Welcome to a new 'Energy in Depth' series. This time we discuss the question: Should the US Government Subsidize Renewable Energy Sources?
With the US president’s executive
order addressing energy regulation last week, the energy industry and the
tension between it and the regulatory body is front and center in many news
reports again. Key themes among reports,
aside from job creation by one or the other energy sector, have been the
importance of affordable energy and the role renewable energy will play in the
power generation stack going forward.
Finally, the president’s actions were a reminder of the significant
impact a government can have on the competitiveness of one fuel versus another
and the fact that renewable energy sources have not fully established
themselves as alternatives to fossil fuels.
The current events were a
catalyst for our decision to explore the issue of government subsidies in the
energy industry with a focus on the renewable energy sector. In addition to
discussing the benefits and drawbacks, we will also dive into the different forms
of subsidies and alternative tools available to the sector to complement or
replace government subsidies.
To provide some context for the
recurring discussion of energy subsidies, one has to understand a few
fundamental concepts:
(a) Most
people consider energy, in particular
electricity, a basic household need and are supportive of measures that reduce
the cost to them. Companies, in
particular energy intensive ones (manufacturing, chemical), have a strong
interest in lower cost. People want low
cost energy.
(b) Developing
a new renewable energy is expensive and requires large upfront investments to
build infrastructure. Costs include prospecting
locations, environmental studies, permitting, and construction of generation
assets (solar fields, hydro plants, wind turbines) and the infrastructure
required to bring those to market. You
will see in the table below that the capital cost associated with renewable
energy technology on a per-unit-of-output basis is among the highest in the
industry (Source #1: Penn State). The
high, upfront capital investment creates a barrier for entry for early-stage, pure-play
renewable energy companies. It is also hard for large scale utilities to
justify the investment in higher cost electrical generation over fossil fuels
like coal and natural gas. These investments increase the cost of
providing renewable electricity and the vulnerability to the cyclical nature of
the market.
(c) Whether
the majority of people in the US believe in climate change or not, many people
value the benefits associated with renewable energy. Fossil fuels are a finite resource so there
is a need for developing alternative energy sources for our long-term energy
needs. According to the Natural
Marketing Institute 2016 State of Sustainability in America report
sustainability “is becoming a cultural shift” to the extent that companies are
evaluated by their sustainability initiatives (Source #2). This also explains Deloitte’s findings in
their annual Resources Study 2015 which showed 39% of surveyed companies invested
in solar panels (Source: #3: Deloitte). In
addition, you will see in the table above that the ongoing operating cost of
renewable energy is the lowest among alternatives. This is another reason for continued interest
in exploring this technology. Overall, renewable energy is a more
relevant piece of the energy mix than ever.
Together, these three premises
explain why subsidies for renewable energy exist today. Defined as ‘Measures that keep prices for
consumers below market levels or for producers above market levels, or reduce
costs for consumers and producers’, they address concerns (a) and (b)
above. Whether it is because or despite
of these subsidies, renewable energy became more meaningful in the last 10-15
years as evidenced by the graph below (Source #4: EIA 2017 Annual Energy
Outlook).
The recipient of the subsidies is
usually the power generation company, though programs assisting end-users with
the installation of renewable distributed generation exist as well. By providing funds for R&D, lowering the
tax burden, or awarding tax credits that can be traded in markets, the
government helps decrease the drag on return from high initial investments. The idea is that an accelerated payback
incentivizes the investment in the first place, and allows the generation
company to bid into the market at a lower cost and ultimately reduces the cost
to the consumer. In addition, it may
also help companies manage through market cycles, which are more pronounced in
energy than in other industries. Along
with this comes job security within the energy sector. On the other hand, subsidies are financed through
taxes, which have a direct impact on consumers and corporations. The choice for subsidies also assumes that
there is a greater benefit to society from the government’s investment that
exceeds the benefits from spending elsewhere (or reducing taxes).
