Green Quagmire

Deck: 

The black art of pricing social costs.

Fortnightly Magazine - January 2010

At the Power-Gen International trade show in December, Questar Chairman & CEO Keith Rattie delivered a firebrand speech opposing the prospect of CO2 cap-and-trade legislation. To summarize, he said the Waxman-Markey climate bill is an “asinine” piece of legislation—which it is, as anyone who reads it quickly discovers. But more broadly, he said concerns about greenhouse gases (GHG) are based on incomplete science and politically motivated alarmism. If carbon constraints are adopted globally, they’ll force the global economy back to the 18th century, in terms of energy consumption and living standards. And it’s all unnecessary, he said, because market forces already have demonstrated the ability to reduce carbon intensity and improve efficiency.

It wasn’t the first time Rattie delivered a speech opposing GHG regulation, but it might’ve been the first time a Power-Gen keynote speaker elicited a standing ovation.

Rattie earned the ovation because his speech was refreshing and thought-provoking. Rather than taking a nuanced and politically safe approach to the topic, Rattie came with guns blazing. The Power-Gen audience appreciated this straight-shooting approach—especially given its timing on the first day of the U.N. climate conference in Copenhagen, and the accompanying green love fest taking place in the popular media and the industry.

EES North America

Among Rattie’s many compelling assertions, his conclusion merits the most careful analysis:

Energy choices favored by politicians, but not confirmed by markets, are destined to fail. If history has taught us anything, it’s that we should resist the temptation to have politicians substitute their judgment for that of the market. Instead we should let markets decide how much energy gets used; what types of energy get used; where, how and by whom energy gets used.

In truth, no source of energy is perfect, and thus only markets can weigh the pros and cons of each choice. Government has a role, and that role is to set reasonable standards for environmental performance, and then to make sure that markets work.

On their face, these assertions are indisputable. Free markets produce the most efficient and cost-effective solutions to virtually any problem presented to them. Central planning and tax spending can’t touch the innovation and cut-throat cost pressure of a healthy competitive market.

But Rattie’s thesis begs a fundamental question: Can straightforward environmental standards and market competition produce an energy industry that’s both cost-effective and socially responsible? More specifically, how can lawmakers make sure the market works to price-in external costs—such as environmental damage, price volatility and dependence on imports—without imposing precisely the kinds of regulatory judgments that Rattie considers unnecessary?

Pure Speculation

As this column pointed out last month, hardly any energy investment happens anymore without some type of federal or state subsidy (see“Subsidy Addiction,” December 2009). With prices so thoroughly clouded by government incentives and disincentives, we’ll never have the market competition of Adam Smith. Instead, we get competition among lobbyists, tax experts and regulatory economists, competing for the biggest possible piece of the public-funding pie. The invisible hand of the market is remotely controlled by politicians and their most vocal and generous constituencies.

This might seem like a damning indictment of both the industry and its lawmakers, but arguably it’s a reasonable price to pay for an electric grid that has been the envy of the world for decades. Our utilities are investment-grade companies with ready access to low-cost capital, which benefits the customers who ultimately pay for infrastructure investments. Over time, we’ve tapped a variety of fuel sources to create a highly reliable system, and on the whole, rates are reasonably low. America wouldn’t have the world’s most powerful economy today if it weren’t for the regulated—and subsidized—utility industry.

But because the industry operates under so many layers of subsidy, regulators can’t just set environmental standards and expect markets to work. Prices never will be transparent within the industry’s tangled mess of government grants, guarantees and tax incentives. And the quagmire is getting deeper as lawmakers attempt to internalize social costs in market transactions. This is happening at the legislative level, through carbon cap-and-trade, renewable portfolio standards (RPS) and markets for renewable energy credits (REC), and also in such regulatory arenas as FERC’s demand response and transmission pricing proceedings.

As Publisher Bruce Radford observes in this month’s Commission Watch column (“Wellinghoff’s War”), “green-grid proponents want FERC to consider factors such as … greater fuel diversity, improved resource adequacy, lower and more stable rates, and access to new generation technologies.” But as ongoing policy battles show, appraising and apportioning the costs of such factors is a black art at best. “There should be no non-quantified costs or benefits,” Radford quotes the Ohio PUC. “Everyone should be charged in relation to the amount [of energy] they inject or withdraw. Failing this, any attempt to quantify is purely speculation.”

Unwinding the Mire

Unfortunately, in the process of crafting America’s energy strategy, lawmakers have little choice but to engage in the black art of quantifying social costs. And the product of this black art usually turns out to be some kind of subsidy.

This stands to reason, because from a political perspective, subsidies appear to be highly effective policy tools. They seem to reward precisely the behavior (and the constituencies) that policy makers want to reward. By contrast, such straightforward regulatory constraints as emissions standards are only punitive. They can be very effective at driving private investment dollars toward clean energy infrastructure, but the politicians who enact them make more enemies than friends among the regulated community. Moreover, environmental standards aren’t well suited to dealing with other policy concerns, like import dependence and price volatility. And direct intervention in those areas—vis-à-vis import tariffs and price controls—poses even larger barriers to free market competition.

America’s energy markets are evolving to achieve a demanding set of requirements, including maintaining reliability and affordability while also internalizing an array of external costs. In the midst of the industry’s subsidy morass, perhaps the best we can hope for is an honest and accountable approach to shaping these new market mechanisms. That way, when America finally gets ready to kick the subsidy habit and unwind the market mess, we’ll have a clearer idea of where to start.