Thursday, December 19, 2013

Is the Wind Energy Tax Credit About to Expire for Good?

  • The expiration of the federal subsidy for wind power on 12/31/13 provides an opportunity to replace it with a smaller benefit, more focused on innovation.
  • Comprehensive tax reform is the best way to approach this, including making tax incentives for energy consistent across the board.
With the end of the year fast approaching, the US wind power industry faces yet another scheduled expiration of federal tax credits for new wind turbines. The wind Production Tax Credit, or PTC, was due to expire at the end of 2012 but was extended for an additional year as part of last December’s “fiscal cliff” deal. With the PTC and other energy-related “tax expenditures” subject to Congressional negotiations on tax reform, it was looking like this might truly be its last hurrah in its current form, until Senator Baucus, Chairman of the Senate Finance Committee, released his draft proposal yesterday. Unfortunately, from what I have seen so far it falls short of sunsetting this overly generous subsidy and replacing it with a new policy emphasizing innovation.

In its 20-year history, minus a few year-long expirations in the past, the PTC has promoted tremendous growth in the US wind industry, from under 2,000 MW of installed wind capacity in 1992 to over 60,000 MW as of today. For most of its tenure, the PTC did exactly what it was intended to do: reward developers for generating increasing amounts of renewable electricity for the grid at a rate tied to inflation.

However, unlike the federal investment tax credit for solar power and some other renewables, the amount of the subsidy didn’t automatically decrease as the technology improved, with wind turbines growing steadily larger, more efficient, and cheaper to build. Instead, the PTC’s subsidy for wind power increased from 1.5 ¢ per kilowatt-hour (kWh) to its present level of around 2.3 ¢. That figure equates to up to $39 per oil-equivalent barrel, depending on which conversion from kWh to BTUs you choose.

It's also roughly one-third of today’s average US retail electricity price for industrial customers and exceeds most estimates of typical operating and maintenance costs for wind power. The latter point has serious implications for the impact of wind farms on other generators in a regional power grid.

If wind turbine installations continued at their remarkably depressed rate of just 64 MW in the first three quarters of this year, the cost of extending the current PTC for another four years and beyond, as Senator Baucus seems to be proposing, would be negligible. However, it’s evident from industry data that a major reason installations are so low in 2013 is that the uncertainty over last year’s scheduled expiration caused developers to accelerate projects into the record-setting fourth quarter of 2012. The American Wind Energy Association cites over 2,300 MW of new wind capacity under construction as of the end of September, while installations over the last three years averaged just under 8,400 MW annually.

At that rate, a one-year extension of the current PTC would add around $5 billion annually to the federal budget over the succeeding 10 years that each year's new wind farms would receive benefits. Congress’s Joint Committee on Taxation apparently came up with a slightly higher estimate of $6.1 billion for a one-year extension.

Before reflexively supporting or opposing another status quo PTC extension, we should ask what we’d be getting for that $5 or $6 billion a year. One of the commonest rationales I encounter justifying the continuation of the current PTC is that conventional energy still receives billions of dollars in subsidies each year. Without getting bogged down in arguments over the definition of a subsidy, or the real and imagined externalities associated with using fossil fuels, it is certainly true that the US oil and gas industry benefits from deductions and tax credits in the federal tax code to the tune of around $4.3 billion per year, based on figures in the latest White House budget.

If we compare these benefits on the basis of the energy production they yield, the PTC starts to look pretty expensive. For example, wind capacity additions in 2012 of over 13,100 MW increased wind generation by 20 billion kWh over the previous year. That’s the energy equivalent of about 140 billion cubic feet of natural gas in power generation, or 66,000 barrels per day of oil. (Although less than 1% of US oil consumption is used to generate electricity, oil is still an easily visualized common denominator.)

By comparison, US oil production expanded by 837,000 bbl/day, while natural gas production grew by the equivalent of another 606,000 bbl/day. So on this somewhat apples-to-oranges basis, oil and gas added more than 20 times as much new energy output to the US economy as wind power did, for roughly the same cost to the federal government.

Now, it’s true that domestic oil and gas both had banner years in 2012, in terms of growth, reversing longer-term decline trends in earlier years, but US wind had its biggest year ever last year. Another factor making this comparison more reasonable than it might otherwise seem is that these are all essentially mature technologies. Wind turbines are still improving, but these improvements are mainly incremental at this point. Nor do they or the billions in annual subsidies for wind address the single biggest obstacle to the wider adoption of wind energy, arising from its fundamental intermittency and disjunction with typical daily and seasonal electricity demand cycles.