In the next two blog posts we
will discuss to what extent these premises hold and what common arguments for
and against subsidies towards renewable energy are brought forward most often.
Stay tuned for a more in-depth
discussion next week!
Topics in this series:
-
Why you should support subsidies
-
Why subsidies do more harm than you think
-
Subsidies in all their shapes and sizes
-
Tools that support renewables in a world without
subsidies
Sources:
- Course material for ‘Energy Markets, Policy, and Regulation’, Penn State University. https://www.e-education.psu.edu/eme801/node/530
- 14th Annual Consumer Report: 2016 State of Sustainability in America, Natural Marketing Institute. http://www.nmisolutions.com/index.php/research-reports/sustainability-reports/14th-annual-consumer-report-2016-state-of-sustainability-in-america
- Alternative Energy Trends, Deloitte. https://www2.deloitte.com/us/en/pages/energy-and-resources/articles/alternative-energy-trends.html
- EIA 2017 Annual Energy Outlook. https://www.eia.gov/outlooks/aeo/
The blog raises some important questions about the role (if any) that government subsidization should play in the development of renewable energy sources. I would like to use the worlds own history of energy subsidization as a jumping off point for my response.
ReplyDeleteWhile certainly not an expert, I don’t think that there is anything new or novel to the idea of governments around the world subsidizing the costs of energy. In 2015, global fossil fuel subsidies are estimated to have reached $5.3 TRILLION dollars. That is an awfully large number, in fact it is about 6.5% of the global GDP in 2015. I would imagine that much of the pushback against subsidizing the production of renewable energy costs is coming from the fossil fuel based energy companies and their supporters who have long been drinking from the government provided subsidization punchbowls. The fossil fuel industry is by most accounts pretty mature. I have no doubt that capital costs and operating costs were much at higher during the infancy of the industry. Through technological innovation at least partly funded by these subsidies the industry grew and matured into what it is today.
I think history provides us with a pretty clear picture of what we can expect as an evolutionary path for renewables. Through investment and innovation that is at least partially funded by increasing subsidies, we will see those capital costs come way down. The table provided by the author has already shown us how cheap the operating costs are. To expect any reduction there is unreasonable as they are already near 0.
The government does not have to implement massive tax hikes to pay for these subsidies as opponents of them will tell you. How about we “move the money around” a little bit? Studies have shown that “eliminating the 12 subsidies fossil fuels in the US would save $41.1 billion over 10 years without increasing fuel prices, reducing employment, or weakening US energy security. (Brookings Institute, February 2013, http://bit.ly/1h3mDhB) That is just the tip of the iceberg, I (maybe ignorantly) refuse to believe there isn’t enough money already in budgets that can be reallocated to renewables without a crippling tax to households.
Renewable energy is here to stay and I think it’s the way of the future as the author’s energy consumption chart shows. We would be wise to everything we can to help foster and nurture its growth.
I agree with Brian regarding the possibility of [re]moving fossil fuels' subsidies. The objective of subsidies is to help immature technologies reach a commercial scale price, or help them compete against mature technologies in the same field. They are a way of "leveling the playing field". The large history of fossil fuels in the US shows that natural gas, oil and coal industries have reach their maturity stage long ago.
ReplyDeleteThere is an important temporal dimension in the implementation of subsidies, that must be clear since their conception. If the face-out of subsidies is done without previous warning, the political environment can be perceived as riskier, which would increase the risk perception in the affected industry. On the other hand, if there was never an explicit "expiration date" of the subsidy, the industry grows addicted to it, without incentives to increase efficiency or reduce costs. Therefore, the subsidy becomes another permanent revenue stream that distorts the market.
In the particular case of renewables, the need for subsidies must consider the local context of the place where the project will be installed. If the solar radiation or the wind speed is sufficiently attractive, the "rules of the game" are clear, and there is ease of connection to the transmission system, the project should sustain itself without the need of subsidies. But considering that the competition (i.e. fossil fuels) have a subsidy, that renewable power plant would be in disadvantage and might face bigger barriers than the case where nobody has subsidies.
