Pitting Wind and Solar Against Nuclear Power

• With US electricity demand stalled, expanding wind and solar power is increasing the economic pressure on equally low-emission nuclear power.
• New state incentives for nuclear plants are facing resistance from the beneficiaries of renewable energy subsidies, as both battle for market share.

It's an old adage that a growth market has room for all participants, including new entrants. The US electricity market is now experiencing the converse of this, with increasing competition for static demand leading to headlines like the one I saw earlier this week: "Lifeline for Nuclear Plants Is Threatening Wind and Solar Power."

The idea behind that headline is ironic, considering that for more than a decade renewables have depended on government mandates and incentives to drive their impressive expansion. Along with recently cheap natural gas, they have made conditions increasingly difficult for established generating technologies like coal and nuclear power. In the case of coal, that was an entirely foreseeable and even intentional outcome, but for nuclear power it has come as a mostly unintended consequence.

Much as the slowdown in gasoline demand brought on by the recession created a crisis for biofuel quotas, stagnant electricity demand has hastened and  intensified the inevitable fight for market share and the resulting shakeout in generating capacity. US electricity consumption has been essentially flat since the financial crisis of 2008-9, thanks to a weak economy and aggressive investment in energy efficiency. More generation serving the same demand means lower prices for all producers, and fewer annual hours of operation for the least competitive of them.

At the same time abundant, low-priced natural gas from soaring shale production has made gas-fired turbines both a direct competitor in the 24/7 "baseload" segment that coal and nuclear power formerly dominated, and the go-to backup source for integrating more renewables onto the grid.

The US is essentially swimming in energy, at least when it comes to resources that can be turned into electricity. The only rationale left for the substantial subsidies that wind and power still receive--over $3 billion budgeted for wind alone in 2017--is environmental: mainly concerns about climate change and the emissions of CO2 and other greenhouse gases linked to it.

That's the same reason why some states have become alarmed enough by the recent wave of nuclear power plant retirements to consider providing some form of financial support for existing facilities. Nuclear power isn't just the third-largest source of electricity in the US; it is by far our largest producer of zero-emission power: 3.5 times the output of wind in 2016 and 22 times solar. A large drop in nuclear power is simply not compatible with the desire to continue cutting US emissions. Environmental groups like EDF are reaching similar conclusions.

Nuclear's scale is even more of a factor when it comes to considering what could replace it. For example, it takes the output of about 2,000 wind turbines of 2 megawatts (MW) each--roughly half of the 8,203 MW of new US wind installations last year--to equal the annual energy production of a single typical nuclear reactor. An infographic I saw on Twitter makes that easier to visualize:

I can appreciate why utilities and others that are investing heavily in wind and solar power might be convinced that providing incentives to keep nuclear power plants from retiring prematurely is "the wrong policy." After all, we have collectively pushed them to invest in these specific technologies, because it has been easier to reach a consensus at the federal and state levels to provide incentives for renewables, rather than for all low-emission energy.

As long as we are promoting renewables in this way, though, we should recognize that nuclear power is no less worthy. The biggest benefit of renewables is their low emissions (including non-greenhouse air pollutants,) an attribute shared with nuclear power. Yet because of their much lower energy densities, requiring much bigger footprints for the same output, and their lower reliability, incorporating a lot more renewables into the energy mix requires additional investments in electricity grid modernization and energy storage, along with new tools like "demand response." Nuclear power is compact, available about 90% of the time, and it works just fine with the existing grid.

By experience and philosophy, I'm a big fan of markets, so I would normally be more sympathetic to the view expressed by the American Petroleum Institute that states shouldn't tip the scales in favor of nuclear power over gas and other alternatives. However, we don't have anything resembling a level playing field for electricity generation, even in states with deregulated electricity markets. The existing federal incentives for wind and solar power, together with state Renewable Portfolio Standards, are already tipping the scales strongly in their favor. These subsidies will remain in place until at least 2022, consistent with the most recent extension by Congress. Why do renewables merit such subsidies more than nuclear power?

Wind and solar power are key parts of the emerging low-emission energy mix, and we will want more as their costs continue to fall, but not at the expense of much larger low-emission energy sources that are already in place. Less nuclear power doesn't just mean more renewables. It also means more gas or coal-fired power. That's the experience of Germany's "Energiewende", or energy transition.

As long as that is the case, and without corresponding incentives for equally low-emission nuclear plants, as well as for fossil-fuel plants that capture and sequester their CO2, we will end up with an energy mix in the next few years that is less diverse, less reliable, and emits more CO2 than necessary. I wouldn't consider that progress.

An Expensive Subsidy, Twisting in the Wind

• The expired federal Production Tax Credit for wind energy has missed another opportunity for renewal in the US Senate.
• If renewed at the proposed level and extended repeatedly, its annual cost could eventually exceed US tax breaks for oil and gas by a factor of 9:1.

I see that the 2014 "tax extenders" bill, S.2260, failed to pass a cloture vote in the US Senate yesterday. That has spoiled for now the chances of reviving the Production Tax Credit (PTC) for wind and other (non-solar) renewables that expired at the end of last year. The bill might get another opportunity in revised form, but in coming up 7 votes short, it calls into question the Senate majority's preferred approach of tackling the entire package of dozens of tax breaks en masse.

I've written about the PTC at length, most recently just prior to the expiration of its latest version last December. Long-time readers know I am convinced that reform is overdue for this excessively generous subsidy for what amounts to a mature industry. Here's a different way to put both of those aspects of the PTC into context.

First, consider its cost if applied to all current and future wind power installations. As a benchmark, the highly controversial tax benefits received by the oil and gas industry amount to around $4 billion per year in the federal budget.

If all US wind-generated electricity received the PTC at the rate offered in the current extenders bill, the annual cost would approach the oil and gas "subsidy", at $3.9 B/yr based on last year's actual US wind generation of 168 billion kWh, which equates to less than 3% of US oil and gas production in 2013.

If wind and similar renewable sources reached 30% of US electricity generation, as many hope and the Department of Energy has concluded is feasible, then the annual subsidy would exceed $28 B/yr, based on 2013 US net generation. US electricity demand is expected to grow by as much as 29% between now and 2040. That would bring annual PTC outlays to $36 B.

This looks like a reductio ad absurdum argument, because it is. Simply put, is it reasonable, after twenty years of such support, for the wind industry to expect to continue to receive an extremely generous subsidy, compared to other forms of energy, until wind power reaches market saturation?

As for arguments that wind power is not yet mature, other mature industries have exhibited similarly impressive growth and cost reductions in recent years. Natural gas production comes readily to mind. The fact that wind developers assert they still need this subsidy at this level speaks more to the competitiveness of the technology than to its maturity.

Ultimately, the PTC must be seen as a proxy for the comprehensive carbon policy we don't have and may never have. If there's a consensus in the government to support low-emission energy technologies, in lieu of a carbon tax on all energy, shouldn't it at least reward technologies on the basis of their actual emissions reductions, rather than merely for deployment (the 30% solar Investment Tax Credit, which expires in a few years) or operation (the PTC)? At $0.023/kWh, the tax credit for wind power displacing gas-fired power from a combined cycle power plant results in an implicit cost of around $65 per metric ton of CO2 avoided. That's far higher than the price at which emissions credits trade in any of the regional US or international markets.

The perils of the PTC are a microcosm of the provisions included in this bill, which might still eventually be passed. It includes measures with nearly universal support, like the Research and Development tax credit, which has also expired, and a grab bag of narrower and in some cases bizarre tax breaks, such as providing three-year depreciation for race horses. PTC supporters are now left to hope that enough additional legislative favors can be squeezed into the next version of the bill to carry the whole bunch over the top.

