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.