Are Energy Subsidies Working?

Amid historically high oil prices and widespread concern about global warming, the presidential campaign has produced a lot of talk about energy subsidies. Supporters of subsidies to the oil, gas, and coal industries say the subsidies help promote energy independence. Opponents say that companies making record profits don’t need subsidies. And they claim that subsidies merely prolong dependence on outdated energy sources. When it comes to alternative energies such as solar, wind, geothermal and biofuels, supporters of subsidies say they are necessary to foster the growth of critical new industries that are still too young to enjoy the economies of scale of their more mature competitors. Skeptics, however, say that the markets for such energy sources are distorted by subsidies and could only exist in the presence of government support.  

Are energy subsidies working?  

The Purpose of Subsidies  

Economic subsidies are granted by governments to help achieve policy goals that are considered beneficial to public welfare and but are not being achieved through market forces alone. Subsides can be controversial if questions arise, as they often do, about the worthiness of the policy goals being supported and whether subsidies are the most efficient means of achieving them.  

Where the Money Goes Today  

According to the Energy Information Administration, the federal government spent an about $16.6 billion in energy-specific subsidies and support programs in fiscal year 2007, more than twice the amount spent in 1999. For purposes of comparison, the 2007 federal budget was almost $2.8 trillion dollars.  

  

Alternative—or renewable—energy received $4,875 billion in subsidies and support, more than any other single energy source or conservation program. But renewables are not a a single energy source. As I mentioned above, they include wind, solar, geothermal and biofuels.  As a group, traditional energy sources, including coal, oil and natural gas, receive even more subsidies—nearly $5.5 billion. The total outlay tells only part of the story, though. The coal, oil and gas industries are huge, and generate the vast majority of our energy. Relative to the amount of energy generated from each source, subsidies targeting traditional energy are a bargain.  

The table below lists the amount of energy produced by each of several sources and the amount of subsidy that source received. Coal received nearly 5 times the total subsidy that solar power did. But as a function of how much power each method produced, coal was cheap, swallowing just .44 per megawatthour compared to solar’s $24.34 per megawatthour. 

   

FY 2007 Net Generation (billion kilowatthours)  

Allocated to Electric Generation (million FY 2007 dollars)   

Subsidies and Support per Unit of Production (dollars/megawatthour)  

Natural Gas and Petroleum Liquids   

919  

227  

0.25  

Coal   

1,946  

854  

0.44  

Hydroelectric   

258  

174  

0.67  

Biomass   

40  

36  

0.89  

Geothermal   

15  

14  

0.92  

Nuclear   

794  

1,267  

1.59  

Wind   

31  

724  

23.37  

Solar   

1  

174  

24.34  

Refined Coal   

72  

2,156  

29.81  

   

   

   

   

Total  

4076  

5626  

   

Source: Energy Information Administration, Federal Financial Interventions and Subsidies in Energy Markets 2007, SR/CNEAF/2008-1 (Washington, DC, 2008).  

So traditional energy sources are more heavily subsidized than emerging energy sources, but we get more power per dollar of subsidy in oil, gas and coal then we do in wind and solar. Are we spending our money wisely? To answer that question you need to look at the purpose of the subsidies and whether those purposes are being met.  

Are Energy Subsidies Effective?  

Early in its history, the oil industry was plagued by a cycle of surging and collapsing prices that created booms and busts, impairing the development of the industry. (For a fascinating and definitive account of the development of the oil industry, see The Prize: The Epic Quest for Oil, Money & Power by Daniel Yergin.) Today, a principle purpose of subsidies to the traditional energy industries is to ensure their smooth operation and to secure domestic supplies of energy. According to a brief by the EIA, however, in recent years they have had negligible impact on domestic energy supplies:  

Between 1999 and 2007, the average real price of total energy per British thermal unit (Btu)3 consumed increased more than 80%. Meanwhile, total energy consumption or demand, including imports, grew by about 5%. Most subsidies and support to energy producers should stimulate supply; so too should higher prices and rising energy demand. Yet in 2007, the United States supplied roughly 72 quadrillion Btu from domestic resources, about the same amount as in 1999. This leaves the impression that energy subsidies had little effect on net domestic production other than to help prevent further declines. But the enactment of various production-oriented tax incentives in the Energy Policy Act of 2005 and subsequent legislation may have contributed to the slight increase in primary energy production over the last two years.  

