Energy subsidies in a free market

This blog was written by John D. Wilson, former Deputy Director for Regulatory Policy at the Southern Alliance for Clean Energy.

Guest Blog | November 17, 2011 | Climate Change, Energy Policy

This blog is one of a series of posts about how the “power of free markets” may be able to help solve climate change. You can view the rest of the posts here.

Bob Inglis’ call to “simultaneously eliminat[e] all subsidies” for energy is another way that he believes we can use the “power of free markets” to make better choices about energy use. Although “subsidies” are often discussed, it is a concept that is hard to pin down. The World Trade Organization definition of a subsidy amounts to, “a financial contribution by a government, or agent of a government, that confers a benefit on its recipients.”

I hate writing that starts out with a definition in the first paragraph. But I felt it was necessary just this one time because it is too darn easy to think of subsidies as being direct cash grants and their easy-to-recognize siblings.

There are so many other ways that government “confers” financial benefits on energy businesses: tax breaks and market protection are two of the reasons that energy companies are so profitable. It is not hard to conclude that many parts of the energy market are not truly “free markets.” As David Roberts of Grist puts it, “when it comes to energy, saying ‘let markets decide’ is, more often than not, tantamount to saying ‘leave the status quo as it is.'”

Research & development subsidies are well-established

Energy subsidies are viewed by many as essential to energy resource development. For some, the evidence suggests that government support is nearly always a key factor in fostering innovation. For others, government is the risk-taker that can find a technology miracle. And a sympathetic economist might accept that a free market does a great job at finding the right price and quantity for goods, but markets don’t provide enough incentive to drive highly-speculative research.

For these reasons, R&D support has been carefully studied in energy and other sectors. Overall, research suggests that federal R&D support is an essential component of the collaborative approach that is the engine of U.S. leadership in innovation.

When it comes to federal R&D in the energy sector, no industry has benefited more than nuclear power. Since 1978, nuclear power has averaged well over $1 billion per year in federal R&D support, more than double the amount invested in renewable energy. Even in 2010, spending on nuclear R&D outpaced that of renewable sources of electricity such as wind and solar.

High levels of federal subsidy for renewable energy and energy efficiency are a recent phenomenon. With an influx of stimulus funds from the 2009 American Recovery and Reinvestment Act, overall subsidies (including R&D as well as other types of support) to the renewable energy sector spiked to temporarily reach 55% of federal support for electricity technologies. Recovery Act support has advanced key technologies from demonstration to market.

Tennessee and other Southeastern states have effectively used conventional economic development strategies to expand the region’s clean energy industrial base.

Bob Inglis’ opposition to energy subsidies have been echoed recently by others, although most of the new voices have focused on renewable energy, and the bankruptcy of Solyndra has been a rallying cry for rollbacks in federal energy policy.

But is Bob Inglis really aiming to eliminate all subsidies? Even with the long history of federal financial support for nuclear power, eliminating subsidies for nuclear power would have an enormous impact on its viability. Exelon CEO John Rowe “likes” nuclear but doesn’t think nuclear plants will be built without federal loan guarantees because “they simply cost too much and they are too risky.” He went on to say, “will you see anyone build a merchant nuclear plant? I don’t think so.”

Even so, the nuclear energy industry is trying to distance itself from the attacks on renewable energy loan guarantees, emphasizing that its loan guarantees are different – they will go to companies that are large and well-run. It seems that the nuclear energy industry is saying, “Loan guarantees are needed, but they won’t be necessary.”

Bob Inglis seems to think that free markets would deliver nuclear power plants better than the system of federal subsidies does today. But considering that nuclear power has received more federal subsidies than any other energy resources, that seems improbable at best. The problems with today’s subsidies for nuclear power are too numerous to discuss here, but if they are such a good deal for taxpayers, then why are government agencies and utilities collaborating to keep the basic facts secret?

