Carbon Emission: Regulatory Controls vs. Market Based Solutions

Many of you have been asking what the difference is between regulatory approaches and market based solutions to carbon emissions.  The answer is fairly simply but depends on what you want the outcome to be.  The whole question can be boiled down to: Tax or Trade?

A carbon tax is a pure price instrument that establishes a certain price on pollution.  While the price is guaranteed, the final emissions reduction is not.  For example, a $5 tax/ ton on CO2 emissions for a firm that pollutes 100 tons of CO2/ year would cost the firm $500.  This policy creates certainty for businesses and governments, but leaves uncertain the amount of emissions reduction. 

On the other hand, a cap-and-trade system (or quantity instrument) determines the final output of allowed emissions, but leaves the price uncertain.  In a certain year where polluters find it hard or costly to reduce emissions, the price of each credit would rise as companies bid up the price of the allowance.  In a different year, the price of the credits might fall as many industries would have a surplus of their pollution credits available on the market.  As companies find it harder to meet the required pollution allowances, the price of each credit would increase with demand.  Every so often credits would be removed from the market in order to achieve the desired level of emissions.

So which one is better?  Depends.  It all depends on what the predicted damage costs are.  If the marginal damage costs are high, then it is better to use a quantity mechanism because you know the level of pollution output.  The market will set the rate.  If the marginal damage costs are low, and policy makers are worried about the high costs of transition to a low-carbon economy, then a price mechanism would be the better option because it would provide more clarity to the business community when making future investment decision.  Hit me back and let me know your thoughts.

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.

Primer on US Solar Industry

The following is an excerpt from a white paper I wrote this summer regarding the US solar industry.  I hope you enjoy!

The United States has until recently lagged behind Europe in terms of embracing solar energy.  However, over the past few years there has been a steady increase in federal and state incentive policies that make solar energy more beneficial to producers and consumers alike.  Due to the lack of a clear federal mandates, there are many policies and incentives offered through the federal government, state governments, local governments, utilities, and private companies.  These incentives can be mandates to acquire a certain amount of energy from renewable sources, cash grants, tax credits, tax exemptions, performance based incentives such as feed-in tariffs, accelerated depreciation of equipment as well as many other measures.
Renewable Portfolio Standards
Renewable Portfolio Standards (RPS) are state policies that require energy suppliers or utilities to purchase a certain amount of energy from renewable sources such as solar, wind, and geothermal.  For example, Arizona can say that 2% of its energy must be generated from renewable sources.  This also creates a market for renewable energy credits (REC’s) that can be purchased, sold, or traded by the utility to comply with RPS policies.  Currently, 29 states and the District of Columbia have enacted RPS policies.  Together these states account for almost 40% of the US electricity load.  In addition to requiring a certain percentage of the electricity mix come from renewable sources, states can create “carve outs” or “set asides” that specifically target a certain type of renewable energy.  One example of this is New Jersey’s solar carve-out that requires 5,316 GWh of solar power by 2026.  There is no federal RPS yet although the Obama administration has advocated for 25% of America’s electricity come from renewable sources by the year 2025.
Financial Incentives 
Financial incentives can include grant programs that usually target larger commercial or industrial projects and offer direct cash payments to defray the cost of eligible systems or equipment.  A rebate is another financial incentive that is offered to the purchaser after a system has been installed in order to make the cost of the system more competitive compared to conventional energy systems.  These direct financial incentives lower the initial cost of the technology and lead to an increase in production, thereby decreasing the price further.  The goal is to have producers ramp up the production cycle to reduce costs to the point that a subsidy is no longer necessary.  Performance based incentives are cash payments resulting from the actual energy output of a solar system on a dollar per kilowatt-hour ($/kWh) basis.  These incentives are generally reserved for large scale solar facilities, however, there is a new interest in feed-in tariffs based on their success in Europe that can be used on a smaller scale and even residential properties through the use of net metering.
Net Metering
Net metering allows the owner of a solar system to sell back energy to the grid via a contract with the utility at a determined rate per kilowatt-hour.  Basically, electricity flows both ways through the meter – using power when it needs it and selling power back to the grid when the solar system is producing more energy that the facility is using.  Net metering is the cornerstone of distributed generation, and distributed generation lends itself to solar photovoltaic installation on residential and commercial properties.  Distributed generation not only allows a PV user to power their property, but it also rounds out the peak electricity loads that utilities face in the afternoon when power comes from the dirtiest sources.   There is no federal net metering policy yet, but 43 states have adopted policies to allow it.
Two of the most common financial incentives are direct cash incentives that provide money to lower the upfront costs associated with solar projects and tax incentives that reduce the tax liability of the individual, company, or organization that installed the solar energy system.
Federal Grant Program
Currently, the federal government is offering direct cash incentives for solar energy through the Federal Grant Program, but more than 30 states and 130 utilities throughout the US offer anywhere between a few hundred dollars up to a million in cash for solar PV projects.  In 2009, as part of the American Recovery and Reinvestment Act (ARRA) the federal government passed the Section 1603 Treasury Grant Program that offers a renewable energy grant worth 30% of the value of qualified renewable energy projects including solar, wind, and geothermal.  This grant includes commercial, industrial, or agricultural solar projects started before 12/31/2011 and completed by 12/31/2016.  As of May 5, 2011 the 1603 program has awarded 2,044 grants for solar electric technology totaling $936 million for more than 6,300 individual solar projects in 45 states and has supported over $3.1 billion in investment. The largest problem with direct cash incentives is that they have to be budgeted for and are not politically feasible in difficult economic times.  This leads to volatility in the solar industry and discourages long-term investment and stability.
Federal Tax Credits
Tax incentives including credits, deductions, and exemption are other financial incentives that the federal and state governments are using in order to expand solar energy production.  An investment tax credit reduces the taxpayer’s liability for a portion of the cost of buying and installing a solar energy system.  Investment tax credits are fairly straightforward and usually limit the dollar amount that the taxpayer can claim.  Policy makers favor tax credits because the amount of the incentive generally does not have to be appropriated or withdrawn from a budget.  By encouraging development through tax credits, policy makers hope to grow the industry and eventually create jobs in solar and related industries and thus increase the tax base in that district.  The 2009 American Recovery and Reinvestment Act (ARRA) also extended the investment tax credit through 12/31/2016 for residential solar electric installations.  The credit is equal to 30% of expenditures with no limit to the maximum amount.  The ARRA allows taxpayers eligible for the federal renewable electricity production tax credit (PTC) to take the federal business energy investment tax credit or to receive the grant from the US Treasury Department instead of taking the PTC for new installations.  Currently, twenty-one states and Puerto Rico offer personal and/or corporate investment tax credits to help offset the expense of purchasing and installing solar energy equipment.  Tax credits range from 10% to 50% of project costs, with maximum credit limits ranging form $500 to $12,500 for residential systems and from $25,000 to $10 million for commercial systems.  However, a major drawback of the investment tax credit is the policy discourages institutions with a low tax liability from reaping the benefits.  Recently, some states and municipalities have attempted to remedy this problem by creating provisions that would allow a “pass-through” option whereby the tax credit can be claimed by a third party who does have a tax liability.  This could include a partner of a non-profit as well as homebuilders who integrate solar systems into new construction.  In either case it encourages solar power systems to organizations that would not normally be afforded the tax benefit.