have lower gas taxes, but didn’t mention the wellhead rates.


    Texas, for example, has a maximum rate of 4.6%. They also have lower gasoline taxes, and their overall average gasoline prices are lower than California’s (as are all states mentioned in the article).

    Actually, though, I’m not sure these two taxes are directly comparable, in that one is paid by the producer and the other by the consumer.

    As I pointed out in the essay, it ultimately doesn’t matter. The consumer will pay the tax either way. This measure will pass because the proponents are assuring voters that this cost will be born by the oil companies. The irony is that this measure will increase the cost of gasoline for the reasons I laid out, but who do you think will be blamed? The proponents? No, the oil companies will be blamed.

    And MSFT has NEVER had a year like XOM just had!

    This is a very common mistake people make when comparing the two. MSFT had a return on sales of 26.5%. XOM had a return on sales of 10%. Which had the better quarter? XOM, because they are a much larger company than MSFT? Come on. The size of XOM dwarfs MSFT, and that’s why they made more money. But don’t confuse profits and profit margins.

  15. I am wondering is you do not oppose a rise in gas prices, have you considered the affect this would have on those that could not then afford to go to work? Public transportation at least in the SF bay area is not what it needs to be to get people off the road and many like myself cannot afford to purchase “cleaner” cars as we are barely paying rent many miles from our work because we need work where the salary is higher, but cannot afford to rent there because the rent is too high for the salary we make there etc. I am all for conservation and in everyway I can I try to conduct myself in an evironmentally friendly manner. The answer is not a rise in a gas prices. The answer lies in fixing public transportation so that it becomes a viable alternative to driving.

  16. The one thing that bugs me the most on this proposition is the usage of the term “Drilling fees” in their ads. I was under the impression that my fellow Californians (not me) decided that no one would ever again be allowed to drill in this state, no matter how much it hurts us. How can you charge a fee for something that can’t happen?

  17. I am wondering is you do not oppose a rise in gas prices, have you considered the affect this would have on those that could not then afford to go to work?

    Yes, I have. That is one reason I favor higher gas taxes, offset by lower tax rates for low-income drivers. In my opinion, this would be the best solution. Gas prices are driven by supply and demand. We have to come up with a way to reduce demand, because our fossil fuels aren’t going to last forever. The only thing that people are guaranteed to respond to is higher prices. If they know they are coming, in the form of taxes, they can prepare. If they sit around with the expectation that prices will come back down, and don’t change their driving habits, then they will be in for a world of hurt.

    Peak Oil is going to hurt many people. There is no question about that. Even the situation we are in now, with tight supplies (my “Peak Lite” scenario) is hurting a lot of poor countries. Drivers in the U.S. are feeling the pinch, but over the long-term it’s going to get worse. Best to start making preparations now.

  18. Here’s another point. Take a look at this article which got some publicity last March:

    Undeveloped Domestic Oil Resources Provide Foundation For Increasing U.S. Oil Supply

    It describes the possibility for enhanced oil recovery techniques that could tremendously increase economically recoverable oil within U.S. boundaries. Based on this analysis, the U.S. could have as much as 400 billion barrels of technically recoverable oil. (For comparison, Saudi Arabia has 260 billion barrels of proven reserves.)

    Clearly, advanced oil recovery techniques are going to be key to the energy future. However the down side to this technology is that it is expensive to set up and operate. It will only make sense for oil companies to invest in this area if costs are minimized.

    Adding an oil tax is going to make oil production more expensive and slow investment in advanced oil recovery techniques. Many California oil reservoirs are well suited for this technology, which could benefit the state economy as well as the nation and the world. By putting a roadblock in the way of this potential technology California is only going to make future oil shortages more severe, and increase hardship to Californians and the rest of the world.

  19. That is kind of the point.

    Californians should get something from the runup in oil prices (they sure deserve it more than Saudi Arabia).  To the extent that the tax raises world oil prices, it encourages conservation and reductions in carbon emissions – another Californian initiative.  And because it affects global oil markets rather than just the state, it forces the whole world to go along.

    It’s more sneakily brilliant than was first apparent.

  20. Watching Prop 87 as well a the global climate change initative activities underway within CA government I can’t help but see a fairly quiet effort to establish huge new state government programs. The structure and specifics for these programs are unclear, but the operating budgets and scope of existing agencies will expand–a lot. I also note that the Lung Association is endorsing Prop 87. Beyond the ethanol vendors who is behind these initatives? Can we “follow the money”?

  21. I live in the UK so look on with some wry amusement when people in the US complain about the price of on gas but…

    Unless the price of gas rises how do you encourage people to reduce their consumption or make it viable for alternatives to mature?

    Isn’t there a big problem with ethanol from maize (which is where I believe most of the US’s comes from) in that it takes more oil to produce it that the oil it replaces – essentially a sop to agri-business.

    Surely the solution is to reduce the amount of oil being used in the first place, then the US doesn’t have to fund wars in the middle-east, go drilling in the artic reserve etc.

    I know it’s easier said than done and it’s not meant as a dig at you guys, here in Europe we’re screwed up to (but in different ways)

  22. Peak oil is looming. In my opinion, it will be here sometime before 2011. This is a momentous event that needs to be addressed. Prop87 will at least spur research in Cellulosic ethanol and solar power. With the brain power that exists in California, I have to support Prop87 for this reason alone. We can’t turn down any opportunities.

    That said, I’m not optimistic about our energy future. I think we are looking at shortages and high prices.

  23. Taxes on cars and gasoline in Europe is much higher than in CA – while traffic congestions is higher than ever there. From this
    I conclude that people would rather
    eat less meat than leave their cars. Regardless of public tranportation being very extensive
    in Europe.
    So I’d say just put another 50 cents tax per gallon – and solve obesity while doing it.
    Put the money in incentives for people to buy cleaner cars.
    They did it in the Netherlands – where a gallon costs about $4.80 or

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