Posted by: bmeverett | January 29, 2012

The President’s SOTU Fallacies


President Obama’s State of the Union message contained a muscular defense of his clean energy programs. The New York Times was naturally thrilled, stating “There is a powerful case to be made that clean energy investments that will create real jobs and keep America competitive in a $5 trillion global market for advanced energy technologies.” The case for clean energy is based on four arguments, all of them wrong. Here’s the list.

The first argument is that clean energies are better than fossil fuels because of the externalities involved in fossil fuel use. Externalities are economic jargon for the costs of a transaction imposed on third parties and not reflected in the price. Pollution is the classic example. I build a factory and sell widgets to consumers. If my factory emits pollutants, people who neither buy nor sell widgets must pay a cost, and that cost is not included in the price the customer pays. As a result, society overconsumes widgets relative to their true social cost.

This argument is perfectly valid, but useless unless the externality can be quantified. Let’s take the renewable energy production tax credit of 2.2¢ per kilowatt-hour (kWh) which supports an otherwise uneconomical wind power industry. The competitor for wind power is natural gas fired combined cycle power – a high performance, low emission technology. As discussed previously in this blog, wind power is intermittent and unpredictable, while a natural gas power plant can be run as often and as long as needed. But let’s ignore those performance problems for the moment, and just compare kWh’s.

A kWh of electricity generated by a new natural gas combined cycle plant requires about 5,800 British Thermal Units (Btus) of natural gas and emits about 0.3 kilograms of carbon dioxide. Since wind turbines emit no carbon, the production tax credit sets an implicit price of carbon dioxide at about $73 per metric ton. Is it worth it? The European Climate Exchange, where carbon emission rights can be traded on the market, has shown recent prices around 8€ or $10-11 per tonne. In the US, The Regional Greenhouse Gas Initiative among several northeastern states trades carbon allowances. The latest price was $1.89 per tonne. The “cap-and-trade” bills passed in 2009 by the democratic House (but not the democratic Senate) set a price of between $25 and $50 per tonne. On what grounds is a wind power subsidy equivalent to $73/tonne justified?

How about other pollutants? When burned, natural gas contains virtually no sulfur and only about 20% of the nitrous oxides and less than 1% the particulates (soot) emitted by coal plants. Proponents of clean fuel need to get beyond the argument that fossil fuels have external costs and explain why 2.2¢ per kWh is the correct quantification of those externalities. It seems to me quite high.

The second argument is that a combination of research and forced market penetration will push uneconomic technologies over the threshold into commerciality. This has never been true. Advocates always cite the accomplishments of the Apollo Program and the Manhattan Project, both of which involved substantial technical accomplishments, but made no claim to producing commercial results. When was the last time any of you flew in space?

In fact, one can argue that policies like the production tax credit and renewable portfolio standards actually impede technological progress by allowing companies to sell uneconomic products. Why spend the money and take the risks involved in researching improvements when you can sell the stuff you make now at a nice profit? Without these subsidies, companies must innovate or go out of business. Right now we have hundreds of companies living purely off the federal dole. That’s the basic reason that several decades and over $100 billion in federal research dollars have failed to produce any energy technology of commercial significance.

The third argument is that preeminence in clean energy technology is critical to America’s future competitiveness. This argument assumes that sooner or later every country in the world will use renewable energy as its basic electrical generating technology. It also assumes that the country that first moves into the renewable energy space will win an insurmountable technological and market lead. Today, the only reason that so many countries produce wind and solar power equipment is that other countries (mainly the US) subsidize them, creating a market where none would otherwise exist. China produces solar panels because Americans will pay high prices for them and manufacturing costs are lower in China.

The best analogy here is the supersonic commercial airliner. During the 1960s, many Americans, including some of our business, technology and political leaders, insisted that future commercial aircraft would all be supersonic. If the US did not spend whatever it took to develop such aircraft, the US technological lead in aerospace would be irrevocably lost. Fortunately, cooler heads prevailed. The Europeans went ahead and built the Concorde – a technical and aesthetic marvel, but a complete economic flop. The Europeans never recovered the development or manufacturing cost of the airplanes, and flew them only as long as they (barely) covered cash operating costs before taking them completely out of service in 2003. There are no supersonic aircraft in commercial operation today. If the US had gone down that road, we too would have wasted billions for nothing.

If there are ever sufficient technological breakthroughs in renewable energy to make wind systems truly economic, companies from everywhere in the world, including the US, will enter that space. Wind power, for example, is not exactly rocket science. Ford pioneered the modern manufacturing of automobiles and put Model Ts within the reach of average people. That didn’t mean that Ford gained a permanent global advantage. General Electric should manufacture and sell wind turbines when they can make a profit on their own. What GE has done instead is go to Washington and convince the government to force people to buy GE’s products at high prices. Nice work, if you can get it.

The final argument concerns jobs. I have discussed the green job fallacy extensively (See, for example, “Green Jobs or Con Jobs” from April 26, 2009). If the government could create real jobs, life would be easy. The feds could hire 10 million people at $250,000 a year each to dig holes and another 10 million people at $250,000 each to fill the holes in again. This would create 20 million jobs, but no value. It would simply make people get dirty and sweaty in return for welfare. If the government subsidizes like GE companies to build wind turbines, the subsidy part of the labor cost is just welfare. GE employees may like that, but the rest of us shouldn’t.

The case for a broad energy strategy is extremely weak. The federal government should simply opening up more federal lands to drilling and stop impeding meaningful investments like the Keystone Pipeline. I guess the problem is that this approach involves no federal expenditure, which means no opportunity for politicians to direct our money to their favored constituents.

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Responses

  1. Dear Professor,

    I respectfully disagree with your first argument. First of all, you make a big assumption, a valid one in my opinion, but still an assumption that in the future only NGCC plants will be built and not coal ones. If one compares the wind power with coal fired plants the CO2 saved would be much higher, hence the price tag on the externality would be lower. Also, I am not fully persuaded by the comparison of the US subsidy on wind with the price of “green and white certificates” in the European market. As you know those prices are only partially driven by the market as the target in terms of emissions reduction are set by policy markers. This target is the result of painful negotiations and compromises (usually between environmental concerns and economic growth) and are certainly not based on an economic analysis of the real cost of CO2 emissions on our society and future generations.

    • Good questions. Here is my response. First, have a look at the Energy Information Administration’s new US energy forecast, published a few days ago. The economics of natural gas combined cycle power generation have become so strong that EIA is forecasting an additional 62.5 gigawatts of NG capacity, and a net decrease of 24.5 GW of coal-fired generating capacity. What then is the marginal source of power against which renewables should be compared? Second, my point about carbon prices is that no politician anywhere in the world has been willing to support a carbon price higher than $50 per tonne. European politicians, those great advocates of strong climate action, won’t go above about $20. Why then are we willing to support a hidden tax of $73 for wind power? Is that the lowest cost carbon reduction step available? Should we do everything that costs $73 or less? What impact would that have on the economy, which continues to scrape along the bottom? Or is the real iss that wind power manufacturers like GE simply have the political power to convince the federal government to divert taxpayer dollars to their bottom line?


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