Failing The Course: Energy Economics and Subsidies

When I was a young lad in college, at the Massachusetts Institute of Technology (MIT) in the early 1980s, I took a course in energy economics taught by Prof. Morris Adelman.  I was an anomaly:  there were probably no more than a handful of courses then being taught in energy economics in the colleges and universities around the world, and Adelman was one of the very few people around who could have plausibly been called an “energy economist”.

Thirty years on, and the relative dearth of economic understanding in the energy sector persists.

Certainly, there is much more attention now being paid to the intersection of energy and economics at centers of higher education, but these professors are teaching students who will be leaders 20-40 years from now.

Most of today’s leaders involved in energy policy, who went to school decades ago (as I did), do not seem to have been exposed to (or if so, to have grasped) the importance of economic principles when setting energy policies.

Perhaps this economic ignorance in the energy policy realm is most apparent by the prevalence of energy subsidies.

As I’ve posted before, energy subsidies are powerful and dangerous things:  powerful because they are effective, dangerous because their effects can be bad.

And how prevalent are they?  The International Monetary Fund just issued a new study, entitled “Energy Policy Reform: Lessons and Implications”, that brings a fresh analysis of this difficult-to-measure topic.

By IMF’s estimates, on a worldwide basis, energy subsidies of all types summed to nearly $2.5 trillion in 2011, equating to over 3% of global economic output (GDP).

Certainly, some of the less-developed kleptocratic oil producing countries of the world are among the worst performers.  For instance, under the despotic rule of Hugo Chavez, Venezuela directed nearly 17% of its economic output into energy subsidies.

However, the U.S. performed no better than the world average, with fully 2.4% of its GDP subsidizing American petroleum markets.

This is not a good thing at all.  As the IMF notes right at the top of the executive summary of the report:

“Energy subsidies have wide-ranging economic consequences.  While aimed at protecting consumers, subsidies aggravate fiscal imbalances, crowd-out priority public spending, and depress private investment, including in the energy sector.  Subsidies also distort resource allocation by encouraging excessive energy consumption, artificially promoting capital-intensive industries, reducing incentives for investment in renewable energy, and accelerating the depletion of natural resources.  Most subsidy benefits are captured by higher-income households, reinforcing inequality.”

In all, it’s a long litany of ails that are amplified by energy subsidies.  And yet, they persist.  Why?

Do I really need to answer that question?

Whether future leaders have the strength to prevail over political forces that aim to preserve and enhance energy subsidies remains to be seen.  However, it is cause for some hope that a greater number of future leaders are being better taught about energy economics and better informed by estimates such as those produced by the IMF.

Let’s hope these future leaders pass their energy economics courses — not only when they attend school, but more importantly, when they’re out in the real world and make decisions and recommendations and actions that have consequence to us all.

Failure Is An Option: Cost Is Not No Object

I’m pretty skeptical when it comes to polls about energy issues.  Way too often, the questions are posed in such a way that they practically compel the respondent to answer in a certain way. 

Seriously:  if someone asks you “would you like the energy you use to have less environmental impact?”, are you going to answer “no”?

Valuable polls force people to make tough tradeoffs, as it is under “either-or” situations that true preferences are more accurately revealed.  In the case of energy polls, since most consumers are fundamentally economic decision-makers, questions have to be wedded to the potential dollars-and-cents implications.

And so I put a bit more credence in the results of a recent poll by the investment banking firm Lazard (NYSE: LAZ), in which they asked U.S. voters how much more they were willing to pay for lower-carbon sources of electricity. 

As reported in an article by the Financial Times, the Lazard poll indicates that, on a scale of 1-10 (1 meaning highly unwilling, 10 meaning highly willing), only 21% of respondents reported a score of at least 8 in terms of willingness to pay more for clean energy, with an average willingness to pay of an extra $9.74 on the monthly electricity bill.

Since the average American household spends about $100 per month on electricity, these findings suggest that the average American would be willing to tolerate about a 10% increase in electricity bills.  Implicitly, this means that the average American would be willing to pay about twice as much as they normally pay for electricity — for 10% of their electricity supply.  Given that the average price of electricity in the U.S. is about 10 cents/kwh, the typical American would thus be willing to spend up to 20 cents/kwh for 10% of their electricity to support an accelerated transition to cleaner power generation. 

Unfortunately, many clean electricity generation options — especially those that can achieve large-scale in the many locations not endowed with truly excellent renewable resources — remain at costs at or above 20 cents/kwh delivered to the customer. 

Consequently, it’s unrealistic for clean electricity technologies to supply more than a small portion of the overall power generation portfolio in the U.S. unless and until that fact changes.

