Editorial: FIRST OF TWO PARTS: A costly energy course

June 1, 2009
Policy can encourage development of nontraditional energy forms as either supplements to or replacements for traditional forms.

Policy can encourage development of nontraditional energy forms as either supplements to or replacements for traditional forms. Economically, the approaches are poles apart.

The administration of US President Barack Obama has confirmed plans to commit the country to the costlier option and welded its motives to the mitigation of climate change. Soon to be bonded in policy, unless economic judgment prevails, are two uncontrollably expensive programs offering proportionally small benefits.

‘Overproduction’

Long-implied intention became explicit in the Treasury Department’s discussion of a proposed federal budget that would raise taxes on the oil and gas industry by $50 billion over 10 years. Tax preferences favoring oil and gas companies, Treasury said, compromise energy security by encouraging “overproduction” of oil and gas. In each case, “The [measure or its result], like other oil and gas preferences the administration proposes to repeal, distorts markets by encouraging more investment in the oil and gas industry than would occur under a neutral system.” Treasury called this circumstance “inconsistent with the administration’s policy of encouraging the use of renewable energy sources through a cap-and-trade program [to reduce emissions of carbon dioxide].”

To resist global warming, then, the administration will encourage development of renewable energy in place of rather than in addition to domestic production of oil and gas, which it will discourage with taxation. Unbelievable.

Contrary to Obama’s blandishments about “green jobs,” displacement on meaningful scale of economic energy with costlier substitutes can’t happen except at great cost. A two-part editorial series beginning here will attempt to put the effects into perspective. The first part will examine proposed energy shifts in the context of subsidies already pouring toward renewable sources. Next week’s installment will report estimates of costs for the cap-and-trade scheme before Congress.

Try though it will, the government can’t reengineer energy markets efficiently by decree. Efforts in this direction breed handout Hydras like the fuel-ethanol program and create a paradise for subsidy profiteers.

A report last year by the Energy Information Administration offers a basis for extrapolating the costs of deliberately raising the use of renewable energy to the detriment of oil and gas. According to EIA, US subsidies for the production of renewable energy used for electric power generation in 2007 amounted to 82¢/MMbtu. But that encompasses all renewable energy, including sources such as relatively low-subsidy, high-output hydropower, which won’t grow much. In the dominant political vision of the day, oil and gas give way to solar energy, wind, and biofuels.

In 2007, production subsidies for solar amounted to $7.16/MMbtu and for wind, $6.87/MMbtu. Consumption subsidies for ethanol, the main biofuel, were worth $5.72/MMbtu. Because the blending tax credit for ethanol has fallen since then, the subsidy this year will be worth about $5.42/MMbtu. While these values aren’t perfectly comparable, they do indicate what’s required to move these energy forms into commercial markets.

For simplicity, the assumption here is that subsidies for fuels favored by politicians average $6/MMbtu in value over the next 10 years. So how much would the US spend in subsidies alone to cut oil and gas usage rates by, say, 5% each below forecast levels by the end of the budget period and make up the difference with renewable energy?

Moving the needle

Based on EIA projections for 2020, the cuts would be 1.83 quadrillion btu (quads) for oil and 1.1 quads for gas. Subsidies for the replacement energy thus would come to $17.6 billion. That 1-year total is more than the entire annual budgets for some federal departments. And the hypothetical spending would move the energy needle by just 5%.

Fiscal damage wouldn’t end at $17.6 billion. Supplanted oil and gas otherwise produced domestically, for example, would generate no royalty and no tax revenue. And the US still would use 17 million b/d of oil and 61 bcfd of gas—probably not what proponents of these moves have in mind. Costs postulated here take no account of even greater economic sacrifice required by the cap-and-trade program, the subject for this space next week.