Government Energy Policies: What Will Work?

The U. S. gove^rnment mounted a multifaceted response to the oil embargo and the oil price increases of 1973 that included massive pro­grams for alternative fuel supplies as well as accelerated RD&D and

commercialization of renewable energy sources. The projections of the day were based on both erroneous assessments of the accessible reserves of oil and gas and unrealistic, price-independent rates of growth of energy demand. Many were convinced that the energy reserves were being depleted too rapidly to trust in the free market to make the transition to more secure, renewable energy supplies. Thus, it was argued, the govern­ment should provide incentives to accelerate adoption of energy conser­vation practices, renewable energy, and energy-efficient technologies that would benefit societal goals. This approach included the unsuccessful establishment of residential and commercial tax credits for solar heat technologies.

We now know that these incentives were not only unsuccessful in cre­ating a sustainable market for solar energy technologies, but they were also harmful to the very industries they were intended to promote. In the authors’ views, there were three major errors in the design of the incentive programs intended to promote the use of solar energy in the 1970s. The most important was that the incentives were for the purchase of equip­ment and not for the delivery of energy. We have already discussed the consequences of that error in chapter 7. The second was that the incen­tives were provided to the end users who knew little about the tech­nologies and were not motivated to call for changes to the available equipment. Finally, the incentives were not tied to the market prices of alternative energy sources or the societal costs using any rigorous meth­odology. Neither were they timed to begin when the technologies were ready to enter the market, nor to phase out as entry was successfully achieved. If these mistakes are to be avoided in the future, it will be nec­essary to develop more rigorous methodologies for determining how and when to provide incentives for desirable change—and when to impose disencentives to continued harmful practices.

It is admittedly difficult to conceive of a rational, fair, and easily implemented method of delivering incentives to encourage the adoption of solar heat technologies. In most cases, delivered energy is not measured for an installed solar energy system. Faced with the problem of deter­mining the true energy benefits of installing the 1970s state-of-the-art solar energy systems, it is easy to see why Congress succumbed to the simplicity of residential and commercial tax credits. But the simplistic tax credits did not accomplish their objectives; more sophisticated and rig­orous incentive strategies are required.

Because the ultimate goal should be to transform the energy market into one in which transactions are based on total societal costs, the first step toward designing workable policies is to agree on a rational meth­odology for estimating the total societal costs of energy produced from different sources. In the last decade, many countries have come to realize the importance of including these costs in making decisions or policies on energy matters. Although there is no generally accepted definition or methodology for calculating the total costs, in 1989 the American Solar Energy Society Round Table on Societal Costs, estimated the total extra cost of energy production—including such societal costs as atmospheric corrosion of equipment and structures, crop losses and soil contamina­tion, impacts on public health, disposal of radioactive waste, military forces needed to maintain energy security, subsidies for all forms of energy, and job losses of all sorts—at from 100 to 260 billion dollars per year. That is equivalent to an additional cost of 2 cents/kWh of electricity or 25 cents/gallon of gasoline on average.

A number of studies in the late 1980s and early 1990s attempted to calculate the societal energy cost by fuel and production type. A com­parison of some of these studies done by the authors in 1993 again showed a wide range of methods, terms, and values. For conventional coal-burning power plants, for example, the average of seven studies was

8.5 cents/kWh and the range was from 0.6 to 30.3 cents/kWh; the aver­ages for oil and gas were 3.9 cents and 1.6 cents/kWh, respectively. Most of these studies were based only on environmental impact and did not attempt to include other factors such as security, subsidies, and jobs.

Although there is considerable uncertainty in the values to assign to the various terms in the cost equation, and which terms should be included once the procedure is established, the uncertainty in the values will grad­ually be reduced. The process should not be fundamentally more difficult than maintaining the economic indicators that heavily influence the national economy today. There is no reason why the societal cost of energy conversion and other industrial and commercial activities cannot be tracked in the same way we now track the consumer price index.

Once the societal costs of energy from all sources are established, it will be easy to determine not only which commercial energy technologies are too expensive and should be discouraged, but also which emerging energy technologies are ready for market entry and warrant some form of in­centive, and which need further R&D or demonstration. New technologies that can be applied at costs lower than the societal costs of conven­tional energy supplies they would replace are beneficial and should be encouraged, even though their market price may be higher than that of the commercial energy technologies they would replace. Technologies that show potential for near-term societal cost competitiveness may need further development or demonstration, and promising technologies whose ultimate costs cannot be determined may need more research and devel­opment. However, because the market does not yet use societal costs as the basis for investment, even those technologies with low societal costs may not make any headway in the present market without some inter­vention. Gove^rnment incentives may still be needed to bring technologies with lower societal costs into the energy mix and to close the gap between market prices and societal costs.