In other words, without significant cost reductions, the promise of many clean energy technologies will remain just that:  promise.  Customers — citizens, voters — will not bend over backwards economically to foster a high degree of penetration of new clean energy technologies.  And, we’ll keep more or less doing what we’re doing today.

Against this backdrop, it’s interesting to read the recent report by Google (NASDAQ: GOOG), “The Impact of Clean Energy Innovation”.  Google recognizes that the clean energy movement needs significant cost breakthroughs to become massive in scale, and aims to depict what could happen if such breakthroughs were achieved over the next few decades:  offshore wind down from 20 cents/kwh today to below 5 cents/kwh, solar from 15-20 cents/kwh today to 2-4 cents/kwh, and carbon-sequestered coal generation from ???? (i.e., unavailable) today to below 5 cents/kwh.

As much as anything, the report is a call to unstick the lethargy and break from the status quo do-nothing posture that tends to befall the energy sector.  It’s as if Google aims to goad the energy industry into action, with such implorations as “Technologies that innovate fastest win” — something that Google should know about first-hand.  The closing line of the study couldn’t be any clearer in prodding for acceleration:  “The benefits [of energy innovation] are clear, so let’s go!” 

But Google is fundamentally a nimble and entrepreneurial Internet company, and they are shouting into the din of the massive and bureaucratic energy sector.  It seems naive, to me, that their words will resonate with their (presumably) intended audience.

Alas, along with the rah-rah cheerleading, the Google report’s authors also identify the immense obstacles to the path they themselves promote.  Notably, they confess that “smart policies are needed to drive innovation.”  In today’s toxic political environment, it is difficult to imagine any substantive new policies encouraging further energy innovation being implemented, much less so-called “smart” policies — always difficult to achieve in the best of times.

And, as Devon Swezey of the Breakthrough Institute notes in his recent essay “The Coming Clean Tech Crash” in the Huffington Post, “In an era of heightened budget austerity,  the subsidies required to make clean energy artificially cheaper are becoming unsustainable.”

At bottom, Google recognizes the challenge:  “Coal is very hard to displace on economics alone.”  Coal-fired generation is just so damned cheap (as long as environmental issues are overlooked), that its 50+% market share in the U.S. will be hard to dent materially if the invisible hand of the market is the only hand on the tiller.

Compounding the issue is the return of cheap natural gas.  As Google notes, greater utilization of natural gas generation driven by recent low gas prices would be good in the short-term for reducing emissions, but will slow innovation leading to wider-scale deployment of truly clean (i.e., zero or near-zero emissions) energy solutions truly necessary for the long-term:  yet another example of the type of tradeoffs often faced in the energy sector and indeed in society at large — with the short-term usually winning out over the long-term.

So, ultimately, a cleantech utopia is only achieveable with major technology breakthroughs to reduce costs to politically acceptable levels, yet clean energy innovation is greatly hindered (though not entirely stymied) by many of the forces at work.  This is the playing field on which we in the cleantech sector are faced with playing.  Sound like fun to you? 

Before you opt in, be aware that failure is indeed an option.  Don’t jump into the game thinking that this will be easy, because it will be anything but.  And, the way to score big points in the game is to reduce costs, period.

Dollars and Sense For Energy

One of the most important yet overlooked points about the penetration of clean energy into the marketplace is that there’s pretty much only one thing that matters:  cost.  I’ve said it before and I’ll say it again:  people buy all sorts of things — clothes, cars, electronic gadgets — based on non-economic factors, but energy is purchased based on its price. 

Think of it this way:  How much attention do you pay to the price of a gallon of gasoline?  Of beer?

Generally speaking, energy is a commodity, hard to differentiate, making price the main purchasing factor.  So, when some people object to clean energy technologies, the primary basis for their complaint is typically that it costs too much relative to other (typically incumbent, typically dirtier) energy sources. 

“Making the Case for Clean Energy” by Gabriel Miller, Camilla Sharples and Paul Ho of Hudson Clean Energy Partners does a nice job of comparing the costs of alternative sources of energy supply.  In particular, there’s an excellent graphic in the article depicting the reduction in cost of new energy technologies over the past 100 years as they are introduced and gain traction in the marketplace — thereby giving lots of evidence in support of the claim that new energy technologies will get more cost-competitive over time.

While we can’t rest assured, and must work to make those economic gains happen, those of us in the cleantech space have nothing to apologize for:  if history is any guide, new clean energy technologies will get cheaper over time, and can in many (most?) cases become cost-competitive with fossil fuels — especially as they get scarcer and dearer.