  

Subsidies targeting alternat ive energies have a different purpose. They are meant to support the development of these industries to help them achieve scale economies so that they will become economically viable means of diversifying the sources of our energy. In contrast to its assessment of the negligible impact of subsides on energy production overall (most of which is traditional energy), the EIA notes that tax credits for the development of wind power have had a substantial impact on the increase in supply of that power source:  

The periodic expiration and extension of the production tax credit (PTC) for wind power since 1992 illustrates the effect of tax incentives. Between 1997 and 2007, nearly 16,000 megawatts (MW) of wind capacity have been installed. The Energy Policy Act of 2005 extended the PTC to wind facilities placed in service before January 1, 2008. Subsequently, 8,438 MW of wind capacity was placed in service in 2006 and 2007.  

With Oil Company Profits Surging, Do they Need Subsidies?  

So energy-industry subsidies do not always seem to be effective. What’s more, everyone knows that the big oil companies, recipients of a share of these subsidies, have been raking in the profits lately. Does it make sense to subsidize companies that are generating mammoth profits?  

The oil industry can be divided broadly into two sectors: upstream activities (exploration and production); and downstream activities (refining and marketing). In a period of rising oil prices, exploration and production has become increasingly profitable, while the profitability of refining and marketing has suffered due to challenges in passing along rising costs to consumers and other end users. (For a detailed analysis of oil-industry profitability, see this April 2008 report by the Congressional Research Service.)  

So some parts of the oil industry have been doing very well recently while others have been struggling a bit. When I discovered this I took a deeper look at the nature of the subsidies extended to the oil and traditional energy sectors. (For a detailed description of federal interventions and subsidies in energy markets, see this EIA report from 2007.) It appears that many of the subsidies directed to those sectors benefit upstream activities (the sector that has been wildly profitably recently) and not downstream activities. Following are a few examples of the subsidies that support upstream activities:  

  • Enhanced Oil Recovery
  • Exception from Passive Loss Limitation for Working Interests in Oil and Natural Gas Properties
  • Excess of Percentage over Cost Depletion: Oil, Natural Gas, and Other Fuels
  • Expensing of Exploration and Development Costs: Oil, Natural Gas, and Other Fuels

WIth oil prices high and oil company profitability booming (particularly on the upstream side), those subsidies would appear to be unnecessary. Recall, too, that there is little evidence that subsidies or high prices have helped expand the production of traditional energy supplies.  

Energy Subsidies Should Be Revisited and Retargeted  

My conclusion after this research is that the track record of energy subsidies is mixed. They have directly contributed to the growth of the renewable energy sector, especially wind, solar and biofuels. But they have not had the desired impact on the oil and gas sector—at least in terms of increased production. This may be partly because the subsidies are targeting the wrong part of the traditional energy value chain.  

I think it makes sense to revisit the architecture of the energy subsidy program, building in some limits on subsidies that become redundant when prices rise, and targeting them more carefully in line with policy goals, including possibly shifting some obsolete old-energy subsidies to new-energy areas to foster the development of renewable energy sources while restraining government spending.

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3 Comments

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3 responses to “Are Energy Subsidies Working?

  1. Here’s a crazy idea …. Rather than production tax credit style energy subsidies, which I personally can’t do much with, I would rather see “energy production transfers”. I can’t put a wind turbine or even a solar panel on my house. But what if, as a residential consumer and individual investor, I could buy solar panels, put them on someone else’s property or roof, and use the power as an offset to my own bill.

    Since I pay 37 cents / kWh at the margin, I would love to invest in a nearby solar or wind project. I would pay an upfront purchase price to the project developer for x% of the total project capacity, and x% of annual operating expenses.

    This would save the government the cost of the subsidies, and open up a new market for project equity.

    The utilities might not be happy about losing a 37 cent / kWh customer, but they might appreciate simpler contracting for power purchase agreements, as they would not be forced to “buy” the power, only to transmit it. They would also have to be willing to accept a production voucher as an offset to a residential bill.

  2. David Schatsky

    An interesting idea. It appears to touch on two trends in the renewable power sector. One is the rise of innovative financing schemes for solar power projects. There are two companies I’ve heard of, SunEdison LLC and MMA Renewable Ventures, which finance the installation and operation of solar power equipment on a customer’s premises and then sell the power to the customer. This keeps end users out of the power generating business, which most would rather avoid. Their customers today are commercial, though, not residential.

    The other trend is the smart grid–which I gather is more an aspiration than an actual phenomenon in our power grid. But the vision is power transmission capability that is flexible and intelligent enough to support applications like the one you suggest. Perhaps capabilities like these will appear in certain regions before long. But the hurdles, in terms of capital investment, right of way acquisition, and the politics behind that, are high.

    Thanks for writing.

  3. Pingback: Can We Afford Costlier Energy? « David Schatsky’s Weblog

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