Subsidies to the Energy Industry

“I am a big fan of clean energy, but I am bigger fan of a robust economy.”

-Mr. Greenbacks, 2012

Subsidies to the energy industry are nothing new, they have been around for decades.  Generally speaking, subsidies fall into three main categories: Direct Spending, Tax Expenditures, and Loan Guarantees.   For most of the 20th century, fossil fuels have enjoyed a long run of subsidies such as tax breaks, tax credits, tax exemptions, and deferred depreciation, just to name a few.  This extended period government support firmly entrenched fossil fuels as the sole providers of energy by making renewable energy prohibitively expensive by comparison.  The roles reversed in 2009 with the passage of the American Recovery and Reinvestment Act that eliminated some subsidies for fossil fuels and expanded subsidies for renewables.  However, as you can see below, the level of support to fossil fuels is still 6x greater than renewables.

  • The IEA estimates that in 2010 worldwide fossil fuel subsidies totaled $409 billion.  That number is expected to rise to over $650 billion by 2020 unless changes are made.
  • By comparison, only $66 billion was spent to subsidize renewable energy.

Misguided Policy?
So what is the role of subsidies?  Subsidies should be used to level the financial barriers for new and emerging technologies in order to compete in the marketplace.  Once these technologies are mature enough to stand alone, the subsidy should be removed in order to let the market forces take over and determine a true price for the product.  The support should then go on to fund another technology that could possibly compete with the first one in order to advance a competitive marketplace.   By keeping the subsidy in place for too long, one can create artificial demand that encourages waste and can quickly drain government coffers.  This could apply to any industry, but right now we are focused on the energy industry.

So should we remove all subsidies to the energy industry?  No!  The renewable energy industry has seen more ups and downs than the Cyclone on Coney Island.  Most of these Boom and Bust cycles have been created through a rush of investment in good times (subsidy ON!) followed by a lack of capital (subsidy OFF!) when the music stops.  A clear and definite subsidy policy should be implemented in order to remove the uncertainty faced by investors of clean energy projects.

Subsidies to Renewable Energy
I am a big fan of clean energy, but I am bigger fan of a robust economy.  In today’s economic climate, governments must be extremely careful how they spend their resources.  The current policies offering subsidies to the renewable energy industry have done a wonderful job of creating widespread deployment of clean energy projects.  However, many of these projects are only profitable because of the subsidy.  Current policies should be revamped in order to drive innovation and cost reductions so that renewables such as wind and solar can compete with cheap natural gas WITHOUT the subsidy.

In order to maximize the value of taxpayer dollars the following objectives should be implemented:

  1. Remove subsidies to the fossil fuel industry in order to establish a true market value that takes into account the negative externalities of these resources.  A small fee can be added to fossil fuel transactions to help fund clean energy research.
  2. New subsidies should promote efficiency gains and cost reductions through the use of steadily improving, performance-based standards.
  3. These subsidies should target advanced technologies, decrease as the cost declines, and be temporary in order to deter ongoing support.
  4. The US must increase its investment in R&D as well as leverage talent from universities and the private sector in order to establish public-private partnerships and regional clusters of advanced research and manufacturing.
  5. Utilize the strength and size of the DOD to drive commercialization of technological advances made through ARPA-E.

Implementing these policies will go a long way toward maximizing public dollars, creating a competitive clean tech industry, and ending the addiction to fossil fuels.

Simpson-Bowles on Charlie Rose

Back in March, Charlie Rose had on Erskine Bowles and Alan Simpson, co-chairs of the National Commission on Fiscal Responsibility and Reform a/k/a the Deficit Reduction Committee.  Their view is that spending cuts and tax increases alone are not enough to get us out of our fiscal hole.  We must make difficult choices as a nation in order to pull through this.  However, those choices are not politically feasible and the plan was discarded.  Here is a clip from the 3/29/2012 interview where Mr. Bowles states why the Simpson-Bowles plan has not been adopted.  I can only urge you to watch the full interview at http://www.charlierose.com/view/interview/12265

From OPEC to CHAOS: How Petro-Dollars Fueled the Arab Spring

Alright, let’s get back to the economics associated with climate change here.  More specifically, the economics of oil and how the accumulation of petro-dollars by oil-producing nations (almost in some cases, did in others) bring about their downfall.  Most everyone remembers the “Arab Spring” that began in December 2010 when a 26-year-old street vendor named Mohamed Bouazizi set himself on fire to protest his continued harassment by the authorities.  As the protest spread among the arab world, the grievances highlighted the lack of opportunity for the youth, state corruption, economic decline, human rights violations, censorship, and other wrong doings on behalf of the ruling party or dictators of these countries .  By March 2011, protest had erupted in 17 countries in the region. 

