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A Low-Voltage Energy Bill

While a few provisions are worth embracing, most of its 1,724 pages represent a waste of good timber.

Fortnightly Magazine - October 2005

After four years of legislative trench warfare, contentious legal wrangling, and heated partisan rhetoric, President Bush finally got what he wanted—a really big energy bill. What he did not get, however, was an internally consistent "national energy strategy." Examination of the legislation reveals that its title—the Energy Policy Act of 2005—is less descriptive than the title popularized by Sen. John McCain: the No Lobbyist Left Behind Act of 2005.

The energy bill is an intellectually vacuous document. There is little sense that Congress gave thought to how energy markets work, how they fail to achieve efficiency, and how government intervention might make energy markets work better. Instead, the bill is a massive wish list of contradictory requests forwarded by lobbyists to transfer resources from the general public to their employers.

The Economics of Subsidy

The most remarked-upon feature of the new law pertaining to the electricity sector is the dizzying array of regulatory preferences, tax incentives, and direct subsidies employed to favor some fuels and technologies at the expense of others. By now, the details of those market interventions are fairly well known to the industry. Investments in nuclear power, "clean" coal, and various renewable energy sources are made more attractive than comparable investments in natural gas-fired generators and conventional coal-fired power plants.

What effects will the targeted subsidies have on energy markets? From the consumers' standpoint, the answer depends on the effect those subsidies have on marginal production costs. From an investor's standpoint, the answer depends upon whether there are barriers to enter the generation market.

Subsidies for "clean" coal, nuclear, and renewable energy production appear unlikely to change the marginal cost of electricity. That's because natural gas-fired electricity is setting the price for electricity in most wholesale markets during most times of the day and likely will continue to do so in the future. Accordingly, where wholesale electricity markets have been deregulated, coal, nuclear, and renewable energy subsidies will have no effect on electricity prices.

In states where retail electricity prices are established by the weighted average of production costs, consumers will see a reduction in rates if and only if the coal, nuclear, and renewable energy subsidies increase the share of electricity produced by those fuels at costs lower than the costs of increased natural-gas-fired output. If the subsidies do indeed accomplish this end, the price reduction does not reflect an efficiency gain. Instead, the price reduction is only the result of the flawed weighted-average pricing scheme produced by regulation.

Either way, the subsidies will transfer wealth from taxpayers to the fuel sectors in question-the reason, after all, that those subsidies are so vocally supported by their beneficiaries. The impact of wealth transfers, however, depends on whether there are barriers to enter the sector receiving the transfers. If entry barriers exist (which is the case in most of

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