Optimal Renewable Energy Subsidization

The discussion surrounding energy subsidy reform is dominated by rhetoric and ideological pretext. It has been said that “energy policy is made in a political setting, it rarely comports with principles of economic or public finance theory.”[1] If the goal is to save the environment through the adoption of renewable energy technologies, current subsidies are failing because only 7% of the nation’s energy is provided by non-hydroelectric renewables in spite of substantial expense.[2] Legislators must focus on more thoughtful legislation in order to efficiently and effectively achieve a transition to renewables. The first step is to recognize that careless and exorbitant spending on renewable energy is not ideal. Legislators should focus on the design of efficient programs that maximize the benefit of each appropriated dollar. This can be done by thoughtful consideration of: the principles of competition; alternative means of addressing the negative externalities associated with traditional energy sources; and the role of technology in energy markets.

 

Effective subsidization should embrace the principles of competition.

Some have argued that free-market arguments are inapplicable to an analysis of energy subsidization because the market for energy is a natural monopoly.[3] This argument must fail because subsidies can be designed to encourage competition, and the market for energy production technologies is not a natural monopoly.

A market is any state of affairs where a service or good is exchanged.[4] Within a market, there is the concept of competition. On one end of the spectrum is pure competition, which is characterized by “an infinite number of sellers, complete independence of action, perfect standardization of products, zero governmental intervention and zero monopoly power.”[5] At the other end of the spectrum is a monopoly, characterized as a market with a “single seller of a differentiated product.”[6] The extent of monopoly power depends upon the barriers of entry into the market.[7] Monopolies are disfavored because innovation, low cost, and other positive results are expected to come from the interplay of independent companies in a competitive market.[8]

Empirical evidence suggests the existing market for energy-production technologies is at least somewhat competitive because there are several sellers of energy production technologies. This is unlike the market of electricity to consumers, which is often dominated by a single utility company. For example, General Electric and Siemens both manufacture and sell traditional and renewable power-plant technologies to various markets all over the globe.[9] This means that some level of competition exists in the market for energy production technologies. However, the market is not in a state of pure competition. General Electric, Siemens, and many other energy-production technology companies are large firms that have made significant investments in their products. Large firms are probably major players in this market because of barriers to entry such as the substantial expense and technological expertise required to design and sell energy-production equipment. Large firms also probably enjoy a benefit in this sector from purchasing bias in favor of established companies.[10] Legislators should therefore attempt to increase competition in energy markets by encouraging new market participants, specifically renewable energy producers, through the reduction of barriers to entry. Such programs may take the form of research and development grants or subsidized lending programs. However, legislators should also keep in mind that there are several reasons why pure competition may not be ideal. First, economies of scale in production and distribution may require that sellers be larger in size and fewer in number than pure competition would allow.[11] Second, effective innovation may require the presence of large firms.[12] Third, a competitive structure may result in too free of entry or too intense of rivalry for optimum performance.[13] Defining the proper mix of competition and government intervention should be the “central” role of government intervention in markets.[14]

 

Subsidization of renewables is not an effective means of addressing the negative externalities associated with traditional energy.

Some proponents of renewable-energy subsidies argue that renewables should be subsidized because traditional energy sources have significant negative externalities. [15] This argument fails because subsidizing renewables does not directly address the inefficient allocation of resources produced by negative externalities. An externality is a form of market failure in which all of the costs of producing a good are not borne by the producer.[16] This results in over production. The primary negative externality associated with traditional energy is pollution. Regulatory measures such as a carbon tax or limits on emissions probably do a better job at internalizing these costs because these programs can be designed to force traditional energy producers to pay for the negative externalities that are produced. These costs can then be passed onto the beneficiaries of their production. This would theoretically result in an efficient level of output.

While these types of programs probably do a better job of dealing with externalities than renewable subsidies, they are not without their drawbacks. For example, a carbon tax may be set at a rate that does not accurately reflect the cost of externalities because it is extremely difficult to calculate these costs.[17] Furthermore, government limits on pollution will probably not be set at optimum levels due to information problems. In spite of these issues, it seems that government programs other than renewable subsidies are the best way to deal with the negative externalities associated with traditional energy sources.

 

A shift to renewables requires technological advancement.

Empirical evidence suggests that investment in different energy-production technologies can be accomplished in a relatively short period of time when that technology satisfies the market’s needs at a competitive price. For example, the recent shale boom has resulted in the cheap and plentiful supply of natural gas.[18] In response to this relatively recent phenomenon, there has been a significant investment in natural gas power plants.[19] It follows that if renewables were able to meet the market’s needs at a competitive price, heavy investment would naturally follow.