A Late Christmas Gift for Renewable Energy

The US Senate's "fiscal cliff" package wasn't exactly eight maids a-milking--the traditional gift for the eighth day of Christmas--though it did apparently resolve the impending "milk cliff".  Of greater relevance, the "tax extender" portion of the American Taxpayer Relief Act of 2012 passed by both the Senate and House of Representatives represented a gift to renewable energy producers and developers worth around $18 billion.  Two-thirds of that is attributable to the extension and modification of the Production Tax Credit (PTC) for wind and other renewable electricity projects. Renewable energy technologies have gained another year of generous support from US taxpayers.  What remains to be seen is whether this win represents a last hurrah for the current US approach to renewable energy subsidies as lawmakers focus on shrinking an increasingly unsustainable federal budget deficit.

Based on the analysis of the bill provided in the Wall St. Journal, other energy-related beneficiaries  included producers of cellulosic and algae-based biofuels, blenders of conventional biodiesel and other alternative fuels, purchasers of 2- and 3-wheeled electric vehicles, as well as various energy efficiency investments including efficient homes and appliances.  Renewables should also benefit from other provisions of the bill, including a one-year extension of 50% bonus depreciation on project investments and a two-year extension of the 20% R&D tax credit. 

Of course the problem with all of this is that it sets up additional cliffs at the end of 2013 and 2014, and thus perpetuates the expiration-anxiety roller-coaster that has confounded both manufacturers and investors in these technologies. Part of the blame for that rests with the process by which the Congress drafts and enacts such legislation.  However, it's also a function of the unwillingness of current beneficiaries to shift their lobbying efforts to support realistic and predictable phaseouts of these subsidies, in light of renewables' improving competitiveness with conventional energy and the magnitude of future US fiscal problems.  Considering that the current PTC for wind power is worth the equivalent of about 90% of today's futures price for natural gas, a proposal by the wind trade association for a six-year phaseout ending at 60% strikes me as too much like St. Augustine's plea for chastity.

The high-pressure negotiations to avert the fiscal cliff provided a poor venue for producing genuine tax reform, while giving supporters of the status quo a golden opportunity to attach measures such as these "extenders" that couldn't be amended before the expiration of the current Congress.  The non-partisan Congressional Budget Office estimated that this bill actually increased federal spending by a net $330 billion over 10 years and added nearly $4 trillion to the deficit, compared to going over the cliff.  It's not clear that the even higher-stakes debt-ceiling debate slated for early in the new Congress will be any more conducive to solving these challenges. But whether then or later in the session, it's going to become harder to avoid some form of tax reform and spending discipline that considers all energy subsidies in the context of their direct costs and indirect revenues. I'll be surprised if the current subsidies for renewables can escape again without major adjustments to reduce their high effective cost per unit of energy produced and increase their long-term bang for the buck. 

Last Hurrah for the Wind Power Tax Credit?

Ahead of Thursday's meeting of the Senate Finance Committee, a bipartisan deal has apparently omitted the expiring production tax credit (PTC) for wind power from a package of "tax extenders"--various expiring federal tax provisions, including the annual "patch" for the Alternative Minimum Tax.  This development might surprise some of the industry's supporters, but the politics of wind have changed since I last examined this issue in February.  A measure that once enjoyed solid bi-partisan support is now caught between two presidential campaigns that hold diametrically opposed views on its fate. 

A quick review of the PTC seems in order.  This tax credit, which covers a variety of technologies but with wind as the main beneficiary, dates back to 1992--interrupted by several past expirations but then revived in essentially its present form. That's significant, because during the same 20 years in which the PTC has been escalating annually with inflation--from 1.5 ¢ per kilowatt-hour (kWh) to the present level of 2.2 ¢/kWh--the cost of wind turbines and their output has fallen significantly. In the same period, US installed wind capacity grew from 1,680 MW to nearly 49,000 MW as of the first quarter of 2012.  So in effect, we're subsidizing today's relatively mature onshore wind technology by a larger proportion than we did when it was in its infancy. That makes no sense, especially in the current environment.

The US wind industry has received substantial government support in recent years.  When the long-standing tax credit against corporate profits proved to be much less beneficial during the financial crisis, the administration gave wind developers a better option within the stimulus: a 30% investment tax credit that could be claimed as up-front cash grants, instead of having to wait until power was generated and sold over the normal 10 year period of the PTC.  From 2009-11 the wind industry received a cumulative $7.7 B, in addition to ongoing tax credits on older projects, manufacturing tax credits for new wind turbine factories, and loan guarantees for selected wind farms.  And even with new turbine installations in 2012 running well below their record rate of 10,000 MW in 2009, the wind projects that qualify for the PTC this year could receive a total of $4.5 B over the next decade. 

Many people seem to want to equate the tax breaks that wind and other renewable energy technologies receive with the controversial tax benefits for the oil and gas industry, without realizing how unfavorable that comparison truly is for renewables.  Subsidies for technologies such as wind are much higher per unit of energy produced, consistent with their intended purpose of bridging the competitive gap vs. conventional energy.  Yet since the total output of new renewables is still relatively small, the disparity in total subsidies is much larger than it appears.  One way to illustrate that is that if the oil and natural gas produced in the US received tax credits at the same rate per equivalent kWh as wind power, then the annual oil and gas tax preferences that the Congress and President Obama have been sparring over for the last three years wouldn't be $4.8 B per year, but around $100 B per year. 

As the Reuters article makes clear, there will be other opportunities for the PTC to be reinserted in the extenders bill or other legislation.  However, by persistently arguing for extending the existing credit without modification, the wind industry and its supporters may be misreading the public's appetite for such generous subsidies in a period of protracted economic weakness, notwithstanding the recent Iowa poll.  Despite its rapid recent growth wind still contributes less than 4% of the nation's electricity and just 1% of our total energy consumption, and the green jobs angle is wearing thin. Last year's expiration of the ethanol blenders credit set a precedent for ending another large, generous subsidy before its beneficiaries agreed they were done with it. If congressional Republicans line up behind their party's standard bearer on this issue, the wind industry will have missed its opportunity for a graduated, multi-year phaseout of the PTC, instead of stepping off a cliff in 2013.

Does All-of-the-Above Energy Include Long Shots?

An article in Tuesday's Washington Post described the current funding woes of US research into nuclear fusion, focused on anticipated budget and job cuts at the Princeton Plasma Physics Laboratory, MIT and several other sites.  Aside from the general challenge of funding all of the Department of Energy's programs at a time of huge federal deficits and ballooning debt, it appears that domestic fusion research is being cut mainly to meet our commitments to the International Thermonuclear Experimental Reactor (ITER) being built in France.  The article goes on to suggest that fusion has been excluded from the list of "all-of-the-above" energy technologies that the administration has embraced.  That raises questions that would merit attention at any time but seem particularly relevant in an election year.

Before discussing its proper priority in US federal energy research and planning, it's important to recognize, as the article does, that fusion is very much a long-shot bet.  We know that nuclear fusion works, because it's the process that powers our sun and all the stars.  However, that doesn't guarantee that we can successfully harness it safely here on earth for our own purposes.  I've heard plenty of energy experts who think that the only fusion reactor we need is the one 93 million miles away, which remains the ultimate source of nearly all the BTUs and kilowatt-hours of energy we use, except for those from nuclear (fission) power plants and geothermal energy. 

Unfortunately, the challenges of harnessing the sun's energy bounty in real time, rather than via the geologically slow processes that produced fossil fuels or the faster but still ponderous growing cycles of biofuels, are distinctly non-trivial--hence the debate about whether and how to overcome the intermittency and cyclicality of wind and solar power through optimized dispersal, clever use of Smart Grid technology, or with energy storage that requires its own breakthroughs if it is to be an economical enabler of wind or solar. A working fusion reactor would provide an end-run around all those problems and fit neatly into our current centralized power grid, with what is expected to be negligible emissions or long-term waste.  Who wouldn't want that?

