Get the Energy Sector off the Dole

Why ending all government subsidies for
fuel production will lead to a cleaner energy future—and why Obama has a rare chance
to make it happen.

By Jeffrey Leonard

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Composite: oil rig by Joel Sartore; White House by Altrendo Travel

 ast September, President Obama promised that the cornerstone of his legislative program for 2011 would be to set an energy policy “that helps us grow at the same time as it deals with climate change in a serious way.”

Today, the president might seem to stand a better chance of refreezing the melting Arctic ice caps. After all, he’s up against a House Republican majority rife with members who openly deny that humans contribute to global warming, as well as members of his own party who are beholden to domestic fossil fuel industries. In November, West Virginia’s new Democratic senator, Joe Manchin, boasted to his constituents that he had secured Harry Reid’s assurance “that cap and trade is dead.”

But not all is lost. If President Obama wants to set us on a path to a sustainable energy future—and a green one, too—he should propose a very simple solution to the current mess: eliminate all energy subsidies. Yes, eliminate them all—for oil, coal, gas, nuclear, ethanol, even for wind and solar. It will be better for national security, the balance of payments, the budget deficit, and even, believe it or not, the environment. Indeed, because wind, solar, and other green energy sources get only the tiniest sliver of the overall subsidy pie, they’ll have a competitive advantage in the long term if all subsidies, including the huge ones for fossil fuels, are eliminated. And with anti-pork Tea Partiers loose in Washington and deficit cutting in the air, it’s not as politically inconceivable as you might think.

 nergy subsidies are the sordid legacy of more than sixty years of politics as usual in Washington, and they cost us somewhere around $20 billion a year. To put that sum in perspective, that’s more than the State Department’s entire budget. It’s also enough to send half a million Americans to college each year with all expenses paid. Energy subsidies undermine the working of the free market, and they make rational approaches to long-term energy challenges and climate change impossible. They are not an aid to energy independence or environmental stewardship. They are an impediment.

Energy subsidies take many forms. Some of them are direct outlays of taxpayer dollars, like payments to corn producers for ethanol. Most are in the form of tax benefits, such as the deduction for “intangible drilling costs” (labor, repairs, hauling, you name it) in oil exploration—a notoriously abused provision of the tax code. The sheer number of subsidies is part of what makes them so hard to track.

But one thing about them is easy to summarize: they are heavily tilted toward fossil fuels. Government statistics show that about 70 percent of all federal energy subsidies goes toward oil, natural gas, and coal. Fifteen percent goes to ethanol, the only renewable source of energy that consistently gets bipartisan support in Congress (think farm lobby and Iowa). Large hydro-power companies—TVA, Bonneville Power, and others—soak up another 10 percent. That leaves the greenest renewables—wind, solar, and geothermal—to subsist on the crumbs that are left.

None of these estimates account for continuing support to the nuclear industry, estimated to be about $1 to $2 billion, much of it to promote research and development efforts on new nuclear technologies and waste disposal methods. There are plenty of hidden subsidies, too. We place a cap on liability for accidents (like the BP oil spill). We offer the nuclear industry large loan guarantees. And, of course, we maintain an immense military embroiled in the Middle East and elsewhere as it tries to secure access to energy resources around the globe.

What do we taxpayers get in return? Not much. Certainly there’s no evidence that subsidies do anything significant to increase our domestic energy supply. A recent study by the U.S. Energy Information Agency found that subsidies for domestic energy production doubled between 1999 and 2007, but despite all the extra money the amount of energy supplied by domestic sources stayed the same.

Oil lobbyists like to warn of dire consequences if petroleum subsidies are cut—fewer oil sector jobs, higher gasoline prices. But that’s nonsense. Petroleum is an international market; U.S. domestic supplies, which make up only 2 percent of the world’s proven petroleum reserves, have little effect on global oil prices. And it is world oil prices, not federal subsidies, that really determine how much drilling oil firms will do. Cutting oil subsidies, the Treasury Department has estimated, would reduce domestic energy production in the long run by less than one-half of 1 percent, would cut domestic oil jobs by the same amount, and would affect GDP by an amount “too small to measure.”