Another dimension to consider as an incentive to implement renewable energies is the environment. A place that suffers the negative externalities of a thermal power plant might be benefited by the presence of renewable generation, as the need for the thermal generation would be reduced. But if that place has not the best conditions to make a renewable power plant feasible, a subsidy would help. In this case, the magnitude of the subsidy should be compared to the magnitude of the negative externalities that the renewable generation would be offsetting.
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ReplyDeleteYour introduction to the financing of renewables is excellently structured.
ReplyDeleteThe topic of renewables as a relevant contributor to the power stack is extremely interesting. Subsidies for renewable energy development will undoubtedly increase the financial viability of large-scale infrastructure projects. However, like Brian mentioned in an earlier comment, there are many factors at play, e.g., lobbying power of traditional power sources. To better help your reader understand the other factors impacting renewable viability I think there are a few other items worthy of being addressed…
(1) You mention that renewables are expensive and require large upfront capital investments. This is true, the upfront investments are substantial and in many instances, more expensive than other non-renewable options. However, it might be worth looking at the long-term cost per kwh when accounting for asset life and utilization. These projects are typically financed and the cash outflows are dispersed over the life of the asset. Therefore, if you were to disperse the “upfront” capital expense over the life of the asset and allocate a portion of the cost to each kwh produced I believe renewables are far more reasonable in terms of cost than the generation technologies it is looking to replace. This concept is called levelized cost.
(2) The cost analysis compares all energy generation technologies. This could be misleading as these technologies play different roles within the energy stack. For example, coal-fired and nuclear plants comprise most base-load power while gas turbines are primarily contributing load following and peak power. These generation segments are typically dictated by operating costs. For renewables to be economically viable they need high utilization, meaning, they need to be a part of the base load to take full advantage of their low operating costs.
(3) So you might ask, “If renewables have a competitive levelized cost then why are they not more prevalent?” Great question, there are 2 reasons: (1) renewables produce intermittently and (2) current ISO/RTOs in deregulated markets have constrained capacity rules. Since renewables are reliant upon wind and solar radiation they only produce when wind and radiation exist. Meaning, they cannot be relied upon as a constant source of energy. The market makers (ISOs/RTOs) for energy in deregulated markets have established 2 routes for power producers to generate revenue (1) the capacity market and (2) the spot market. These market makers have in place rules that relegate renewables to the spot market and prevent them from earning the large sums provided to traditional producers in the capacity market specifically due to the aforementioned reliability issue.
It would be interesting to see what the impact of changing these capacity market rules would have on the financial viability of renewable energy projects. There are ways to get around the intermittency of renewables, e.g., energy storage via solutions such as lithium-ion batteries. These changes along with the right type of subsidies (research-based) could prove to make renewables a lucrative alternative to traditional, environmentally harmful generation technologies.
Great start on a very topical issue. I look forward to seeing you position more clearly articulated as you move forward. Are you pro or con for subsidies? (pro, I’m guessing … good to start with the lay of the land though). What kind of subsidies? Are some better than others? What are the con arguments against subsidies and how do you respond (you might have a look at The Economist article in the blogging-topic-list-item “Renewables are Sowing the Seeds of their Own Destruction” for one take on how subsidies and market-design are causing major problems)?
ReplyDeleteEffective writing style …. discussion followed by boldfaced summary-statement.
One thing to be careful of. You describe the point of subsidies as reducing consumer prices. Price is strongly affect by marginal cost. Total returns for investors (those building the generation resources) are determined by average cost. So it’s entirely conceivable to subsidize up-front CAPEX but have a limited effect on price. You seem to get at this toward the end … but being more clear might help.
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: G
Substantiates the position: G
Informs the casual reader: VG
Clarity/quality of exposition: VG