Posted by: bmeverett | August 10, 2012

Friedman Watch 8-9-12


It’s been a while since we’ve taken on our old friend Mr. Tom Friedman, but his August 4 New York Times column “Get it Right on Gas” demands a reply. In this piece, Mr. Friedman echoes a common lament about the recent revolution in US natural gas. Instead of seeing the shale gas revolution as the economic and environmental bonanza it is, he chooses instead to warn “A sustained gas glut could undermine new investments in wind, solar, nuclear and energy efficiency systems — which have zero emissions — and thus keep us addicted to fossil fuels for decades.” OK, where to start?

First of all, let’s remember what we are looking for: a balance between low emissions and low cost. Everyone would be willing to pay a little more for electricity that emits less carbon, but Mr. Friedman’s favorite low-carbon sources, including wind, solar and nuclear, are prohibitively expensive, poor-performing systems. My latest estimates of power generation costs (based on capital and operating cost data and current fuel prices from the Energy Information Administration) indicate that a new advanced combined cycle natural gas power plant can spin out kilowatt-hours (kWh) for about 3½¢ each. This price would cover all the financing, maintenance and fuel costs on the plant plus give the utility a 15% return on its equity investment. By comparison, nuclear and onshore wind come in at over 9¢/kWh, offshore wind at 20¢, solar photovoltaic at 35¢ and solar thermal at 38¢. The nuclear estimate does not include any costs for spent fuel disposal – one of the major issues with today’s nuclear power plants.

Given these extremely high costs, we get back to the old question of how to value carbon. Mr. Friedman has long advocated a carbon tax to help reduce carbon emissions, but the real issue is how big should the carbon tax be? It makes no sense for politicians to say that they are in favor of income taxes. The only meaningful issue is how big an income tax and on whom it should be imposed. Even those elected officials who support a carbon tax are aware of the difficulty of setting a number. The cap-and-trade bills proposed a few years ago in Congress would have set the tax at $25-50 per metric ton (mt). Recent European carbon market prices have been around $10 per mt, and the US Northeast Regional Greenhouse Gas Initiative (RGGI) has set prices below $5 per mt. Are these taxes sufficient to effect a real change in our energy balance or are they just rhetorical devices for politicians? A few years ago, Mr. Friedman endorsed a plan by democratic Congressman John B. Larson of Connecticut that would have set an initial tax of $15 per mt, increasing at $10 per year. If certain targets were not met, an additional $5 per mt would be added. OK, sounds good, but how well would it work given the actual economics of alternative energy?

To equate the costs of natural gas power and nuclear power (again ignoring the costs of disposing of nuclear waste) or natural gas and onshore wind power, the carbon tax would have to be about $220 per mt. If Mr. Larson’s plan had been put into effect in 2009 when it was proposed, the tax would not hit $220 until 2029. To equate the costs of natural gas power and offshore wind power, the carbon tax would have to be $650 per mt, which the Congressman’s proposal would not reach until 2072. To equate natural gas and solar photovoltaic power, the tax would have to be $1,225, a level not reached until 2130, more than 100 years after its initial imposition. Until these levels were reached, the carbon tax would be nothing more than an excise tax on electricity, serving to reduce economic growth and grow government with no meaningful impact on our energy balance. Doesn’t anybody do the math anymore?

There is certainly an argument to be made for continued R&D on energy technologies, but we need to face the fact that spending large amounts of money to force these technologies into the marketplace won’t make them competitive or viable. In fact, allowing the manufacturers and owners to make a profit on the current generation of technology removes the incentive to improve them. Why should private companies put research dollars at risk, when the government will force people to buy the inferior technologies you have now?

Mr. Friedman seems to miss the most important point of all regarding central planning of the economy. A few years ago, before any of us had even heard of the shale gas revolution, Mr. Friedman and his friends were confident that they fully understood the nature of our energy balance and how to structure it for our common benefit. Forget markets, government bureaucrats knew just how to get us where we needed to go. In just a few years, however, the energy industry has been turned on its head. “Peak Oil” is dead, and fossil fuel prices have fallen, particularly for natural gas. Instead of seeing these unforeseen developments as a reason for a touch of intellectual humility, Mr. Friedman is just as convinced that he now knows everything he needs to know to plan out our future.

The reason that the Soviet Union failed as a society was not that the state planners were stupid (they were not) but that nobody has sufficient information to make millions of economic decisions in real time. Only free markets can do that. Markets don’t always get it right, but they correct quickly and efficiently. When governments make decisions (for example, ethanol and nuclear), we have to live with them forever. During the 1930s, we rejected the European fascist model of state planning. In the post-war period, we rejected the Soviet model of central planning. As a result, we are now a rich and free society. For some reason, however, people like Mr. Friedman just can’t accept that we wouldn’t be better off if he could make all the key economic decisions rather than allowing the rest of us to have a say. As a left-wing French economist was once reported to have said, “Capitalism may work in practice, Monsieur, but it will never work in theory!” We are now in the process of testing once again whether the American people can be seduced into central planning. Let’s all hope that we continue to reject this potential disaster.

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