The single biggest energy subsidy, worth some $2.2 billion per year to the oil industry, doesn’t even support domestic production. It is a tax break, first inserted into the Internal Revenue Code in the 1950s, that allows American oil companies to subtract the royalty payments they make to foreign governments from the corporate income taxes they owe at home. This is a super-sized benefit, since a royalty is paid on the total value of oil extracted, while income taxes are paid on only the profits after all expenses. Even worse, of course, the tax break creates an incentive for oil companies to import petroleum, only increasing and perpetuating our dependence on foreign oil.

In other energy industries, federal subsidies have for decades brought little or no public benefit even as they support an infrastructure of lobbyists hired to keep the money tap flowing. The coal industry receives more than $2 billion per year through the alternative fuels production tax credit, largely to produce coal-based synthetic fuels, or refined coal. This is a pointless use of money. These fuels do nothing to reduce carbon dioxide or promote energy efficiency, and absent the subsidy, more power plants would probably just burn the basic coal rather than its synthetic form.

The U.S. government also allocates about $2 billion per year toward coal-related research and development into various “clean coal” technologies. So far, the return on this investment has been pretty much nil. But the coal lobby has done a good job of blurring that fact.

Today, a whole new round of government-promised subsidies is enabling the energy industry to make multibillion-dollar investments—in ethanol refineries, nuclear power facilities, and “clean coal” plants. The danger with these large-scale and highly capital-intensive “white elephant” projects is that the decisions made today will drive energy supply considerations for the next forty years. The very industries supporting such projects admit that they cannot survive in the market without government support. But, once built, these boondoggles create political interests demanding still more subsidies while limiting our nation’s flexibility to shift to cleaner and more cost-efficient energy sources.

As an investor in clean and green energy, I will confess that some of our companies have benefited from increased sales of equipment and services thanks to federal incentives to step up investment activity in solar and wind power in recent years. The primary jumpstart was the new tax credits that were built into the Energy Act of 2005 and renewed, haltingly, on an annual basis by Congress since then. I find myself concluding, however, that even subsidies for the truly green renewable sources can lead to perverse energy outcomes. For example, the entrance of the green renewable industry into the energy subsidy race over the past few years has in many places created the energy equivalent of suburban sprawl—a patchwork of wind and solar farms being deployed helter-skelter across the landscape. Thus, in some instances, wind projects have been launched without due attention to the additional infrastructure expenses that will be necessary to build new transmission lines, leaving new wind facilities stranded or underutilized. Texas, for example, has found that it must create at least $3 billion worth of transmission lines to get electricity from its wind projects to its cities, and concluded, ironically, that in some instances transmission line corridors must incorporate plans for new coal-fired power plants to justify the investment.

So we can waste money and distort the market by subsidizing all of these forms of energy. Or we can just call it quits on the waste. Disarm completely. Kill all the subsidies—yours and mine.

 iberals and environmentalists may fear that they have no cards left to play except pushing for gradually increasing subsidies for their favored clean energy solutions. After all, they have struggled to get Congress to address what they consider to be the heart of the global warming problem: the failure of the market to factor in pollution and other externalities that result from our use of fossil fuels. The whole point of the cap-and-trade bill was to remedy that shortcoming, which would have had the effect of making green energy sources more competitive. That’s why the collapse of cap and trade has left many environmentalists despondent. It is also why they are now pressing President Obama to use the regulatory power of the EPA to set limits on carbon emissions. But let’s be honest: neither cap and trade nor carbon taxes are coming back any time soon. And Obama is going to face a political firestorm in Congress and around the country if he moves aggressively through EPA regulatory fiat.

What the green lobby may underestimate is the degree to which the “free market,” given the current natural direction of the energy sector, would ultimately support the cause of clean energy in the absence of subsidies. Hence a “benign neglect” approach by Washington to the energy industry would be the best strategy for now. Emphasizing the elimination of existing subsidies and the creation of a level playing field would benefit green energy sources by enabling them to fit into rational long-term energy supply strategies pursued by public utilities, while also allowing the whole energy sector to respond better to price signals and consumer demands.

Major changes in the picture of domestic energy supply make it possible to sweep away decades of accumulated subsidies without seriously threatening the affordability of energy. In the mid-1900s, the dominant fuels and sources of energy in America—for all sectors of the economy—were petroleum and coal. The rationale for subsidizing these fuels was simple: they were the backbone of the economy, and adequate supplies needed to be assured. The good news is that this rationale no longer applies: the U.S. energy market, if left to its own devices, without distortions or subsidies, will continue to provide plentiful and affordable power while gradually evolving away from oil and coal as the primary energy sources. This changeover to what will be cleaner energy solutions will accelerate considerably in coming years, thanks to several major trends.

