January 9, 2011

Letting the Market Decide

This interesting piece by Jeffrey Leonard in the Washington Monthly calls for an end to energy subsidies of all kinds--including the "green power" industries with which he is professionally involved--and insists that it would actually contribute to a greener future. Energies subsidies, which he estimates at some $20 billion a year, take many forms:

Some of them are direct outlays of taxpayer dollars, like payments to corn producers for ethanol. Most are in the form of tax benefits, such as the deduction for “intangible drilling costs” (labor, repairs, hauling, you name it) in oil exploration—a notoriously abused provision of the tax code. The sheer number of subsidies is part of what makes them so hard to track.

But one thing about them is easy to summarize: they are heavily tilted toward fossil fuels. Government statistics show that about 70 percent of all federal energy subsidies goes toward oil, natural gas, and coal. Fifteen percent goes to ethanol, the only renewable source of energy that consistently gets bipartisan support in Congress (think farm lobby and Iowa). Large hydro-power companies—TVA, Bonneville Power, and others—soak up another 10 percent. That leaves the greenest renewables—wind, solar, and geothermal—to subsist on the crumbs that are left.

None of these estimates account for continuing support to the nuclear industry, estimated to be about $1 to $2 billion, much of it to promote research and development efforts on new nuclear technologies and waste disposal methods. There are plenty of hidden subsidies, too. We place a cap on liability for accidents (like the BP oil spill). We offer the nuclear industry large loan guarantees. And, of course, we maintain an immense military embroiled in the Middle East and elsewhere as it tries to secure access to energy resources around the globe.
Leonard doesn't suggest any action for eliminating the subsidy for oil deriving from that immense military establishment embroiled in the Middle East, but otherwise calls for a complete end to government support. He points to five developments that will help ensure a less carbon intensive future even in the absence of government action:

What the green lobby may underestimate is the degree to which the “free market,” given the current natural direction of the energy sector, would ultimately support the cause of clean energy in the absence of subsidies. Hence a “benign neglect” approach by Washington to the energy industry would be the best strategy for now. Emphasizing the elimination of existing subsidies and the creation of a level playing field would benefit green energy sources by enabling them to fit into rational long-term energy supply strategies pursued by public utilities, while also allowing the whole energy sector to respond better to price signals and consumer demands.

Major changes in the picture of domestic energy supply make it possible to sweep away decades of accumulated subsidies without seriously threatening the affordability of energy. In the mid-1900s, the dominant fuels and sources of energy in America—for all sectors of the economy—were petroleum and coal. The rationale for subsidizing these fuels was simple: they were the backbone of the economy, and adequate supplies needed to be assured. The good news is that this rationale no longer applies: the U.S. energy market, if left to its own devices, without distortions or subsidies, will continue to provide plentiful and affordable power while gradually evolving away from oil and coal as the primary energy sources. This changeover to what will be cleaner energy solutions will accelerate considerably in coming years, thanks to several major trends.

The first trend, a real game changer, is the discovery in recent years that America is sitting on many decades’ worth of exploitable natural gas. Natural gas emits half the carbon dioxide of coal. Although its extraction poses threats to underground water supplies in some places, these can be managed with proper regulation and are in any event much less serious than the environmental threats posed by coal mining. Gas is also more cheaply and safely transported. It can be moved to power plants through underground pipelines, unlike coal, which requires heavy trucks and trains to struggle over mountain ranges. And it is every bit as abundant as coal, if not more so, and as widely dispersed geographically. Since the late 1980s, natural gas has been the fuel of choice for the majority of new electricity-generating plants constructed in the United States. Over the next forty years, nearly all of America’s existing coal-fired power plants will reach the end of their useful lives, and a significant portion of them will probably be replaced by cleaner-burning natural gas facilities, especially if the subsidies that buoy the coal industry today are allowed to expire. Now that adequate supplies are assured for the future, a lot of investors are betting that natural gas will gradually replace coal as the dominant fuel in the electricity-generation sector. This trend by itself will significantly lower America’s carbon footprint by 2050.

Natural gas–fueled electric plants will also foster increased use of wind and solar power. Both these renewable energy sources require a backup source, because the wind blows intermittently and the sun doesn’t always shine. A coal plant must be kept burning once it’s been fired up, so coal-fired electric plants make a poor intermittent source. Gas-fired plants, by contrast, are virtually the only economical sources of electricity that can be powered up and powered down to support lulls in other sources of power.

Another encouraging market trend involves nuclear power. While Washington has been hurling loan guarantees and other subsidies at the industry in order to spur the building of a new generation of reactors, only a few new projects, if any, are going to move forward. The reason is simple arithmetic. When the huge construction costs of new nuclear power plants are factored into the price of the electricity they produce, they can’t compete with power from natural gas–fired plants. That arithmetic won’t change unless Washington throws even more subsidies to the nuclear industry (something many Republicans are keen to do).

