There is nothing more dismaying to football fans that a referees call that goes against their team and changes the course of game. The cry goes out: “Hey, ref let’em play.” The battle over energy policy these days has devolved to the same cry of “let’em play” as energy subsidies and tax breaks have become targets for all sides.
By Mark Jaffe/theBalanceSheet Blog (Denver Post)
Republican lawmakers have lambasted the Obama Administration over guarantees for solar  panel companies, such as the now bankrupt Solyndra. Environmental groups have drawn aim on the 1995 royalty waiver program designed to encourage development of expensive, deep water wells in the Gulf of Mexico. BP’s Deepwater Horizon, cause of the worst offshore oil  spill in history, received those waivers.
The feeling expressed by some is that energy sources and technologies ought to compete mano a mano in the open and free market and let the solar chips fall where they may. In opposing a bill pending in Congress – HR 1380 which aims to use tax breaks to promote natural gas  as a transportation fuel – the Heritage Foundation argues: “Tax incentives like these allow government to decide which energy sources thrive or fail—and thereby distort the market.”
But two recent analyses of energy markets, including one entitled What Would Jefferson Do?, show, they are pretty much distorted all around and it raised the question to me of what would Adam Smith, the 18th century Scottish economist and prophet of the free market with its “invisible hand,” make of the situation and what advice he might offer.
In The Wealth of Nations , Smith focused on mercantilism – the dominant economic policy of his day which protected domestic enterprise, even if it was inefficient, and tried to wrest as much as it could from its trading partners while giving little away.
It was a system that made it nearly impossible for Englishmen to drink French wines and Frenchmen to buy English woolens. While wind  production tax credits and oil depreciation allowances are a far cry from wine and wool, Smith’s analysis offers such honesty and clarity that it is worth thinking in his terms.
But first a quick look where the energy market stands when it comes to market-distorting subsidies.
The International Energy Agency’s 2011 annual report puts the total energy subsidies worldwide at close to $500 billion last year and in What would Jefferson Do?, Nancy Pfund and Ben Healey calculated that since 1918 the U.S. government has given $670 billion in energy industry subsidies, with two-thirds going to the oil industry.
The IEA estimated that there were $409 billion in fossil fuel subsidies, with oil accounting for almost half, and renewable energy  getting $66 billion, including $22 million for biofuels.
Those numbers are being cited by some renewable energy advocates to show how outsized the fossil subsidies are, but it is a false comparison because most of the global subsidies are in countries, such as Iran, Russia and India, where the government for political reasons, is keeping fuel prices below market rates.
In oil producing countries, which account for 86 percent of the oil subsidies, it isn’t real dollars at play but the foregone opportunity costs of selling the product for more on the international markets.
“Both fossil fuel consumption and production subsidies, by encouraging excessive energy use, lead to in efficient allocation of resources and market distortions,” the IEA.
While oil producing countries accounted for most of the fossil fuel subsidies, it was non-producing nations, lead by the Europeans, that spent most of the money – and this time it was real money – on renewable energy, primarily for electricity generation.
Wind got $18 billion and solar $12 billion in 2010, but since solar was only four percent of generation its support came to $425 a megawatt-hour compared with $53 a megawatt-hour for wind.
A lot of this money has come as feed-in tariffs, which guarantee renewable energy producers a fixed price for each megawatt-hour they generates. “The consumer sees no price benefit (and pays a higher average unit price for electricity), but the producer is enabled to draw on a more costly supply,” the IEA notes – offering another market distortion.
Ontario, Canada has embarked on feed-in tariff program that offers 13.5 cents a kilowatt-hour for on-shore wind and 71 cents for small roof-top solar.
By way of comparison the average charge for a kilowatt-hour by US utilities in August was 12 cents, according to the federal Energy Information Administration. The U.S. production tax credit for wind and solar that critics rail against, and which is set to expire, is 2.2 cents a kilowatt-hour.
In a conversation with Jim MacDougall, manager of Ontario’s feed-in tariff program, I questioned the rich incentives. MacDougall said that “this isn’t about price.” It was about moving the province to an energy profile where coal is zeroed out, natural gas is cut by two-thirds and solar, wind and biomass is more than tripled.
The subsidy story in the U.S. may be even more complicated. In What Would Thomas Jefferson Do?  Pfund and Healy lay out a long timeline of subsidies for resource and energy development going back to the 19th century.
A spoiler alert: Pfund is a managing partner at DBL Investors, and sponsors or sits on the board of six renewable energy companies. Healy is a Yale graduate student.
Whether it is the capital gains treatment of coal – a $1.3 billion boon between 2000 and 2009 – or the 1916 tax rule that allowed oil companies accelerated cost recovery for “intangible drilling costs,” energy subsidies have been big and long-lived in the U.S.
In an artful exercise Pfund and Healy normalized the subsidies across types of energy in 2010 dollars and found that of the $670 billion in energy support:
• Between 1918 the oil and 2009 the oil and has industry received two-thirds of the total or $447 billion.