The first trend, a real game changer, is the discovery in recent years that America is sitting on many decades’ worth of exploitable natural gas. Natural gas emits half the carbon dioxide of coal. Although its extraction poses threats to underground water supplies in some places, these can be managed with proper regulation and are in any event much less serious than the environmental threats posed by coal mining. Gas is also more cheaply and safely transported. It can be moved to power plants through underground pipelines, unlike coal, which requires heavy trucks and trains to struggle over mountain ranges. And it is every bit as abundant as coal, if not more so, and as widely dispersed geographically. Since the late 1980s, natural gas has been the fuel of choice for the majority of new electricity-generating plants constructed in the United States. Over the next forty years, nearly all of America’s existing coal-fired power plants will reach the end of their useful lives, and a significant portion of them will probably be replaced by cleaner-burning natural gas facilities, especially if the subsidies that buoy the coal industry today are allowed to expire. Now that adequate supplies are assured for the future, a lot of investors are betting that natural gas will gradually replace coal as the dominant fuel in the electricity-generation sector. This trend by itself will significantly lower America’s carbon footprint by 2050.

Natural gas–fueled electric plants will also foster increased use of wind and solar power. Both these renewable energy sources require a backup source, because the wind blows intermittently and the sun doesn’t always shine. A coal plant must be kept burning once it’s been fired up, so coal-fired electric plants make a poor intermittent source. Gas-fired plants, by contrast, are virtually the only economical sources of electricity that can be powered up and powered down to support lulls in other sources of power.

Another encouraging market trend involves nuclear power. While Washington has been hurling loan guarantees and other subsidies at the industry in order to spur the building of a new generation of reactors, only a few new projects, if any, are going to move forward. The reason is simple arithmetic. When the huge construction costs of new nuclear power plants are factored into the price of the electricity they produce, they can’t compete with power from natural gas–fired plants. That arithmetic won’t change unless Washington throws even more subsidies to the nuclear industry (something many Republicans are keen to do).

But the surprising good news is that America’s existing nuclear plants, which were built at exorbitant cost decades ago, are now largely paid off. Today, these plants supply 20 percent of the nation’s electricity, all of it carbon free and priced competitively. Thanks to gains in plant utilization at existing nuclear installations—brought about through improvements in maintenance and safety—the nuclear industry has increased its output by 40 percent since 1990, the equivalent of adding twenty-nine new 1,000-megawatt reactors. This is a lot of unexpected new electricity supply for the country; by way of comparison, at the end of 2009 the U.S. had in total about 35,000 megawatts of installed wind power and about 500 megawatts of solar photovoltaic panels providing electricity.

For the next several decades, even without new subsidies (except liability protection), power from these existing nuclear facilities will remain an important part of the American electricity-generation picture. It will help reduce imports of oil and prevent overdependence on natural gas. The operational cost of the already constructed nuclear power capacity in America is very cheap; at less than two cents per kilowatt hour, it is only a fraction of the operating costs for either coal- or gas-fired power plants. The Nuclear Regulatory Commission now expects to extend the operating licenses of at least ninety of the country’s nuclear power plants from their original expiration dates in 2020 to 2040, and the industry in that case will invest hundreds of millions of dollars in refurbishments. This could buy several decades of time for the development of superior technologies as we combat global warming.

A third positive trend is the increasing competitiveness of solar, wind, and geothermal power to provide diversification and decentralized power generation, and to enable utilities to meet consumer demands and state mandates for green power. Nearly half of all states now have renewable portfolio standards (RPS) requiring their utilities to procure a certain percentage of electricity from renewable sources in coming years, with California leading the way by requiring that 33 percent of electricity come from renewables by 2030. RPS mandates, along with consumer and industry demand for and local government procurement of green electricity, are gradually becoming more important drivers of the wind and solar industries than tax subsidies.

But let’s face facts. The renewable industries will mature as commercially viable on their own only in future years, as more natural gas generation is deployed on the grid, transmission grids are extended and interconnected, and energy storage technologies become more available. The government tax credits were valuable to support the industry in its infancy, but the solar and wind industries can, and will need to, become cost competitive. In the past few years, the prices of solar photovoltaic modules have fallen in the United States by more than 50 percent, and the efficiency of large wind turbines has increased dramatically. This provides great hope that, with a level playing field, and if they do not get “addicted” to subsidies like so many other energy industries are, solar and wind will be able to compete and grow to generate some 20 to 25 percent of America’s electricity in the next few decades.