But the surprising good news is that America’s existing nuclear plants, which were built at exorbitant cost decades ago, are now largely paid off. Today, these plants supply 20 percent of the nation’s electricity, all of it carbon free and priced competitively. Thanks to gains in plant utilization at existing nuclear installations—brought about through improvements in maintenance and safety—the nuclear industry has increased its output by 40 percent since 1990, the equivalent of adding twenty-nine new 1,000-megawatt reactors. This is a lot of unexpected new electricity supply for the country; by way of comparison, at the end of 2009 the U.S. had in total about 35,000 megawatts of installed wind power and about 500 megawatts of solar photovoltaic panels providing electricity.

For the next several decades, even without new subsidies (except liability protection), power from these existing nuclear facilities will remain an important part of the American electricity-generation picture. It will help reduce imports of oil and prevent overdependence on natural gas. The operational cost of the already constructed nuclear power capacity in America is very cheap; at less than two cents per kilowatt hour, it is only a fraction of the operating costs for either coal- or gas-fired power plants. The Nuclear Regulatory Commission now expects to extend the operating licenses of at least ninety of the country’s nuclear power plants from their original expiration dates in 2020 to 2040, and the industry in that case will invest hundreds of millions of dollars in refurbishments. This could buy several decades of time for the development of superior technologies as we combat global warming.

A third positive trend is the increasing competitiveness of solar, wind, and geothermal power to provide diversification and decentralized power generation, and to enable utilities to meet consumer demands and state mandates for green power. Nearly half of all states now have renewable portfolio standards (RPS) requiring their utilities to procure a certain percentage of electricity from renewable sources in coming years, with California leading the way by requiring that 33 percent of electricity come from renewables by 2030. RPS mandates, along with consumer and industry demand for and local government procurement of green electricity, are gradually becoming more important drivers of the wind and solar industries than tax subsidies.

But let’s face facts. The renewable industries will mature as commercially viable on their own only in future years, as more natural gas generation is deployed on the grid, transmission grids are extended and interconnected, and energy storage technologies become more available. The government tax credits were valuable to support the industry in its infancy, but the solar and wind industries can, and will need to, become cost competitive. In the past few years, the prices of solar photovoltaic modules have fallen in the United States by more than 50 percent, and the efficiency of large wind turbines has increased dramatically. This provides great hope that, with a level playing field, and if they do not get “addicted” to subsidies like so many other energy industries are, solar and wind will be able to compete and grow to generate some 20 to 25 percent of America’s electricity in the next few decades.

A fourth positive market trend, at least from an energy-efficiency and environmental standpoint, is the future price of oil. Right now, because of the economic slump, petroleum prices are moderate. But analysts and the energy futures market are anticipating that in 2011 oil prices will begin to climb again as worldwide demand works back toward 2006–2007 levels. Regardless of short-term fluctuations, virtually all international studies of the petroleum industry show substantial demand-supply imbalances during this coming decade, particularly as China and India continue to add tens of millions of new cars to their motorways each year. Sooner or later, prices at the pump will rise considerably and permanently.

American consumers will feel the pain. But as was evident during the last (albeit short-term) run-up in petroleum prices, which drove gasoline prices over four dollars a gallon in 2008, Americans will respond to higher prices with countless adjustments—in the cars they buy and in their daily routines—that in turn will move the whole economy toward more efficient energy use.

The rising price of oil will hasten yet another market clean energy trend that is already apparent: the growing dependence by every sector of the economy on electricity and, in particular, the nascent move toward electrification of transportation (see “The Plug-in Revolution,” August/September/October, 2008). The much-ballyhooed new crop of electric cars, like the Nissan Leaf and the Chevy Volt, are the popular face of this trend, but these are but precursors of a market that is still some years away. Meanwhile, a more salient development is the return of electric-powered rail transit. Today, metro areas around the country are building and expanding light rail lines, a movement that will almost certainly accelerate. It could well be followed by the eventual electrification of heavily trafficked freight and passenger rail corridors. Gasoline-powered cars will be the mode of choice for most Americans for many years to come, but not forever.

Taken together, these market trends—cheaper natural gas; more expensive oil; the gradual turnover of old, polluting, inefficient power plants and their replacement by natural gas or cleaner-generating technologies; the extended life of existing nuclear facilities; and the slow but steady electrification of transportation—will gradually turn America’s economy toward reducing greenhouse gas emissions while supplying us with abundant and affordable energy. These trends will also buy us time to develop the more innovative energy sources of the future.
For a smart critique of Leonard's essay, see these two pieces by David Roberts in Grist.

1/25/11: Michael Levi notes also that Leonard's math is seriously misleading:
There are two problems with [Leonard's argument]. First, the statistics are wrong. The Department of Energy reports that renewable energy gets far more subsidies than any other source. As of FY2007, renewables received 30% of federal subsidies. Coal, oil, and gas together received 33%. (The rest went to end use, generic electricity, nuclear, and conservation.)

Second, fossil subsidies are spread across a much bigger base than subsidies for alternative fuels, since alternative fuels still make up a tiny fraction of U.S. primary energy. The same DOE report I just linked to showed that coal- and gas- fired electricity received average subsidies of 44 and 25 cents per megawatt hour, respectively. In contrast, wind and solar got subsidies of $23 and $24 per megawatt hour, respectively. Take those subsidies away, and you can guess which energy source wins. Even if Leonard’s statistics were correct, the much larger base for fossil fuels would still lead you to conclude that renewables wouldn’t benefit from eliminating all subsidies.

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