• Between 1947 and 1999 the nuclear industry received $185 billion.
• Between 1980 and 2009 biofuels received $32 million.
• Between 1994 and 2009 renewables got $6 billion.
Pfund and Healey’s argument is that given the long and often generous subsidies fossil fuels and nuclear energy have received, they have built up infrastructure that in the short market gives them a price advantage, but may undercut long-term market and national interests.
We titled this paper, “What Would Jefferson Do?” We believe that the answer to that question is now clear. He would do what our country has always done—support emerging energy technologies—to drive innovation, create jobs, protect our environment, (and) enhance our national security.”
Maybe so, but what would Adam Smith make of this welter of subsidies and grants and corporate goodies? What would Adam Smith do?
There is no direct answer for during Smith’s day the water wheel, the beast of burden and human muscle were the energy at hand. It would be Glasgow contemporary of Smith’s – James Watt – who would perfect the steam engine, setting the stage for the industrial revolution.
Without getting either too evangelical or Talmudic, there are some passages in Wealth of Nations, which was published a few months before Jefferson drafted the Declaration of Independence that offer some ideas.
In looking at foreign imports and domestic products and the question of import tariffs and national taxes, Smith says that a levy on an import – and this is the thing he is in the main arguing against – may be appropriate to balance a domestic tax.
“This would not give the monopoly of the borne market to domestic industry, nor turn toward particular employment a greater share of the stock and labour of the country than would naturally go to it.” And it “would leave the competition between foreign and domestic industry, after the tax, as nearly as possible on the same footing as before it.”
So if we the aim is true competition among energy sources the question is how best to put them on an equal footing, as Smith would say, so that each would capture the share of labor and stock that would “naturally” go to it.
Cutting or reducing subsidies where possible is one step and equalizing them is another. There are problems with this for the legacy investments for fossil fuels will be hard to compensate and polices, such as Colorado’s carve-out requiring a percentage of renewable energy to come from solar, that are in a Smithian world unnatural.
Still, the leveling would likely keep all but the costliest of technologies in the game and over time give an advantage to those that reduce costs and become more competitive.
As it is the spread in the current market in producing a kilowatt-hour of electricity between wind turbine and a natural gas-fired plant is 1.9 cents – natural gas at 6.3 cents and wind at 8.2 cents, according to the Energy Information Administration.
Solar is higher 14.5 cents a kilowatt-hour, but dropping with technological innovation. For more on this “levelized cost” of energy analysis approach see my Denver Post story .
Smith also makes a distinction between the market and things that should not be left to the market. These include national defense, public works, a justice system, education, funding the monarch.
Both the left and the right have given full voice to the belief energy security is a national priority and if that is the case than by Smithian lights it can’t be left to the market.
If dependable, affordable and price-stable energy is seen as a national good than public involvement and the use of public funds may be appropriate.
“The expense of maintaining good roads and communications is, no doubt, beneficial to the whole society, and may therefore, without any injustice, be defrayed by the general contributions of the whole society,” Smith wrote.
So, looking at US energy policy Smith might in the first instance argue for equalizing the taxes and subsidies among energy products and if energy security really is a national priority then there is a role for government action and federal dollars.
On this second point, Smith is always cautious about government action and tends to look for the most limited way of obtaining the good he is seeking. I’m not sure what Smith would think of Ontario’s feed-in tariffs. He might defer to the public good argument, maybe not.
There are two reasons that natural gas is the cheapest generating source. One is the current low prices for natural gas – 3.45 cents for a million British Thermal Units at this writing. The second is the high efficiency of natural gas turbines.
Pfund and Healey point out that gas turbine technology benefited enormously from US Department of Defense research and development on jet engines.
R&D is clearly one of the places that government can take-on a role without market distortions and while it might make sense to buy a natural-gas fired plant based on today’s levelized costs, a nation of gas plants may not be in the national interest.
The price of natural gas – which makes up half the levelized cost of gas-fired generation according to a Lazard study – in the past, has been volatile. So, for the public weal a program that encourages diversity might be in order.
There is one other element that Smith dwells upon that is lacking from our current debate – fairness. While seeing tolls on roads as a good, user-pays way to raise revenue for a project, he frets about a toll by weight because while it does measure use, a load of potatoes to be eaten by the poor would be more heavily taxes than light-weight luxury goods for the rich. This is not a sentiment much held by the Republicans today.
There are issues, such as climate change, that are difficult to place in a Smithian context.
Still, a few things are clear. In looking at the morass of energy tax breaks, subsidies and grants, not doing anything is picking winners and loser for some energy sectors already have an advantage.
Smith would argue for is equality and transparency in the market and if energy security truly is a national goal a plan that meets a clearly defined need – he is, in his book, against bridges to nowhere, really – at a price a Scotchman can love.
In the end what Smith brings to the discussion isn’t an answer but a standard of intellectual honesty and clarity. Those are two things that are sadly lacking in our national energy debate.