A fourth positive market trend, at least from an energy-efficiency and environmental standpoint, is the future price of oil. Right now, because of the economic slump, petroleum prices are moderate. But analysts and the energy futures market are anticipating that in 2011 oil prices will begin to climb again as worldwide demand works back toward 2006–2007 levels. Regardless of short-term fluctuations, virtually all international studies of the petroleum industry show substantial demand-supply imbalances during this coming decade, particularly as China and India continue to add tens of millions of new cars to their motorways each year. Sooner or later, prices at the pump will rise considerably and permanently.

American consumers will feel the pain. But as was evident during the last (albeit short-term) run-up in petroleum prices, which drove gasoline prices over four dollars a gallon in 2008, Americans will respond to higher prices with countless adjustments—in the cars they buy and in their daily routines—that in turn will move the whole economy toward more efficient energy use.

The rising price of oil will hasten yet another market clean energy trend that is already apparent: the growing dependence by every sector of the economy on electricity and, in particular, the nascent move toward electrification of transportation (see “The Plug-in Revolution,” August/September/October, 2008). The much-ballyhooed new crop of electric cars, like the Nissan Leaf and the Chevy Volt, are the popular face of this trend, but these are but precursors of a market that is still some years away. Meanwhile, a more salient development is the return of electric-powered rail transit. Today, metro areas around the country are building and expanding light rail lines, a movement that will almost certainly accelerate. It could well be followed by the eventual electrification of heavily trafficked freight and passenger rail corridors. Gasoline-powered cars will be the mode of choice for most Americans for many years to come, but not forever.

Taken together, these market trends—cheaper natural gas; more expensive oil; the gradual turnover of old, polluting, inefficient power plants and their replacement by natural gas or cleaner-generating technologies; the extended life of existing nuclear facilities; and the slow but steady electrification of transportation—will gradually turn America’s economy toward reducing greenhouse gas emissions while supplying us with abundant and affordable energy. These trends will also buy us time to develop the more innovative energy sources of the future.

Government has a legitimate and vital role to play in dramatically accelerating this evolution. It should invest heavily in long-term research and development to hasten the progress of new energy technologies. It should stiffen regulations on coal use and all fossil fuels so that the fuel’s environmental and health costs are born by industry and reflected in its price. It should make sure that natural gas produced from hydraulic fracturing techniques is environmentally responsible. And eventually, when the political climate is right, it should impose a tax on carbon.

What government shouldn’t be doing is subsidizing and protecting incumbent energy producers. All that will do is slow the transformation to a cleaner energy future. In my rounds in Washington recently, I have heard persons representing, separately, the nuclear, ethanol, coal, and green renewable industries float the suggestion that the government set a floor on the price of natural gas because the low prices of gas are making their existing and planned projects uneconomical and uncompetitive. Energy lobbying firms are surely being paid right now to work up the talking points on this harebrained idea.

 onventional wisdom in Washington has long been that addressing the energy subsidy issue is a political nonstarter, given the deeply entrenched lobbying capacity of incumbent energy interests. Last year, the Obama administration made a noble run at cutting oil and gas subsidies. Republicans in Congress shut down that effort.

Indeed, rather than cutting energy subsidies, the political dynamic in Washington in recent years has been to increase them. Establishment Republicans from John McCain to Newt Gingrich have promoted an “all of the above” strategy of subsidizing just about every form of domestic energy, from oil to nuclear power. Meanwhile, liberal Democrats in Washington, long opposed to subsidies for fossil fuels on environmental grounds, have backed government funding for environmentally dubious ethanol because they want to curry favor in the Farm Belt or because doing so gains them votes for wind and solar subsidies.

Yet all of a sudden, two political developments have emerged that open the door for the president to sweep away business as usual.

The first is the rise of the Tea Party and of the budget- and deficit-cutting mood of the new Congress. There have always been libertarian elements within the Republican Party that have railed against “corporate welfare,” including the massive tax expenditures that favor oil production. Now they are joined by many Tea Party sympathizers who, appalled by the bank and auto company bailouts of recent years, instinctively share the same hostility to big business subsidies.