There are basically three ways our gove^rnment can influence markets where it is not a major participant: (1) it can use tax credits or other fiscal incentives to lower the effective prices of desirable alternatives; (2) it can use taxes or other fiscal disincentives to raise the prices of undesirable alternatives; and (3) it can command all the various media channels to convey its message to the citizenry. Because they will apply to only a small segment of the energy economy, substantial incentives for switching to renewable energy forms may be offered with minor perturbation of the economic system—at least initially. Incentives, however, further exacer­bate the problem of fairness in paying the societal costs of energy con­version by adding energy-related taxes to the general tax burden. The practical argument against disincentives is that, applied against dominant energy resources, they would have to be very large to achieve an appre­ciable switch to the use of renewable energy. Indeed, most economists estimating the price increases necessary to motivate energy consumers to switch from conventional to sustainable energy resources based on price elasticities would conclude the costs are too great for the economy to bear. However, sudden imposition of such large disincentives on conven­tional energy conversion is not needed.

The authors believe that a combination of incentives and disincentives, dynamically linked to each other and to the total societal costs of energy through a rigorous methodology, applied over a long period of time can move the energy market to a more sustainable structure. This can be accomplished gradually, without any serious disruption of business or economies, a way that slowly lowers the total costs of energy to society, and never exceeds the societal costs of “business as usual.” Our concept has three fundamental principles:

1. Provide subsidies (incentives) only for conversion and delivery of end – use energy from renewable resources when it is possible to deliver such energy at societal costs lower than those of the conventional forms of energy they would replace;

2. Provide these subsidies to qualified suppliers of renewable energy in an amount proportional to the difference between the societal costs and the market prices of the conventional forms of energy replaced, and fund them from taxes (disincentives) on the conventional forms of energy just sufcient to cover the cost of the subsidies; and

3. Adjust the subsidies and taxes periodically (every few years, say) so that transition is achieved, the subsidies are reduced and eventually elim­inated when no longer needed, and the taxes on conventional forms of energy are eventually transferred from funding the subsidies to paying for the external costs of the forms of energy being replaced (e. g., use part of the tax on coal to pay for the black lung program).

The implementation of this concept is not simple. It requires long-term commitment and fiscal discipline by government and patience on the part of those who advocate change, but if faithfully applied, these three prin­ciples would assure a market-driven transition to a sustainable energy economy at minimum societal cost.

For example, subsidies offered to businesses or utilities that supply heat or power to end users on the basis of principles 1 and 2 would serve as powerful incentives for any renewable energy technologies that could deliver energy at costs lower than the social costs. They would also be powerful incentives for businesses and utilities to supply end-use energy services to customers unable or unwilling to make energy-efficient choices for themselves. Initially, the cost of the subsidies could be offset by small carbon or Btu taxes collected from the suppliers of the conventional energy forms being replaced. The amount of the taxes would be deter­mined by the costs of the subsidies provided. Because, initially, the market shares of the subsidized forms of energy would be very small and the market shares of the taxed energy forms large, the taxes would be very small. As the use of renewable energy increased, the tax rates would need to grow, further increasing the prices of the conventional energy forms relative to the subsidized energy forms, and thus accelerating market penetration of the renewable energy forms. As the renewable energy market shares increased, (1) the subsidies could be cut back in such a way as to maintain a fixed relation between the market prices of the conven­tional and renewable forms of energy; and (2) economies of scale would cause the unit cost of delivering the renewable energy forms to fall, thereby further decreasing the required subsidies.

Although the taxes on nonrenewable energy forms could be reduced as the need for renewable energy subsidies diminished due to both cost reductions and market saturation, it might be wise to continue to collect the taxes on nonrenewable energy forms and to apply any excess revenues to pay for the external costs of those energy forms, societal costs not included in energy prices (infrastructure, defense, environmental restora­tion, health, etc.). To the extent that renewable energy forms also con­tributed to such societal costs, they might also be taxed. At the same time, the government should start to pass on to the energy suppliers involved other societal costs of energy conversion and environmental remediation. Citizens and business now pay some of the societal costs of energy conversion through income taxes (defense, infrastructure, environmental restoration, etc.), medical costs and insurance rates, and tangible and intangible losses in quality of life, while other societal costs are passed on to future generations. Correcting the inequities in our energy pricing sys­tem will take a long time and great political courage; eventually, the prices of all forms of energy would be brought into line with their true societal costs. Note that this scheme never increases the total societal costs of energy for the total population. It simply shifts some of the burden from the general population to those who use the forms of energy that increase the societal cost. The increased costs of some forms of energy would be offset by decreased taxes and nonenergy costs. This may seem utopian, but it is fair, equitable, and farsighted—and perhaps even polit­ically feasible. There are many indications that our political system is becoming less willing to pass on liabilities like the national debt, social security, and radioactive waste storage to our grandchildren.

Although Germany and Denmark have recently imposed small con­ventional energy taxes to cover the cost of their subsidies to renewable energy suppliers, to the authors’ knowledge, no country has yet developed the rigorous methodology needed to set and maintain incentives and dis­incentives in accordance with societal costs.

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