(Black = Government Overthrown; Dark Blue = Sustained Civil Disorder and Governmental Changes; Light Blue = Protests and Governmental Changes; Red = Major Protests; Beige = Minor Protests)

Now we know the reasons for the protests and the scale of the uprisings, lets take a look behind the scenes at the conditions that set the stage for this upheaval. 

Current Account
In Economics, the Current Account is the broadest accounting of a country’s trade and investment with the rest of the world.  The Current Account measures 4 areas of trade – Merchandise Trade (goods), Services, Investment Income Flows, and Unilateral Transfers such as foreign aid or remittances from workers sending money back home.  The Current Account provides a snapshot on the financial health of the country, and of how much the country is importing and exporting of each area measured.  While there is no direct impact on the stock or bond markets, the Current Account does show how much money is coming in (surplus) or leaving (deficit).  Consistent and increasing deficits could impact the value of the dollar if creditor nations begin to doubt our ability to pay back the borrowing.  If other countries balk at our debt levels, the dollar will depreciate.  Below is a graph of our current account since 1980.

Now when you think of the America’s current account deficit, you probably think of China’s account surplus.  Images of container ships filled with cheap, disposable goods probably came to mind.  But in fact, the largest creditors of America’s current account deficit have been oil-producing nations.  I was recently brushing up on some economic terminology and this theory was confirmed by my Macroeconomics textbook from 2008.  Amazing that the problem was identifiable even back then.  Recently, The Economist published an article called Petrodollar Profusion that contained the graph outlining the current account surpluses as a percentage of GDP for these oil-producing countries.

So what is the problem?  The problem is that the oil exporting countries have been hoarding these dollars instead of spending them.  They could either spend them on imported goods from oil importing countries (machinery from USA for example) or they could put them to use by investing in their own economies and building out infrastructure, improving education, healthcare, housing, or agriculture, thereby creating jobs and building a middle class.  Spending on imports from other countries would grease the wheels of the global economy and balance out the payments.  After all, that is what keeps the world trading.  Instead, most of this wealth was transferred to sovereign wealth funds who further line the pockets of the ruling class.  For more info on sovereign wealth funds and the rise of state capitalism, please see the book The End of the Free Market by Ian Bremmer.  The point is that building the middle class was not what they chose to do, and the protests continued.  

Unemployment
One of the most prominent cries coming out the protests was the lack of opportunities for the young population.  In many of these countries there is a young (age 15-24) and growing population but a disproportionate lack of jobs for them.  Throughout the Middle East, the unemployment has historically hovered around 12% overall, but the unemployment rate for the youth is averaging 27%.  Aside from the high unemployment rate, there is the mysterious fact that there is an inverse relationship between education level and employment.  This means that the most highly educated young people are also the most likely to be unemployed.  Of those with jobs, many find themselves working in the public sector instead of the private sector where market forces would spur innovation and growth and thus create more jobs.  Across the region, the labor force participation rate is at 48%, compare that to 63.6% in the US, our lowest level since 1981.  

Over a year later we have seen significant changes in the mid-east (except Syria where the fighting continues) but only time will tell what results the arab spring ushered in.  One thing is certain, the oil keeps pumping and the money keeps flowing.

I know it is horrible to think about, but every time we fill up at the pump, we are sending our dollars overseas to strengthen these regimes and prolong the behavior that has kept them in power for so long.  It is a brutal reality, but it is the world we live in.  Until we develop a clean and renewable source of power, our money is going to chase the fossil fuels that power our lives.  But when you follow the money to the source, it isn’t a very pretty picture at all.