The distinction is often lost on progressives, who hear Tea Partiers railing against cap-and-trade legislation or Sarah Palin crying, “Drill, baby, drill,” and conclude that they are simply gullible tools of Big Oil. But it is one thing to believe, as Sarah Palin and many of her followers do, that the government has no place telling citizens they can’t drill for oil or gas on their own land, or sell the right to do so to big oil companies. It is quite another thing to believe that government should use our taxpayer dollars to provide big oil companies, or any energy company, with corporate welfare. Though it’s seldom remembered, Palin boasted during the 2008 campaign that as governor she imposed $700 million in new taxes on oil producers in Alaska; companies like Exxon and ConocoPhillips, she bragged, are “not my biggest fans.”

Since the midterms, this Tea Party willingness to take on energy interests has migrated to Washington. In November, two senators who are darlings of the Tea Party, Jim DeMint and Tom Coburn, drew the ire of Senator Chuck Grassley of Iowa by signaling their opposition to ethanol subsidies. Coburn went on to say that even subsidies for the oil and gas industries should be on the agenda for budget cutting.

The other big political change is on the left. After years of going along with big ethanol subsidies in return for minuscule investments in wind, solar, and other alternative energy sources, many liberals and environmentalists have finally decided that the compromise isn’t worth it. A signal moment came in November when Al Gore announced at a green energy business conference in Athens that he was reversing his long-standing support of subsidies for corn-based ethanol, declaring them “not good policy.” Gore explained his previous support in political terms, mentioning that he had paid “particular attention to the farmers in my home state of Tennessee, and I had a certain fondness for the farmers in the state of Iowa because I was about to run for president.” This fall, environmental groups like Friends of the Earth joined forces with Dick Armey’s FreedomWorks (a key supporter of the Tea Party) and Taxpayers for Common Sense to oppose extension of one of the most senseless of all subsidies, the so-called Volumetric Ethanol Excise Tax Credit (VEETC), which pays oil refiners like BP forty-five cents a gallon to blend ethanol in with gasoline.

So we find ourselves in a new political moment when for the first time it is possible to imagine an alliance of GOP libertarians, disaffected environmentalists, and budget hawks coming together for a grand deal that would sweep away sixty years of bad energy policy. Obama should seize the moment to bring this coalition together in support of a single objective: to eliminate all government subsidies and tax credits on production of all primary sources of energy. Of course, he’d have to abandon his own long-held support for ethanol (the tax deal his administration brokered with the GOP in December included a twelve-month extension of the VEETC). But if he did so, he might well find that other establishment politicians in Washington would join him in giving up on their favored energy subsidies to serve a greater goal. In December, the Bowles-Simpson deficit reduction commission released a plan calling to cut or end billions of dollars in tax subsidies for the oil and gas producers and other energy interests. Though it didn’t get the fourteen of eighteen votes required to move it to Congress, a majority of commission members, including lawmakers from both parties, supported the plan.

There is no question that the elimination of energy subsidies across the board would bring disruptive change to the energy landscape. Oil producers would keep profiting handsomely but mourn the elimination of their deeply embedded—and beloved—government largess. But they would probably start to invest a lot more of their available capital in energy industries and technologies of the future. Nuclear energy advocates and ethanol producers—the recipients of the lion’s share of “new energy” subsidies awarded in recent years, and poised to receive hundreds of billions of new subsidies in coming years—would see their so-called private funding sources shrivel overnight. And renewable energy interests, newly nurtured on the mother’s milk of Washington cash, would have to scramble to cut costs rapidly to ensure continued consumer demand. Some players in the renewable energy industries would be less competitive, and eventually would go out of business, but others would take their place—and do much better in honest competition. The winner, in spite of its loss of subsidies, would be natural gas. It is the cleanest and most intrinsically competitive energy source for electricity production and as a direct fuel for heating homes and commercial spaces.

The real question to ask is not whether some energy companies, and indeed whole industries focused on certain “protected” or government-favored technologies or fuels, would survive in their current form if we did slash energy subsidies. Imagine where the American economy would be today if the government had decided to protect and continue to subsidize steam engines or whale oil as sources of energy in past eras. The important question is whether the elimination of energy subsidies would constitute good long-term energy policy for America. Never in my lifetime has it been more important to ask this question.
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Jeffrey Leonard is CEO of the Global Environment Fund, a growth-capital-oriented investment firm, and chairman of the Washington Monthly board of directors. He is the author of five books and numerous articles on issues relating to energy, the environment, and economics.  
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