When the PTC was first implemented in 1992, by its very existence it fostered innovation in a technology that was still in its infancy as a commercial means of generating meaningful quantities of electricity. That’s no longer the case. I’ve seen various ideas for reforming the PTC to make it more innovation-focused, but while these might be preferable to the status quo, they strike me as overly narrow. We don’t just need wind innovation, but energy innovation, and in fact innovation across the whole US economy if we want to remain globally competitive, and if we want to make more than incremental reductions in our greenhouse gas emissions.

It’s ironic in that context that the federal 20% research and development tax credit is also due to expire at the end of the year. If it came down to a choice between extending the R&D tax credit and extending the PTC, I’d hope that even the wind industry would opt for the R&D credit. That’s not entirely a false choice, considering the scale of ongoing federal deficits and debt, and the need for the government to borrow around 20% of what it spends.

Now is the ideal time to rethink the Production Tax Credit. Its expiration now wouldn’t be as abrupt as was foreseen at the end of 2011 or 2012, because last year’s extension redefined how projects qualify for the PTC. Any wind project that has either started significant work or spent 5% of its budget by year-end could still qualify for the current PTC in 2014. I have seen analysis suggesting a project begun now might even qualify after 2015, as long as work on it had been continuous.

That sets up a smoother transition, while Congress and the wind industry reevaluate what role, if any, specific wind-energy subsidies have in a national energy economy that looks very different than the one in which the PTC was first conceived in the 1990s. Making tax incentives more uniform across competing energy technologies, as Chairman Baucus's draft would do, is a good start, but instead of locking in a perpetual subsidy for current wind power technology at 50 times the rate of today's disputed oil & gas tax incentives, Congress should focus on making the tax incentives for all energy production consistent across the board, at levels that taxpayers can afford no matter how much these energy sources grow in the future.

A different version of this posting was previously published on Energy Trends Insider.


Anonymous said...

i see no justifiable excuse to provide any sort of tax credit incentive for fossil fuels; these aren't fledgling industries in need of taxpayer support. What should be happening is tapering fossil tax incentives - towards complete elimination - with a redirect of that capital into the technological energies of the future. Tax incentives for oil companies? ~ what a rip-off!

Geoffrey Styles said...

First of all, please register when you comment in the future. Anonymous comments don't usually get a response. In this case, since one hears this opinion often, it's worth a reply. If these incentives were truly subsidies like the PTC, I'd generally agree with you. Instead, the oil and gas tax incentives in question mainly fall into 2 categories:

1. Cost-recovery mechanisms similar to the depreciation that every other business claims, but that have been specifically tailored for extraction companies.

2. The Section 199 manufacturing tax deduction, enjoyed by all US manufacturers, but only given to oil & gas firms at half the rate of other firms. It's intended to keep US manufacturing competitive, and on that basis refineries and such are as deserving of it as steel mills, electronics plants, etc.

What I fully expect is for all of these to go away as part of future tax reform, in exchange for a lower, more globally competitive corporate income tax rate.

Craig said...

One thing that I haven't seen discussed with regards to the PTC is the existence of Renewable Portfolio Standards. Wind Farm Development didn't really pick up until the Mid 2000's, which is approximately the same time that RPS's were being implemented. I believe that RPS's have played a much larger role in driving renewable development. Now, think about this; We're mandating the purchase of Renewable Energy by users, then giving a Tax credit to producers. Seems a bit wrong, doesn't it? Ultimately, as long as RPS's remain in place, eliminating the PTC will only slow the amount of renewable sources installed. This would be a good thing for a couple reasons 1) give the technology more time to develop so that it can be competitive without subsidies. 2) Give the grid and its regulators time to catch up to make sure the systems and processes can appropriate handle the intermittant nature of renewables.

Geoffrey Styles said...

That's right, and I probably should have made that point in the post. Currently 29 states plus DC have an RPS in place, creating a mandated market for wind and other renewables, irrespective of the PTC. As it happens, those 29 states include the vast majority with good wind resources, so there's more than a safety net in place for wind farm developers and turbine manufacturers.

Krista Hiles said...

Such projects are really going to help find a better situation of the problem that is scarce energy.There is a need to tap all these unused energies to save the environment.

Geoffrey Styles said...

The issue here isn't whether wind, solar, etc. will be an increasingly important part of our energy mix, but rather how much we should pay project developers to encourage them. As the comparisons in the post demonstrate, subsidy at the level of the US federal PTC are abnormally high and unsustainable as wind grows further.

As for "scarce energy", that's really not the issue any more, at least in the US. We're spoiled for choice, including low-cost choices.