Renewables are not currently competitive with traditional energy because renewables are technologically incapable of matching energy output to demand. The difference between the ability of traditional energy sources and renewables to match demand can be seen by reviewing the projected availability of installed capacity used for the purposes of projecting Texas’s energy production needs. Only 8.7% of the installed wind capacity in Texas could be relied upon for this purpose.[20] In contrast, that number was 84% to 89% for traditional energy sources.[21] This is because wind only produces power when the wind is blowing. Similarly, solar only produces power when the sun is out. Battery technology could eventually provide a solution to this dilemma, but the state of that technology is not where it needs to be. As a consequence, no matter how much renewable energy capacity is installed, there must still be traditional energy sources in place to provide reliable power on dark and calm days.

In response to these technological shortcomings, subsidies should focus on research and development. This is particularly important with regards to renewable energy because the environmental issue that renewable advocates are concerned with is not a purely domestic problem. For example, projected coal consumption in China far exceeds the United States.[22] Increased production of coal power plants in China can affect the global environment, and China as well as other developing countries are likely to continue to invest in the lowest cost power source that can reliably meet their energy needs. If the goal is to save the environment, global adoption of renewables would seemingly be required. The United States can’t expect the rest of the world to follow our example and enact expensive production-based subsidy provisions. Admittedly, technological advancement is one byproduct of the increased investment that results from production-based subsidies; however, this is a less than ideal way to spur innovation because it results in investment in soon-to-be-outdated infrastructure and does not directly incentivize technological advancement. The better plan is for the United States to advance the technology through research and development initiatives to a point where it becomes a cost efficient and reliable means of energy production that countries around the world can invest in without a need for production-based subsidies.

 

Conclusion

Legislatures have not effectively encouraged a meaningful shift to renewable energy sources. The current discussion regarding renewables needs to cleanse itself of rhetoric and ideological pretext and become a thoughtful discussion that embraces the economic and technological realities that govern energy production; maybe then, a real shift will occur.


[1] Mona Hymel, The United States’ Experience with Energy-Based Tax Incentives, 38 Loy. U. Chi. L.J. 43, 67 (quoting Salvatore Lazzari, CRS Issue Brief for Congress: Energy Tax Policy, at CRS-3 (2005))

[2] U.S. Electricity Generation by Energy Source, U.S. ENERGY INFORMATION ADMINISTRATION, https://www.eia.gov/tools/faqs/faq.cfm?id=427&t=3 (last visited Nov. 28, 2016).

[3] Melissa Powers, Sustainable Energy Subsidies, 43 Envtl. L. 211, 221 (2013).

[4] JOHN R. HAYS, JR., THE CHALLENGE OF PRODUCER ACCESS TO NATURAL GAS MARKETS: GATHERING AND OTHER PIPELINE ISSUES 20-11 (2006), pdf available upon request.

[5] ALFRED E. KAHN, II THE ECONOMICS OF REGULATION: PRINCIPLES AND INSTITUTIONS 114 (3rd prtg. 1990).

[6] Id. at 116.

[7] Id.

[8] Id. at 115.

[9] See GE Power Generation, GENERAL ELECTRIC https://powergen.gepower.com/ (last visited Nov. 28, 2016); see also Power Plants, SIEMENS http://www.energy.siemens.com/hq/en/fossil-power-generation/power-plants/ (last visited Nov. 28, 2016).

[10] Consider the axiom “nobody ever got fired for buying IBM.”

[11] KAHN, II THE ECONOMICS OF REGULATION at 114.

[12] Id.

[13] Id.

[14] Id. at 113-14.

[15] Powers, Sustainable Energy Subsidies, 43 Envtl. L. at 216.

[16] Kahn, II THE ECONOMICS OF REGULATION at 193.

[17] Powers, Sustainable Energy Subsidies, 43 Envtl. L. at 218.

[18] Natural Gas, U.S. ENERGY INFORMATION ADMINISTRATION, http://www.eia.gov/dnav/ng/hist/n9190us3m.htm (last visited Nov. 28, 2016).

[19] Natural Gas Expected to Surpass Coal in Mix of Fuel Used for U.S. Power Generation, U.S. ENERGY INFORMATION ADMINISTRATION, http://www.eia.gov/todayinenergy/detail.php?id=25392# (last visited Nov. 28, 2016).

[20] TEXAS COMPTROLLER OF PUBLIC ACCOUNTS, Getting the Most from Your Energy Dollars 3 (2014), pdf available upon request.

[21] Id.

[22] International Energy Outlook 2016, U.S. ENERGY INFORMATION ADMINISTRATION, https://www.eia.gov/forecasts/ieo/coal.cfm (last visited Nov. 28, 2016).

Dominick Constantino is a second year law student at The University of Texas School of Law. He graduated with honors from the University of California at Santa Barbara in 2009 and graduated with a master's degree from the University of Southern California in 2014. Dominick worked in public accounting prior to enrolling in law school and will be returning to Houston this summer to intern with the income tax department at Baker Botts.