Of course fusion power isn't easy, either; it's the definition of difficult.  Scientists around the world have been chasing it for at least five decades.  I recall eagerly reading about its potential when I was in my early teens.  Then, it was seen to be 30-40 years from becoming commercial, and that's still a reasonable estimate, despite significant progress in the intervening decades.  I admit I don't follow fusion research nearly as closely as I used to, in all its permutations of  stellarators, tokamaks, laser bombardment chambers and other competing designs, all pursuing the elusive goal of "net energy"--getting more energy back than you must put into achieving the temperatures and pressures necessary to fuse the chosen hydrogen isotopes.

So where does a high-risk, high-reward investment like fusion fit into the concept of all-of-the-above energy that now dominates the energy debate on both sides of the political aisle, and in the trade-offs that must accompany any serious energy strategy or plan for the US?  After all, "all of the above" is an attempt to recognize the widely differing states of readiness of our various energy options, the time lags inherent in replacing one set of sources with another, and the need to continue to supply and consume fossil fuels during our (long) transition away from them.  While I've never seen an official list of what's in and what's out, my own sense of all of the above is that it's composed of technologies that are either commercial today or that have left the laboratory but still require improvement and scaling up to become commercial.  In contrast, fusion hasn't left the lab and it's not clear when or if it will, at least on a timescale that's meaningful either for energy security or climate change mitigation. No one can tell us when the first fusion power plant could be plugged into the grid, and every attempt at predicting that has slipped, badly. 

Fusion wasn't mentioned once in the Secretary of Energy's remarks to Congress concerning the fiscal 2013 Energy Department Budget, and it was only shown as a line item in his latest budget presentation.  Yet I can't think of any other new technology that's customarily included in all of the above that has even a fraction of fusion's potential for delivering clean energy in large, centralized increments comparable to today's coal or nuclear power plants.  We could spend all day arguing whether that's as desirable now (or in the future) as it was just a few years ago, but from my perspective it contributes to the option value of fusion.  No one would suggest fusion as a practical near-term alternative, but with the prospect of a shale-gas bridge for the next several decades, it might be an important part of what we could be bridging towards.

Overall, the DOE has budgeted just under $400 million for fusion R&D in fiscal 2013, out of a total budget request of $27 billion.  That's not insignificant, and devoting 1.5% of the federal energy budget to fusion might be about the right proportion for such a long-term endeavor that is decades from deployment, relative to funding for medium-term efforts like advanced fission reactors and near-term R&D on renewables and efficiency.  The problem is that DOE is cutting deeply into US fusion capabilities, not just at Princeton but also at Lawrence Berkeley Laboratory, Livermore, Los Alamos and Sandia, in order to boost US funding for ITER from $105 million to $150 million next year. Only the fusion budgets for Oak Ridge Laboratory, which is managing the US role in ITER, and for the D.C. HQ grew.

I'm certainly not against international cooperation in science, which has become increasingly important as the costs of "big science" projects expand.  However, even if ITER represented the very best chance to take fusion to the next level on its long path to deployment, the long-term implications of these cuts for US fusion science capabilities look significant.  As with the space program, once the highly trained and experienced fusion workforce and teams are laid off and broken up, it becomes enormously difficult to reconstitute them, if needed.  This is particularly true of those with advanced degrees in fields that have declined in popularity at US universities, or for which the majority of current graduates are non-US students who will return to their countries of origin in search of better opportunities.  I wouldn't support keeping these programs going just to provide guaranteed employment for physicists, but we had better be sure that we won't need them later.  I am skeptical that we can be sufficiently certain today of the likely deployment pathways for fusion to be able to make such an irreversible decision with confidence.

I understand that in times like these we must make tough choices; that's the essence of budgeting.  I'm also sympathetic to those who might think that fusion researchers have had ample time and support to deliver the goods, already.  Yet I can't help being struck by the contradiction of a DOE budget in which US R&D for such a long-term, high-potential technology is cut, at the same time that Secretary Chu and the President are pushing hard for multi-billion dollar commitments to extend the Production Tax Credit for renewable energy and reinstate the expired 1603 renewable energy cash grant program, a substantial portion of the past benefits from which went to non-US manufacturers and project developers. The total 2013 budget cuts for the US fusion labs are equivalent to the tax credits for a single 90 MW wind farm, which would contribute less than 0.01% of annual US power generation.  Although we clearly can't fund every R&D idea to the extent researchers might wish, I believe it is a mistake to funnel so much money--about 40% of which must be borrowed--into perpetual support for the deployment of relatively low-impact and essentially mature technologies like onshore wind, when the same dollars would go much farther on R&D.

Administration's Tax Proposals Would Hamper US Energy Output

The Obama administration is proposing significant changes in US corporate taxes, as reported in today's Wall St. Journal. If enacted, the corporate tax rate would fall from 35% of income to 28%, although the elimination of numerous tax incentives would subject many companies, including most in the energy sector, to higher taxes overall. On the surface, this looks like the kind of tax reform that has been long overdue; however, as always with such efforts, the details matter enormously. In this case, the details would create an even less-level playing field for US energy producers, while doubling down on the expensive tax benefits currently provided to favored sectors and technologies. It's ironic that this is being proposed just when rising gasoline prices have put the administration on the defensive concerning its energy policies. It will do the President little good to point to increasing US oil production--demonstrably the result of energy prices and policies in previous administrations--if he simultaneously jeopardizes that recovery in output by making it less attractive to produce oil and gas here.

The basic principle of cutting marginal corporate tax rates in exchange for the elimination of "tax expenditures", or loopholes, in common parlance, is consistent with the much broader tax reform proposed by the fiscal commission established by the White House in 2010, even if the administration has opted for the upper end of the range of tax rates suggested by Simpson-Bowles. In general, US oil and gas companies wouldn't be worse off for losing the various deductions and tax credits in the current tax code, if the marginal tax rate were reduced sufficiently and if the administration weren't proposing to raise royalty rates on US onshore production by 50% at the same time. However, the combination of the proposed changes, including subjecting part of their non-US income to US taxation, would not only make US oil and gas projects less attractive, relative to projects in other countries; they would also make it less attractive to be a US oil and gas company, instead of a non-US company that operates here. For an administration that is concerned about US competitiveness, this is perverse logic, indeed.

It doesn't take a crystal ball to predict that the combination of higher corporate taxes on energy companies, higher royalties, and the more complex permitting processes instituted by the administration even before the Deepwater Horizon accident will make it much harder to sustain the recent recovery in US oil output beyond the completion of projects that were initiated during the previous administration. New oil and gas production would probably still be profitable here after these changes, particularly if oil prices remain as high as they are now, but company portfolios would begin to shift back towards non-US projects that look more rewarding by comparison, and US companies would lose some of their edge to non-US competitors. None of that would be good for US energy consumers, considering that the oil and gas industry accounts for 62% of the energy we use, including 49% of all energy produced domestically.

Of course, the administration's tax proposals reach well beyond oil and gas. Among other things, they would extend the Production Tax Credit for wind energy by another year, through 2013, as well as extending for another year the Treasury renewable energy cash grants that expired at the end of last year. After 2012, the cash grants would be replaced by refundable tax credits, which essentially means you'd get a check from the IRS, rather than from the Treasury, if the credit were larger than the taxes your firm owes. The net effect of the latter would perpetuate a costly system of renewable energy subsidies that reward the deployment of renewable energy hardware, rather than the actual generation of renewable energy. (That distinction is important whenever the hardware is installed somewhere lacking in good wind, sun, or other renewable resources.)

