Should the government subsidize alternative energy?

When solar panel manufacturer Solyndra went bankrupt after receiving millions in federal loan guarantees, some said that the government should stop interfering in energy markets

December 10, 2011

See the orig­i­nal Yale Insights Dec. 2011 arti­cle here.

By Nancy Pfund, a Man­ag­ing Part­ner of DBL Part­ners, a ven­ture cap­i­tal firm that invests in solar companies.

The bank­ruptcy fil­ing by solar panel man­u­fac­turer Solyn­dra, which received $535 mil­lion in loan guar­an­tees from the fed­eral gov­ern­ment, is grist for many con­tro­ver­sies. While some of them are nar­rowly polit­i­cal, oth­ers involve legit­i­mate pol­icy ques­tions that deserve a full air­ing. It’s fair to ask, for exam­ple, why the gov­ern­ment is sub­si­diz­ing alter­nate energy sources in the first place. Shouldn’t that be bet­ter left to the free market?

As it hap­pens, the Obama admin­is­tra­tion is not the first to have the idea of giv­ing the econ­omy a boost by help­ing out a promis­ing new energy source. Energy sub­si­dies have been a con­stant in Amer­i­can his­tory, lit­er­ally going back to the country’s ear­li­est days, and these sub­si­dies have been cru­cial in America’s over­all eco­nomic development.

Although it is not at all appar­ent from the polit­i­cal dis­course these days, the inflation-​​adjusted sup­port for new energy sources is much lower today than it’s been at any pre­vi­ous point in our his­tory. That’s the rather star­tling con­clu­sion that we came to when we ana­lyzed the actual data on gov­ern­ment inter­ven­tion in the energy mar­ket­place since the United States first slapped a tar­iff on British coal imports in 1789 (read our full report).

We found, first, as the chart below illus­trates, that grow­ing sup­plies of new energy sources have been key to the con­tin­u­ous expan­sion of the Amer­i­can econ­omy over time.

Energy Consumption vs. GDP

Now, oth­ers have doc­u­mented this rela­tion­ship between energy sup­plies and eco­nomic growth before, but what we uncov­ered is the fact that these new energy sources did not sim­ply emerge as the result of free-​​market forces. Rather, the gov­ern­ment heav­ily sub­si­dized each new energy source, often at both the fed­eral and state level. In our study, we looked at those sub­si­dies in their his­tor­i­cal con­text, in order to com­pare the rel­a­tive lev­els of fed­eral sup­port for each new energy source—something that, as far as we know, no one had ever attempted. On an inflation-​​adjusted basis, we learned, the sub­si­dies for “tra­di­tional” energy sources in their early growth days—coal, oil, gas, and nuclear—were many, many times what we are spend­ing on renew­ables today.

Percent of Federal Budget

We quan­ti­fied this dis­par­ity in sev­eral ways. For exam­ple, dur­ing the key growth years of what would become our oil and gas indus­tries, tax expen­di­tures on behalf of pro­duc­ers aver­aged the equiv­a­lent of 5 per­cent of the fed­eral bud­get. By con­trast, the cur­rent sup­port for renew­ables is barely a fifth that size, com­pris­ing less than one per­cent of fed­eral spend­ing. When you add the num­bers up, you dis­cover that, again fac­tor­ing in infla­tion, $1.8 bil­lion per year was spent on sub­si­dies dur­ing the early years of the mod­ern oil and gas indus­tries, com­pared to just $400 mil­lion annu­ally for renew­ables. In short, rather than being some sort of sink­hole for fed­eral sub­si­dies, renew­ables have been get­ting sig­nif­i­cantly less pub­lic sup­port than other new energy sources did upon their intro­duc­tion into the United States.

Comparative Energy Subsidy Trends

As for energy sub­si­dies rel­a­tive to the amount of power gen­er­ated, here again, the his­tor­i­cal data sug­gest that today’s renew­ables sub­si­dies are hav­ing just about the same level of suc­cess in pro­mot­ing growth as ear­lier U.S. sub­si­dies did, even with less sup­port. In our paper, we looked at the effec­tive­ness of his­tor­i­cal sub­si­dies, in terms of annual increases in mil­lions of BTUs (MMBTU) pro­duced per dol­lar of sub­sidy given. We found that, on an inflation-​​adjusted basis, each dol­lar of early oil sub­si­dies pro­duced less than a tenth of an MMBTU more than renew­ables sub­si­dies do today—a tiny amount in light of the fact that mod­ern renew­able energy sources are com­pet­ing against enor­mous entrenched infra­struc­ture. That is to say, today’s renew­ables sub­si­dies are per­form­ing the same task as yesterday’s oil and gas sub­si­dies: dri­ving the sector’s growth in order to fur­ther inno­va­tion, lower costs, and deliver a diverse and secure energy port­fo­lio for future gen­er­a­tions. This sug­gests to us that even if our polit­i­cal lead­ers are unwill­ing to increase incen­tives for renew­able energy gen­er­a­tion, they cer­tainly should not demol­ish the mod­est frame­work we have in place now.