While we can’t depend on energy subsidies to give us certain reductions in greenhouse gas emissions, support for research and development is essential to the development of new energy technologies which expand flexibility in meeting emission reduction goals. Building an economic development strategy around clean, renewable energy resources also makes a lot of sense. Propping up nuclear power to flood the electricity market with power that may not be needed, not so smart.

Less obvious subsides are harder to end

A recent report suggests that energy sector companies are among the largest beneficiaries of “tax subsidies.” According to Citizens for Tax Justice, major US companies paid $223 billion less in actual taxes than they would have at the statutory rate. Some Southeastern utilities appear to be avoiding taxes most successfully (sic).

While tax subsidies are easy to identify, the financial benefits conferred by regulators on monopoly utilities are less familiar to most members of the public. In the Southeast and some other parts of the country, monopoly utilities operate in a competition-free market. Regulators guarantee a reliable customer base, but restrict utilities’ profitability. It is a complex relationship with implications that aren’t immediately apparent.

One such benefit to electric utilities occurs when regulators require utility customers pay for power plants that are not being used. The concept of “stranded costs” was heavily deliberated in the 1990s during the push for retail competition in the electric utility industry, also know as deregulation. For example, the staff of the Virginia State Corporation Commission’s Draft Working Model for Restructuring the Electric Utility Industry (November 1997) offers a comprehensive discussion of stranded costs.

The justification for requiring utility customers to pay utilities stranded costs is based on the premise that the rules are being changed in midstream. Stranded costs, the argument goes, are “sunk investments which the utility made to fulfill its legal obligation to provide adequate and reliable service … To allow the consumer to abandon the financial support of investments legally required on behalf of that transfer … is simply unfair.”

Those who reject this perspective argue that the legal obligation of the utility to serve customers was in exchange for an exclusive service area franchise. Consumers never had an obligation to buy power, and the utility was never guaranteed the sale of electricity.

Georgia Power has proposed to shut down several coal-fired power plants.
Georgia Power has proposed to shut down several coal-fired power plants.

For example, Georgia Power Company (GPC) has applied to the Georgia Public Service Commission for permission to shut down several coal-fired power plants. In its application, it requests permission to “reclassif[y] the remaining net book values” of the coal plants “to regulatory asset accounts” and “amortiz[e] such regulatory asset accounts … over a period equal to the respective unit’s remaining useful life.” Included in the “regulatory asset accounts” would not only be the value of the power plants themselves, but also the “remaining, unusable material and supplies (“M&S”) inventory balance.” What this means is that when customers are paying for power, part of their rates will be used to pay GPC for the value of these shut-down power plants.

So what would it mean to “eliminate all subsidies” for energy? Would that mean mandatory deregulation for the monopoly utilities of the Southeast? Would it mean reshaping the entire free-market system to end the invisible and enormous institutions that favor fossil fuels in the market?

There are companies that are seeking to compete in the Southeastern power “market” today. Companies like Recycled Energy Development, who offer cleaner, cheaper energy resources to industry. Companies like Clean Line Energy Partners, which is showing how it can use high-voltage DC transmission to bring consistent, cheap energy from wind turbines on the Great Plains to the Southeast.

But not only do they have to be cleaner and cheaper than the operating costs of the existing power plants, but for every kilowatt of power sold to the utility, the new electricity product will be priced to help the utility pay for its out-of-service power plants. That’s a pretty hefty tax to pay for innovation.

How necessary is it to get rid of subsidies?

While there is a rich history of solutions to circumstances where price signals don’t work, the simple idea of “eliminating all subsidies” will be tedious to untangle. While the goal of a “free market” for energy may be appealing, in the context of a response to climate change, it is hard to see that it is needed to provide either certainty in reducing greenhouse gas emissions or flexibility in meeting those goals.

In fact, history suggests that it would be unwise to abandon R&D support for innovation in the energy sector; to do so would probably lock in existing resources until they run out, at which point we would have no ready alternatives.

And while an energy economist may be vexed by energy subsidies, perhaps it is the political economist who is more troubled by their effects. In tomorrow’s conclusion to this series, I’ll suggest an unconventional way in which energy subsidies can help point the way to a political solution.

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