Then there's the proposal to boost the electric vehicle tax credit to a maximum of $10,000 per car, and to shift the recipient from the purchaser to the seller. That circumvents the problem that under the current $7,500 credit you'd have to earn enough income to be paying at least that much in federal income taxes, in order to enjoy the full benefit of the credit. However, it also makes it much likelier that manufacturers and dealers would pocket a significant slice of the higher credit, instead of consumers. Since it was nearly impossible to justify the $7,500 per car credit on the basis of actual oil or emissions savings, the higher credit looks even less justifiable, other than as a means of raising the odds of achieving the President's arbitrary target of putting a million EVs on the road by 2015--another near impossibility. The pluses I see here include an automatic phaseout based on time, rather than sales volume, and a broadening of the credit to cover other efficient vehicle technologies such as natural gas, though it's not clear whether it would also cover advanced diesels. Still, if the President has his way, we'll be spending more than $10 billion to put vehicles on the road that will save less than 35,000 barrels per day of oil, or about 0.4% of our total gasoline consumption, along with greenhouse gas emissions worth less than $1 billion at market prices--even European market prices.

The proposals include other provisions that would affect the energy sector, including tax benefits for advanced energy manufacturing such as wind turbines, solar panels, advanced batteries, electric vehicles, and an array of other equipment. I'd be much happier with those incentives if they were provided as an alternative to origin-blind deployment incentives, instead of alongside them. And although oil and gas companies would lose the manufacturing tax deduction on their US production, it appears they might get to keep that deduction on US refining, which has been hurt by higher oil prices. That would be small consolation to independent refining companies that have been forced to close several large east coast refineries or that are barely breaking even.

If President Obama is serious about tax reform, the current proposals--flawed as they are--would have carried a lot more weight had they been introduced a year ago, in the immediate aftermath of the Simpson-Bowles report and various other tax reform suggestions, rather than in an election year. And if he is truly serious about the"all-out, all-of-the-above strategy" for energy that he referenced in this year's State of the Union address, the current proposals look like an extremely odd way to execute that, favoring as heavily as they do sources that account for less than 2% of US energy production, while penalizing those that contribute nearly half. The good news is that this is a meal that won't be eaten hot. For now, this package serves as another plank in the reelection campaign platform. Whether it will ultimately be implemented depends not just on who occupies the White House after January 20, 2013, but also on the composition of the next Congress since it has no chance of passage in the 112th.

New Budget Reflects Inefficient Energy Priorities

An editorial in today's New York Times praising the energy priorities included in the President's latest budget is little more than a rubber stamp of a set of policies in serious need of rethinking. The goals the Times espouses, of "reducing America’s dependence on foreign oil and giving American workers a fighting chance in the global competition for clean-energy jobs", are perfectly fine; however, what's entirely absent is any critical assessment of whether the expensive programs they chose to highlight will contribute meaningfully to accomplishing them.

Start with the reauthorization of Treasury cash grants for renewable energy projects. A quick review of the Treasury's own tracking spreadsheet shows that 77% of the $10.4 billion awarded since 2009 under this program went to projects employing wind turbines, a mostly mature technology, half the value of which goes to offshore manufacturers, based on the American Wind Energy Association's own assessment. If the goal is putting Americans to work producing wind power hardware, this is a grossly inefficient way to do it. Moreover, this temporary program was instituted to fill the gap created when the market for "tax equity"--private transactions that exchange current cash for future tax credits--dried up during the financial crisis. Tax equity investors have recently been returning to the market, but they can't readily compete with free money from the Treasury Department. In other words, at this late date the Treasury cash grants are a solution to a problem that their continuation would help perpetuate.

Then there's the matter of the wind production tax credit, which I looked at in some detail recently. While I agree that it's neither fair nor appropriate to drop the industry off a cliff by allowing this benefit to expire all at once, it is high time that the 20-year-old tax credit for wind power be reduced to account for the maturity of onshore wind technology, and then gradually phased out on a firm schedule. The Times makes no mention of any of this.

It's also important to understand that whatever the technologies covered by these two programs may contribute to reducing greenhouse gas emissions, they don't save a barrel of imported oil, because the US generates less than 1% of our electricity from oil, and much of that in island or other remote locations that can't easily get reliable electricity through other means. That makes it doubly ironic that the only "subsidies" the Times opposes are the current tax benefits for oil and gas companies, arguably the only program mentioned in their editorial that actually does help reduce US imports of foreign oil.

The President's 2013 budget, which has little chance of adoption as proposed, includes a number of other energy provisions. Some of them are very worthy, including increased support for energy R&D that is too risky or long-term for industry to undertake on its own. However, it also includes an extension of the loan guarantee program that gave us Solyndra--a program that should not be renewed without much stronger oversight than the DOE has provided to date, beyond just hiring a "chief risk officer". It also mentions "enhancements to the existing electric vehicle tax incentive", a $7,500 per vehicle credit that benefits mostly higher-income taxpayers and does little to reduce either emissions or oil imports. What I don't see in these proposals is any recognition that many of the programs they seek to extend or expand have either outlived their usefulness or fallen short of delivering the benefits on which they were originally justified, and that every dollar spent inefficiently in this manner adds to our $1.3 trillion deficit, the necessary narrowing of which keeps getting pushed ever further into the future. The administration's latest energy priorities would have us spending as though it were still 2006.

Cleantech Firms Paying the Price for Subsidies

In observing the recent struggles of various segments of the global cleantech industry, including renewable energy and advanced energy technology firms, a pattern is emerging. Today's Wall St. Journal reports "Wind Power Firms on Edge," as the US wind industry hunkers down pending the renewal or expiration of a key subsidy at the end of 2012. A maker of electric-vehicle batteries that received a federal grant to build a factory in Indiana is reorganizing via bankruptcy, wiping out the equity of its original investors. Meanwhile, the US International Trade Commission may be on the verge of imposing retroactive tariffs on imported Chinese solar power equipment. Each of these stories has unique features, but what they share in common is the consequences of renewable energy policies around the world that promoted overcapacity in manufacturing and fierce competition in deployment, effectively setting up some of their past beneficiaries for failure or at least a period of very low margins. Depending on your perspective, this is either an indictment of such subsidies or collateral damage on our way to a brighter future.

One blogger from an advanced battery trade association noted that "Ener1 Is No Solyndra", and I tend to agree. As I've noted previously, the decision to award Solyndra a $535 million federal loan was ill-advised, not just because of competition from other solar manufacturers, but because at the time the government approved the loan the failure of Solyndra's business model was essentially already predetermined. Solyndra didn't contribute much to the global overcapacity in solar modules and panels, because its technology was never competitive. By contrast, Ener1's problems appear more fundamental. Like much of the global wind industry and solar industry, it was induced to invest in new capacity, the market for which depended almost entirely on subsidies and regulations that governments might not be able to sustain as these technologies scaled up, and that has gotten significantly ahead of demand.

The best examples of that are probably the various solar feed-in tariff (FIT) subsidies in Europe, which until recently were so generous that they not only supported the intended growth of an indigenous solar industry to capitalize on them, but also gave rise to an entirely unintended new export-oriented solar industry in Asia that had essentially no local market when it started, yet has since gone on to dominate global solar manufacturing and eat the lunch of the European solar makers and developers who got fat off the earlier stages of the FITs.