Increase in MMBTUs

Just as crit­i­cally, our study also revealed that many early energy sub­si­dies were never phased out, even as the energy source became ubiq­ui­tous and osten­si­bly “prof­itable.” Put more bluntly, coal, oil, and gas aren’t run­ning in this race unaided; much of the time, as tax­pay­ers, we con­tinue to carry these indus­tries on our backs. The best exam­ple of an indus­try with a mas­sive, if largely hid­den, his­tory of spe­cial treat­ment is coal, which has got­ten help for centuries—from an import tar­iff levied in 1789 to pref­er­en­tial tax treat­ment estab­lished dur­ing the Korean War and still in effect today.

Our aim here is not to crit­i­cize his­toric sup­port for coal, or other tra­di­tional energy sources. On the con­trary, as a new indus­try, renew­able energy devel­op­ers appre­ci­ate how impor­tant early fed­eral invest­ments have been in devel­op­ing new energy sources, and the fact that most of them have paid soci­ety back many times over for that early assis­tance. But it is sim­ply false when other energy indus­tries describe renew­ables as sops of fed­eral money; in fact, renew­ables get rel­a­tively less gov­ern­ment help, not more, than their tra­di­tional com­peti­tors ever did.

Many play­ers in the renew­able energy space might look at this his­tor­i­cal data and argue that we should increase cur­rent sub­si­dies to the clean energy sec­tor. While we are sym­pa­thetic to that argu­ment, which makes sense from a his­tor­i­cal equity per­spec­tive, we are nonethe­less aware that cur­rent polit­i­cal and bud­getary con­straints make such increases highly unlikely. Given that real­ity, we sim­ply sug­gest that Con­gress main­tain the exist­ing clean energy invest­ment and pro­duc­tion tax cred­its, and make them permanent—as is the case with nearly every major sub­sidy to fos­sil fuel com­pa­nies. This kind of sta­ble gov­ern­ment pol­icy would pro­vide cer­tainty to the pri­vate sec­tor and ensure that invest­ment dol­lars keep flow­ing to drive clean energy tech­nolo­gies down the cost curve.

It is well chron­i­cled that we are wit­ness­ing an expo­nen­tial decline in the cost of renew­ables, with a 70% decline in the cost of solar and a 40% decline in the cost of wind in just the last three years. Mean­while, the long-​​term cost of coal and oil is headed upward as we finally address the envi­ron­men­tal, health, and energy-​​security con­se­quences that we pre­vi­ously exter­nal­ized. True, the polit­i­cal head­winds cur­rently fac­ing the renew­ables sec­tor are immense. But the fun­da­men­tal eco­nom­ics of the indus­try are incred­i­bly pos­i­tive, with clean energy com­pa­nies cut­ting costs as they achieve bet­ter economies of scale, com­mer­cial­ize more effi­cient power con­ver­sion tech­nolo­gies, and gain access to cap­i­tal that is more appro­pri­ately priced for the declin­ing risk of the sec­tor. In our view, the bot­tom line is that our polit­i­cal lead­ers are mak­ing a huge mis­take if they cut off sup­port for renew­able energy sources just as the sec­tor is reach­ing this crit­i­cal inflec­tion point.

We need to under­stand dis­ap­point­ments like Solyn­dra in an appro­pri­ate con­text. For every suc­cess­ful 19th-​​century coal oper­a­tion, there were dozens if not hun­dreds of bank­rupt­cies. And, today, sev­eral other solar com­pa­nies have received the same loan guar­an­tees as Solyn­dra did. By and large, they are solidly man­aged com­pa­nies poised for robust growth and sig­nif­i­cant job cre­ation. There is noth­ing at all unusual about giv­ing them a lit­tle help. It is, in fact, the Amer­i­can way.

Dis­clo­sure: Nancy Pfund is a man­ag­ing part­ner of DBL Part­ners, a ven­ture cap­i­tal firm that invests in solar companies.