Energy subsidies amount to government intervention to manipulate the market price by lowering the price paid by consumers, raising the price received by producers, or lowering production cost.(1) Governments have established renewable subsidies to reduce the cost of energy to consumers in areas where electricity is scarce/expensive, to reduce carbon emissions, and to transition the energy portfolio to cleantech making nations more source agnostic. The latter helps to foster energy security by reducing dependency on natural resources for which many countries lack substantial reserves. There are a few common methods to deploy renewable subsidies which we will cover this week.
Energy subsidies are not a new concept, they have been around for 50+ years, e.g., the 1954 Atomic Energy Act. In fact, even fossil fuels receive subsidies, which were approximated at $5.3 trillion in 2015.(2) There are 3 common approaches to subsidizing energy: (1) government tax expenditures, (2) regulation, and (3) direct investment.
- Government tax expenditures are often structured as credits for producers effectively increasing the market price for their energy production, e.g., the Renewable Electricity Production Tax Credit (PTC) in the United States. The PTC is a $0.023/kWh credit with a duration of 10 years following construction. It is applicable to Wind, Geothermal, Biomass, and Solar generation technologies constructed before January 1, 2017.(3)(4) The tax credit approach incentivizes construction of renewables through tax reductions, which increase cash flow making projects that were on the cusp creating value without the credit more attractive.
- Regulation can take many forms, the most pervasive are market access restrictions, e.g., capacity and spot energy markets, and mandatory deployment rates like implied by the United States’ Public Utilities Regulatory Policy Act (PURPA). PURPA is a demand-pull regulation meaning that it creates or expands a market for alternative energy sources such as renewables. PURPA enabled non-utility owned generation sources to sell electricity to the power grid by forcing utilities to buy power from more efficient producers if the cost was less than the utility’s avoided cost.(5) This approach created a revenue stream for non-utility alternative sources and reduced the cost to customers at the expense of utility-owned generation.
- Direct investment, though not typically thought of as a subsidy as it is more indirect, holds an important place in the subsidy portfolio. Direct investment typically takes the form of government supported research and development, such as the Advanced Wind Turbine Program (AWTP). AWTP was a joint effort between the National Renewable Energy Laboratory and General Electric in the late 1990’s and early 2000’s. The intent was to reduce the levelized cost of wind power to rates competitive with traditional generation technologies. Through the application of concepts developed during the program, GE reduced wind power levelized cost* by 13%.(6)
As we identified through use of examples, these approaches can be leveraged subsidize renewable energy, but how can we do so while mitigating the adverse impacts of increasing our renewable portfolio? We will breakdown this question in our upcoming blog posts by identifying the adverse impacts and their causal factors, then leveraging these subsidy options to mitigate the adverse impacts of integrating intermittent renewable generation.
*Levelized cost is the all-in cost (capital plus operating expenditures) of the generation asset over its lifetime on a per kilowatt hour basis.
Source Information
(1) “WORLD ENERGY OUTLOOK 2011 FACTSHEET” (PDF). IEA. February 2012
(2) Coady, David; Parry, Ian; Sears, Louis; Shang, Baoping. "How Large Are Global Fossil Fuel Subsidies?". World Development.
(3) "Estimating U.S. Government Subsidies to Energy Sources: 2002-2008" (PDF). Environmental Law Institute. September 2009.
(4) “Renewable Electricity Production Tax Credit” (Website). Energy.gov.
(5) "The Public Utility Regulatory Policies Act". Smithsonian Museum of American History.
(6) “Advanced Wind Turbine Program Next Generation Turbine Development Project” (PDF). GE Wind Energy, National Renewable Energy Laboratory. May 2006.
First of all, well done. I found the post to be very informative and structured in a manner that was very easy to follow. I thought the order you listed the subsidies also makes the most sense for what should be pursued most aggressively. A tax credit per unit is straightforward and easy for firms to incorporate into their economic analysis and decision-making framework. The demand-pull regulation would definitely be effective, but could create political issues as some may see this as big brother exercising a bit too much power if they are pulling the strings behind power grids. Lastly, direct investment would definitely help some firms, but should be the last resort in my opinion. Investors with more skin in the game will always allocate capital more effectively than public entities. Without direct investment, it will ensure that the most effective firms will receive the most capital. No one benefits from governments picking losers, as the outlash could undermine public sentiment toward the first two more effective options. I'll stay tuned next week to see how your team breaks down these options.
ReplyDeleteOn a separate note, I've seen the $5.3 trillion figure for fossil fuel energy subsidies thrown around a few times now. I've always wondered what the number actually meant and how it was derived. I apologize for the timing, but being required to comment on this post pushed me into finally investigating it. Like the article you referenced, there are tons of references online that cite the $5.3 trillion fossil fuel subsidy number. They all trace back to an IMF working paper, one that I don't think ever published. The working paper was written in mid-2015 and forecasts subsidies to be $5.3 trillion globally for 2015. Of the $5.3 trillion, you can deduce from some charts that only about $500 billion, or 10% of the total, is attributed to tax credits. The other $4.8 trillion comes from estimates of the associated costs of using fossil fuels: air pollution, global warming, and other local factors such as traffic congestion and accidents. For instance, the article assumes that if a car that runs on gasoline gets into an accident that costs $10,000, then there was a subsidy of $10,000 to oil companies as they were the cause of that cost to society. I agree that pollution, global warming, auto accidents, etc are real costs to society, but I imagine most people think of immediate financial government subsidies when they see the $5.3 trillion figure. I guess what I'm ultimately trying to say is that I would recommend including appropriate descriptions for very impactful, yet potentially misleading statistics, or else any good op-ed could begin to look over-biased. That's my motive for the investigation, and definitely not because I work for a company that sells fossil fuels... Anyway, the IEA and World Bank both provide estimates that could be used as a sense check. $500 billion is still a pretty large and impactful number, and that figure is close to the IEA government-only estimates.
Nice summary of the menu of subsidy options. I look forward to both hearing about some of the pitfalls (as you state you’ll do), and seeing you articulate a clearer position (by the end) on which subsidy alternatives (if any) you want to convince the reader are the best.
ReplyDeleteAt the risk of going on and on about that Economist article …. you might have a look there for a good discussion of the unintended consequences of government subsidies at work in a market setting.
Grading Rubric (badly formatted because comments don’t allow formatting)
Possible “grades:” Excellent (E), Very Good (VG), Good (G), Could be Better(CBB)
Takes a clear position: CBB
Substantiates the position: CBB
Informs the casual reader: VG
Clarity/quality of exposition: G