Or consider the US wind industry, including the imported equipment that still supplies around half of the US wind turbine value chain, according to the main US wind trade association. If the 2.2¢ per kilowatt-hour (kWh) Production Tax Credit (PTC) is renewed, and if wind generation grows from the current level of 115 billion kWh per year to 141 billion kWh by 2021, in line with the latest Department of Energy forecast, then over the next 10 years the wind industry would collect up to $30 B, with much of that locked in for projects that have already started up, less the amount generated by projects that opted for the expired Treasury cash grants in lieu of the PTC to the tune of $7.9 B from 2009-11. Yet based on these figures, wind would supply just 3.2% of US electricity in 2021. The industry now seems to be arguing that it needs just one more renewal of the PTC in order to become competitive. As of 2012, this benefit has been in place on an on-again, off-again basis for twenty years.

Although the theory that underpins such subsidies doubtless has some validity--that governments can help new technologies to develop quicker than markets alone would support, create markets for them by stimulating demand, and thereby move them down their learning curves to earlier competitiveness with conventional technologies--in practice such policies also have the serious shortcomings we are seeing. Because they do not operate in Soviet-style centrally planned economies, none of these governments can tell manufacturers precisely how much production capacity to build, or how much they will sell when it comes on-stream. In the absence of such powers--which in any case proved to be over-rated--companies and their investors are at the mercy of the boom-and-bust cycles such policies generate, with the normal, self-correcting mechanisms of industry consolidation dampened by continued intervention. Nor do the policies now in place seem very successful at creating industries that can survive without them. If you doubt that, ask the US wind industry for their forecast of new installations next year if the two-decade-old PTC is not renewed. According to the Journal, it would be somewhere between 0% and 30% of 2011's 6,810 MW, which was itself a third below the 2009 peak of 10,000 MW, despite the late-2010 extension of the cash grants to cover last year's projects.

The appropriate response to all of this depends on one's politics and the firmness of one's belief that these technologies are essential tools for combating climate change. Falling between the extremes of "just say no" and "look the other way" is the view that governments at least have an obligation to learn from the past and avoid the temptation to yield to demands that they leave existing subsidies in place until their beneficiaries decide they are done with them. If wind tax credits are extended, it should be at a level that recognizes the narrowing competitive gap with conventional energy and phases them out on a schedule. Electric vehicle subsidies should also be reassessed so that we don't find ourselves still providing upper-income taxpayers with incentives of $7,500 per car, even after sales have taken off and sticker prices fallen significantly. And solar subsidies ought to be fundamentally rethought to make it less attractive to install solar panels in regions with low sunlight, such as New York and New Jersey, than in those with abundant sun. And we shouldn't do that just for the benefit of taxpayers and in response to trillion-dollar budget deficits, but in the interest of producing healthy, globally competitive companies in these industries.

State of the Union: "All-Out, All-of-the-Above Energy"

Anyone expecting the announcement of big new energy initiatives in this year's State of the Union address was disappointed last night. What was new, however, was a welcome shift in the President's emphasis on conventional energy--the fuels he referred to as "yesterday's energy" in last year's speech. Never mind that the resurgent oil production for which Mr. Obama took credit is demonstrably the result of events and policies that preceded his inauguration, or that his administration has pursued policies that have held back faster development. If his remarks signal a return to federal energy policy that expends more than 10% of its effort on the sources that account for more than 80% of the energy we use, we should applaud him. The other new ingredient last night was an effort to ground the rationale for greater support for renewable energy in the argument that it took federally sponsored R&D to make the shale gas revolution possible--R&D that ironically wouldn't have occurred under the research priorities this President has set for the Department of Energy. I hope President Obama is serious about an "all-out, all-of-the-above strategy" for energy, because that's precisely what we need.

The best way to put that in perspective is with the figures in the 2012 Early Release of the Annual Energy Outlook from the Energy Information Agency of the DOE. It was released just in time for the President's speech, and there are few coincidences in today's Washington. The reference case of their forecast for 2035 shows the US consuming 10% more energy within 24 years--an improvement from the 16% predicted in last year's Outlook. It also shows the contribution of renewable energy in the mix increasing from 6.7% today to 8.3%, including mature hydropower. So even after two more decades of strong emphasis on clean energy, oil, gas and coal would continue to provide 80% of our energy. It's clear that there's a disconnect between the lofty rhetoric of last night's speech and the analysis of the government's energy experts. I'll leave it to you to assess whether the discrepancy is due to unrealistic expectations, inadequately ambitious forecasting, or some combination of the two.

A couple of other points from the State of the Union are worth noting. The President called for Congress to "Pass clean energy tax credits," presumably a reference to the Production Tax Credit (PTC) for wind and other renewables that expires at the end of this year. Yet he didn't devote a word to whether the PTC should be restructured and gradually phased out in light of the steadily narrowing competitive gap between renewable and conventional power, let alone the kind of major tax reform he alluded to later in the speech. Mr. Obama also called for a Clean Energy Standard in lieu of a comprehensive climate bill. This is small beer when most of the states with attractive renewable energy resources already have fairly aggressive state-level Renewable Portfolio Standards. Meanwhile, the development of 3 million homes' worth of clean energy sources on public lands that he is directing his administration to allow equates to less than 1% of US electricity demand--helpful, though hardly transformational.

With little likelihood of a divided Congress enacting much that is new on energy this year, the President's remarks last night are mainly interesting for what they suggest about the energy platform on which he will run for reelection this fall. In terms of clean energy, that seems to mean more of the same from 2008 and the last three years, but with much less emphasis on climate change than we heard in his last campaign. The new element is his pivot to embrace rising oil production and the possibilities created by shale gas, even as he cautiously distances himself from the technologies (hydraulic fracturing and horizontal drilling) that make these two trends possible. Although this might appeal to independent voters, it's also vulnerable to deflation by fact-checking and stands in tension with his rejection--for now--of the Keystone XL pipeline. And if tensions in the Persian Gulf or some other oil hot spot were to increase, so would the scrutiny applied to the administration's energy policies. I'll take a much closer look at those policies when the campaign heats up.

The Battle to Extend Wind Incentives

With the end of the year approaching, the annual Congressional debate over extending a variety of expiring federal tax credits and other benefits is gearing up again. Few of these measures are as high-profile as the payroll tax cut, but each has a vocal constituency, including renewable energy. The American Wind Energy Association (AWEA) has launched a major effort seeking inclusion of the Production Tax Credit (PTC) for wind power in this year's "tax extenders" package. That might seem premature, since the PTC won't expire until the end of 2012, until you realize that eligibility for the stimulus-funded Treasury renewable energy grants for which many wind project developers have opted over the PTC ends in a few weeks with little chance of a further extension. However, before simply tacking another year (or four!) onto a tax credit that began nearly 20 years ago, Congress should answer two basic questions: Is this still the most effective way to promote renewables like wind, and does wind power now require subsidies at all?

I don't blame AWEA for tackling this issue early, since the US wind industry has experienced significant volatility when previous PTC expirations went down to the wire, and in several cases lapsed for up to a year. At the same time, taxpayers deserve a more compelling rationale for continuing to subsidize wind power than the one now being offered. The "green jobs" argument is wearing thin, post-Solyndra, and it has become increasingly evident that helping to create a market for renewable energy technologies is a necessary but not sufficient condition to establishing a sustainable, globally competitive renewable energy manufacturing industry. Although more of the wind power value chain is now produced in the US than previously, too much of each wind subsidy dollar still goes offshore for this to be deemed an efficient way to boost to US jobs and manufacturing without reform.

In order to address the first question I posed, concerning the continued suitability of the PTC, it's important to understand how it works and how it compares to other renewable energy incentives. The current PTC provides wind project owners (or the parties to whom the tax benefit has been sold via a "tax equity swap") with an income tax credit of 2.2 cents per kilowatt-hour (kWh) of electricity actually generated and sold from the completed facility. Based on recent estimates of the levelized cost of electricity from unsubsidized wind power, that's over 20% of a typical wind farm's production cost. It's also equivalent to more than half of this year's average wellhead price of natural gas--a far larger subsidy per BTU than the controversial tax benefits currently provided to oil & gas firms.

The best thing about the PTC is that it is entirely outcome-based. You only receive the benefit when your project is completed, brought online, and as power is sold to customers. Mess up any of those steps and you get zilch. Put your project in a location with poor wind resource or limited access to transmission, and you won't get nearly as much tax benefit. So from that standpoint--ignoring the green jobs angle that arose mainly from expediency when the financial crisis and recession hit--we are getting what we pay for: actual low-emission energy. The structure of the PTC has cash-flow implications that are viewed as a problem by many wind developers but might be regarded as a useful feature by taxpayers. Smaller developers, in particular, have greater difficulty financing projects when the incentive must be deferred until after start-up, or they may lack sufficient taxable income to take full advantage of the credit. They complain about the need to transact swaps with bankers and other investors to realize the subsidy sooner, at a cost. But perhaps it's not such a bad thing for companies that small to have to convince an experienced third party that their project is really viable.

There are many alternatives to the PTC, including the 30% Investment Tax Credit (ITC), the same one received by solar and other technologies. The stimulus bill extended the ITC as an option for wind and allowed the Treasury Department to pay it as a cash grant, rather than waiting for subsequent tax filings. This certainly put money in the hands of wind developers much quicker--$7.6 billion since 2009 including $3.3 billion so far this year--and it has the added benefit of automatically scaling down as the cost of the technology falls. The solar feed-in tariffs favored in Europe didn't have such a feature, with the result that countries have had to cut them numerous times, but only after the fat tariffs gave birth to a huge export-oriented solar manufacturing industry in Asia. Similar competition is now emerging in the wind industry.

The main problem with the ITC is that when viewed from an outcomes perspective, which really gets to the question of effectiveness, the outcome being promoted is construction, rather than energy production. You would get the same tax credit for a project with the best wind resource as for one with the worst. (This has also led to a lot of solar installations in places that would never otherwise have been considered.) So of the two main policy tools the federal government has used to subsidize renewable electricity, the PTC is probably more cost-effective in delivering the result we should really want, which is more renewable energy. As it is, even with rapid growth over the last decade, wind accounted for just 2.8% of our power generation this year through August.

That brings us to the bigger question of whether wind should be subsidized at all after the current PTC term expires. I get emails practically every day from folks who have serious concerns about the health and environmental impacts of power, as well as its cost- and emissions-reduction effectiveness. Even if we ascribed all of these concerns to NIMBYism, it doesn't change the fact that the wind PTC, complete with annual inflation adjustment, is providing the same level of incentive as it did when the technology was much less mature and cost many times what it does today; AWEA cites wind costs having fallen by 90% since 1980. Other factors have also changed in the last twenty years. A majority of US states--and most of those with attractive wind resources--now have in place Renewable Portfolio Standards requiring utilities to include increasing proportions of renewable power in their supply. These mandates create a similar redundancy as the one between the ethanol blenders credit, which is also due to expire 12/31/11, and the biofuel mandates of the federal Renewable Fuels Standard. In the absence of the PTC, the state RPS system should provide a safety net--and more--for the industry.

There are two other key factors missing from AWEA's arguments for extending the PTC. The first is the economy, which is the main reason that US electricity demand has not been growing at a rate that would support large generating capacity expansions of any kind. New wind installations have been anemic for the last two years, in spite of last year's extension of the Treasury grants. Moreover, wind must now compete with the explosion of domestic natural gas production from shale, which when used in combined cycle gas turbines produces cheaper electricity than wind, with low emissions of the air pollutants that are of the greatest concern to most Americans, while still beating coal-fired power hands down on greenhouse gases.

Where all this leaves us depends on your priorities. If your main focus is on reducing greenhouse gas emissions and you see renewable power as a key strategy, then in the absence of a price on carbon you might support extending the PTC for at least a little longer. If you are concerned about climate change but more worried in the short term about the deficit, then letting the PTC lapse next year and relying on state RPS quotas to put a floor under wind looks reasonable. If boosting US cleantech manufacturing is your aim, you should prefer a more direct incentive than the PTC. And if your main worry is oil imports, then the PTC is irrelevant, since the US gets less than 1% of its electricity from burning oil, and most of that in remote and back-up power roles that wind can't easily fill. On balance, if after considering all the alternatives the Congress decides to extend the Production Tax Credit, it should be for an explicitly final period, at no more than the 1.1 cent/kWh rate that technologies like marine, hydropower and waste-to-energy now receive, and without the annual inflation adjustment that undermines the incentive to continue reducing costs.

US Renewables Need A Fallback Plan

When I described some of the energy implications of the debt limit crisis last month, the most serious ones were associated with a default by the US government in the event the debt ceiling wasn't extended. That risk has been resolved, for now. But that doesn't mean that everything looks rosy, especially for renewables. Renewable energy technologies and projects are far more dependent on government assistance and policies than conventional energy. The fate of a wide range of federal energy incentives looks highly uncertain, and the impact of that uncertainty is matched by doubts about the health of the US economy and its growth prospects. With the pace of growth already slowing in some renewable energy sectors, any manufacturers or project developers that aren't thinking seriously about how they would manage without federal incentives could be setting themselves up to become roadkill.

Understanding why requires taking a closer look at the debt ceiling bill that Congress passed in the context of the federal budget baseline--never mind that the US Congress has not enacted a budget in more than two years. In April the Congressional Budget Office (CBO) published its assessment of what the economy would look like under the budget submitted by President Obama in February, as well as under the laws already on the books. The latter comprises the "March CBO Baseline" that was mentioned frequently during the debt limit talks and that formed the basis for comparing different proposals. (See Table 1-5 of the CBO report.) Without factoring in this week's debt limit agreement, the CBO projected a cumulative deficit for fiscal years 2012-21 of $6.7 trillion. That figure is important for several reasons.

First, it serves as a reminder that even after the $917 billion of cuts agreed up front and the $1.2-1.5 trillion of future cuts to be determined later this year, the US debt would still grow by more than $4 trillion over the next decade, mainly through increases in mandatory, or non-discretionary spending--entitlements and other untouchables. That won't change even under the deal done by the Senate and House this week; all of its pre-programmed cuts are to discretionary spending, the category into which most federal spending on renewable energy would fall.

But even that $4 trillion figure looks optimistic. As I understand it the CBO baseline assumes that next January 1 all of the Bush-era tax cuts will expire on schedule, resulting in substantial increases in taxes on both ordinary income and dividend income. And that's not just for those earning more than $200,000 per year, or whatever the threshold of "wealthy" is determined to be; it's for everyone. Nor would the Alternative Minimum Tax, which has been biting a growing number of middle class families every year, be indexed as proposed. It also assumes that the Social Security payroll tax will revert to its normal level of 6.2%, up from this year's 4.2%. Barring a dramatic improvement in the economy between now and the end of the year, it seems unlikely that all of those tax increases will be allowed to take effect. That means that the government's revenue through 2021 is likely to be significantly lower than the CBO forecast, because both growth and tax rates are likely to be lower. That translates into bigger deficits and more pressure for deficit reduction.

So the environment for continued support for renewables will be one in which the government's projected deficits continue as far as the eye can see, even after painful cuts, while its ability to continue borrowing on that scale looks suspect. With the main focus of budget cuts falling on the category that includes cash support for renewables, how likely is it that the Congress would extend the Treasury renewable energy cash grant program when it expires on December 31, 2011, or add new appropriations for the Department of Energy's Loan Guarantee Program? And if the Congressional super-committee's proposals include tax reform that would eliminate many "tax expenditures"--tax credits and deductions--then a host of programs such as the solar investment tax credit, the wind, biomass and geothermal energy production tax credit, various biofuel tax credits, and the electric vehicle purchase tax credit, could end up on the cutting block. In the coming scramble to avoid the budget knife, renewables will be competing with better-established programs with broader and more influential constituencies.

It has always been a risky proposition to build companies and industries, the economics of which depended on substantial government subsidies. Some folks could be on the verge of finding out just how risky. If we go down that path, it will probably also result in awkward questions being asked about some of the decisions made by the stewards of these government programs. They should be; I've never understood what kind of due diligence could have resulted in hundreds of millions of dollars in grants or "loans" going to to clean energy and automotive startups with minimal track records, when private investors weren't willing to bet on those risks at that scale. From a national energy policy and strategy perspective, our focus should not be on saving individual companies--no TARP for renewables, I suspect--but on preserving key capabilities essential to ensuring a long-term competitive US position in the global clean energy market.

What would that entail? First, as government funding for renewables becomes constrained it should be focused on R&D at the expense of deployment. Not only would the available money go much farther, but it would also create more options for the future. The next step should be to ensure that whatever the government does spend on deployment should go to projects that are close to being viable without help, or in the case of the military that enhance combat capabilities. That means, for example, focusing solar development assistance on sunny places like the southwest--preferably in proximity to existing transmission infrastructure--and putting an end to paying people to install utility and rooftop solar in places that receive less than about 5 "peak sun hours" (kWh/m2) per day, on average. Again, the money would go farther, and we'd be shoring up nearly viable operations, instead of trying to command the tide not to overwhelm the marginal ones. And finally, as I suggested last week, a greater emphasis on exports to developing country markets, where energy demand is growing at impressive rates and where renewables are becoming increasingly popular, would increase export earnings and employment while participating in volume-related unit cost reductions. And looking beyond renewable energy, the US government has a bird's nest on the ground in the form of the potential lease bid and royalty income from the substantial oil and gas resources that have been placed off limits for various reasons. Tapping those looks like a much smarter source of revenue--not to mention job creation--than selling off the Strategic Petroleum Reserve bit by bit.

If that sounds like a recipe for putting the US cleantech industry on life support after years of robust government-supported growth, then that's consistent with the severity of the fallback plan that could become necessary. The need for this would depend on the priorities set by the special Congressional deficit reduction committee established by the debt ceiling bill, and by the Congress as a whole, along with the subsequent efforts that will be necessary to prevent our long-term debt from growing beyond our ability to service it. Nor would it be quite the starvation diet it might appear, as long as states kept their renewable portfolio standards in place. This isn't a scenario the cleantech industry would willingly choose, but it's one that it can't ignore.

Energy Implications of Tax Reform

I've been thinking about the implications for energy of a major deficit reduction effort along the lines suggested by the co-chairs of the President's fiscal responsibility and reform commission. Our present approach to providing incentives for various energy sources and technologies, new and old, is embedded in a tax code and taxation philosophy that might not survive the upheaval required to bring the US deficit and resulting federal debt back into a manageable range. This goes far beyond the comparatively minor question of extending expiring grants and tax credits that I discussed the other day; under the most stringent of the proposals from Mr. Bowles and Senator Simpson, such things wouldn't even exist. It's not clear how the Administration or Congress would promote favored energy technologies and strategies without these well-established but costly tools.

Start with renewable energy. We currently promote renewable fuels and electricity generation with a combination of mandates--policies such as the federal Renewable Fuels Standard (RFS) and state Renewable Portfolio Standards--and subsidy payments. Until last year's stimulus bill established the Treasury renewable energy grants, for which eligibility is due to expire in a few weeks, most of those subsidy payments have come in the form of reductions in federal taxes, via either an investment tax credit (ITC) based on the cost of a project or a production tax credit (PTC) for actual energy generated. Both of these measures, which have had a checkered history of expirations and extensions, fall into the broad category of "tax expenditures". The Zero Option proposed by Messrs. Bowles and Simpson would permanently eliminate over $1 trillion of such tax expenditures, in exchange for much lower tax rates.

Even if the renewable energy tax credits were reloaded into a streamlined tax code under the "Wyden-Gregg-style" reform presented as Option 2 from the co-chairs, the value of those credits would be reduced--or at least rendered harder to extract--because the corporate tax rate would be reduced from the current 35% to 26%. That means that a higher proportion of companies would likely not pay large enough taxes to take full advantage of the renewable energy tax credits--or have as much appetite for others' credits via "tax equity" swaps. Compounding that, the likelihood of enacting cash grants to get around this restriction would probably be much lower in an environment in which entire herds of sacred cows were being slaughtered in the cause of averting a looming national deficit and debt crisis.

In the absence of such tax credits, renewable energy developers and manufacturers would be forced to rely even more on state-level mandates or a proposed federal renewable electricity standard. The first test of such a mandates-only approach might come in a few weeks, if the ethanol blenders' credit is allowed to expire, while the annual RFS mandate continues to ratchet up. Or companies might simply conclude that without generous tax subsidies for renewable energy deployment here, their best opportunities would be found in markets that are growing much faster than ours, based on actual energy demand, rather than better incentives. Developing Asia comes to mind. That shift might not be the worst outcome, in terms of both the US trade deficit and global emissions reductions.

Conventional energy firms wouldn't escape unscathed, either. They stand to lose significant tax expenditures as well, in the form of oil & gas depletion allowances, the Section 199 manufacturing deduction, and other benefits. However, the oil and gas industry has been paying an effective corporate tax rate above 40% even after all these credits and deductions. A drop to 26% might more than offset the loss of the other benefits, while more importantly bridging the competitive gap between US firms and foreign competitors that operate under lower tax rates and a territorial tax system, rather than being taxed on worldwide earnings, as US companies are today. Bowles/Simpson also proposed increasing the federal gasoline tax by 15¢ per gallon to restore the Highway Trust Fund to solvency. That's a worthy goal, but as I've pointed out previously the Highway fund faces complex challenges as the US car fleet becomes steadily more fuel efficient and increasingly moves away from liquid fuels taxed at the pump. Raising the gas tax is a stop-gap measure, at best, on the way to a different means of collecting road taxes.

With regard to climate policy, tax reform that eliminated tax credits or reduced their value would also tend to nudge the debate back in the direction of putting an explicit price on carbon, either via cap & trade or with an outright tax. Might that prospect suddenly look more attractive as an adjunct to a fairer and simpler income tax system, than it seemed when it would have come as a further complication to an already enormously convoluted tax system that is widely viewed as unfair by both liberals and conservatives? My guess is not, without something else that motivates us to tackle climate change on a much more urgent basis.

Now let's come back to reality. The proposals of the commission's co-chairs have already received a frosty reception or outright hostility from both sides of the aisle, and they haven't yet gotten the buy-in of the rest of their team; the final report requires the consent of 14 of the 18 members. Their ideas must also compete with a growing number of deficit-reduction alternatives, including a widely-reported plan from another bi-partisan group, plus at least one solo proposal from another member of the President's commission. The chances are low for any of these proposals to gain enough traction to be enacted without first being significantly watered down. However, it is starting to look just as risky to assume that the present tax system--and its cornucopia of energy incentives--will continue unchanged indefinitely. A quick glance at the US debt clock ought to make that abundantly clear.

Extend or Reform?

As the US Congress returns from its election recess to take up its "lame duck" session, one of many crucial pending items it will likely take up is the so-called "extenders" package: key tax provisions that are due to expire at the end of the year, unless extended by legislative action. From an energy perspective, this includes both the expiring ethanol blenders credit and the Treasury renewable energy grants issued in lieu of the investment tax credit (ITC) for renewables. Both incentives face a much more uncertain reception when the new Congress is sworn in next January, so the lame duck might just be their last gasp.

For the ethanol credit, that is as it should be; if 32 years of federal subsidies haven't made corn ethanol competitive with gasoline--particularly when its use is now mandatory--then nothing will. The situation for the renewable energy grants is more complicated. This is a relatively new benefit that, as I've noted in previous postings, was instituted as part of last year's American Recovery and Reinvestment Act--a.k.a. the stimulus--to substitute for a class of market transactions ("tax equity") that renewable energy developers could no longer access as a result of the financial crisis. Bridging that gap became all but essential for smaller companies without enough taxable earnings to take full advantage of the tax credit on their own, or lacking adequate working capital to afford to wait until their next tax filing to recoup the applicable ITC portion of the cost of a project.

If that situation still obtained, justifying the extension of the grants for another year or two would be easy. In the meantime, however, much has changed. Although not yet functioning at the same pace as before the financial crisis, the tax equity market is recovering. Banks and insurance companies have announced a growing number of tax equity deals in the last few months. This market might revive even faster if it weren't competing with essentially free money from the Treasury.

The other aspect of the situation that has changed is the growing dominance of large players in renewable energy project development, particularly for wind. Contrary to the perception that the Treasury grants mainly benefited small companies, more than half of the $5.4 billion in grants awarded to date went to just three companies, all of them large and profitable enough to have waited until tax time to collect their ITC benefits--though I don't doubt that getting cash up front improved the economics of their projects. For example, EDP Renovaveis, through its Horizon Wind Energy subsidiary, collected around $565 million in grants in the first half of 2010, after receiving "in excess of 685 million dollars" in 2009. Meanwhile, between its 3Q2010 earnings presentation and its 2009 full-year presentation Iberdrola Renovables claimed approximately $983 million in US renewable energy grants. NextEra Energy (the renamed parent company of Florida Power & Light) booked $556 million in grants in the first 9 months of 2010, on top of $100 million last year. All of this was entirely appropriate under the provisions of the stimulus, but it doesn't quite fit the picture of an emergency measure intended to help small, struggling firms.

Some have argued that in any case the grants are merely a matter of timing for the government: paying eligible developers cash now, or paying them the same amount later, via reduced taxes. That would only be true if every project that was eligible for a grant could (or should) proceed without one. Sparing wind farms, solar installations and other projects from the discipline of rigorous review by private investors risks allowing weaker projects to proceed, when they should either be rethought or cancelled. That was an unavoidable risk in early 2009, when the renewable energy industry was in peril of imploding, but overlooking it seems less justifiable today.

The Treasury renewable energy grants were instituted as an extreme step at an unprecedented time. It's hard to imagine that anyone intended them to become a permanent entitlement to replace the existing renewable energy tax credits, which were simultaneously extended through the end of 2012 for wind power and 2013 for most other technologies. However, if this program is to be extended for now, it ought to be reformed to exclude beneficiaries for which it constitutes merely a convenience, rather than a necessity. That would mean either capping the maximum payout for any recipient at something less than $100 million, or imposing a corporate income threshold. I'll be watching this issue with great interest between now and the end of the year.

A Wind Bubble?

New US wind turbine installations have slowed significantly this year, compared to 2009, and the decline is having consequences. Among other fallout, Suzlon is mothballing a four-year-old wind turbine factory in Minnesota and laying off the remaining 110 workers, due to a lack of new orders. While the industry pins most of the blame for the slowdown on insufficiently aggressive federal energy policies, it suddenly occurred to me to wonder whether wind power, like housing, might have been caught up in an investment bubble that has finally popped, somewhat belatedly.

The idea of a wind bubble goes against all conventional wisdom, including the importance of expanding electricity generation from low-emission sources in order to mitigate climate change; the desire to build a vibrant "new energy" economy in the US for energy security and competitive reasons; and the persistent mantra of the green jobs that are supposed to turn the economy around. Yet every bubble must have a compelling, plausible narrative, or it would never take off.

When you examine the charts of annual and quarterly US wind turbine installations on pages 2 and 3 of the "Third Quarter 2010 Market Report" from the American Wind Energy Association, there are at least two ways to look at them. The customary perspective would attribute the dramatic increase in wind installations beginning in 2006, which set records in each of the next three years, to the rapid scaling up of an industry that many envision supplying 20% of US electricity generation within two decades, up from its current level of around 2%. This growth has been supported by a variety of incentives and mandates, including the federal renewable production tax credit (PTC), the stimulus grants, and state renewable portfolio standards. But in this scenario it's hard to explain why installations would have fallen off so much this year, when all of these benefits are still in place, other than the imminent expiration of eligibility for the stimulus grants--which in another year might have been expected to trigger a mad rush for projects to get in under the wire, as we saw in 2008 when the PTC was due to expire at year end. How can we attribute this year's drop in installations to the absence of a policy--either a national renewable electricity standard or a comprehensive climate bill--that we've never had?

So turn this picture around and ask why wind might have been in a bubble, and why that bubble might have only popped now, roughly two years after the other bubbles for stocks, housing and possibly oil prices. Aside from the policies promoting wind and other renewables, which have not changed, wind power developers would have looked at two other indicators: credit and demand. Wind projects are capital intensive, and in the run-up to the financial crisis they benefited from the same kind of cheap and readily available credit as other businesses and homeowners did. At the same time, between 2000 and 2007 US demand for electricity was growing at about 1.3% per year. That might not seem like much, but at the scale of the US power sector, that translated into the need to add around 7,000 MW of new generating capacity each year. If all of that was from wind turbines, the required nameplate capacity would approach 20,000 MW, because of wind's lower average output per MW. Wind was also becoming a preferred technology, despite its intermittency, because coal was falling out of favor for environmental reasons and the price of natural gas, the fuel for the dominant incremental generation technology for the last 20 years, had spiked and become very volatile.

If wind was indeed being carried along either by its own bubble or by the froth from the other bubbles fueling the economy in the middle of the decade, why has it only now run out of steam, rather than popping in 2008 or 2009? After all, electricity demand growth evaporated when the financial crisis and recession hit, and demand has not yet recovered to its 2007 peak. For 2008, perhaps the dash to complete projects before the expected expiration of the PTC--it wasn't extended until October of that year--provides sufficient explanation. As for 2009, the charts show that installations did fall dramatically until the implementation of the Treasury stimulus grant program, which injected $1.7 B into wind projects last year and another $2.9 B this year. Moreover, the stimulus grants were more valuable to wind developers than the PTC they formerly received. That isn't just because developers got the money up front, rather than having to wait until a project started up and produced electricity, but also because the grants were based on the 30% investment tax credit (ITC). Using NREL's simplified calculator for the levelized cost of electricity, at a typical cost of around $2,200/kW of capacity the ITC could be worth at least 20% more than the 2.2¢/kWh PTC. In other words, just as the wind market was collapsing last year, the government increased its incentives and accelerated them into up-front cash. That might have been enough to keep a bubble going for a while longer.

Of course there's no way to know whether this scenario is more accurate than the standard explanation for what has happened to the US wind market this year. Nor does it doom wind power to the doldrums even after the economy resumes growing and creating jobs at a healthier rate, and electricity demand picks up. However, if there is a grain of truth in this view, then it might alter our perspective on providing more aggressive support for the wind industry based on the notion that installations should still be running at 10,000 MW per year or more, as they were in 2009, rather than at the lower rate of around 5,000 MW we see today.