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Three Inconvenient Energy Policy Truths

Pres­i­dent Elect Obama nom­i­nated his energy team yes­ter­day and empha­sized that energy pol­icy is a national pri­or­ity. Every Pres­i­dent since Jimmy Carter has talked about U.S. energy inde­pen­dence, but no Pres­i­dent has actu­ally bro­ken the U.S. addic­tion to imported oil. In the 1970s, I stud­ied energy eco­nom­ics and pol­icy and learned that man­dates, slo­gans and “feel good” poli­cies based on fads don’t work. Only eco­nom­i­cally and finan­cially sound poli­cies will break the U.S. addic­tion to imported oil.

A lot is rid­ing on a suc­cess­ful energy pol­icy. National and eco­nomic secu­rity, the auto­mo­bile industry’s future, the cost and avail­abil­ity of food, the future of the envi­ron­ment and the nation’s eco­nomic recov­ery plan are all tied to energy policy.

Unfor­tu­nately, for as long as any­one can remem­ber the United States has lacked an effec­tive energy pol­icy. Our coun­try has never been more depen­dent on imported oil than now. Hope­fully, $145 per bar­rel oil and our fear of run­ning out of oil all together will move us to a con­sen­sus on energy that will actu­ally work.

In the past year, a pub­lic con­sen­sus has formed around four prin­ci­pal energy pol­icy goals. These goals are:

  • Min­i­mum depen­dence on energy pro­duced out­side North America;
  • Low envi­ron­men­tal impact from the gen­er­a­tion of energy;
  • Rea­son­able cost; and
  • Preser­va­tion of the Amer­i­can “way of life” includ­ing strong national and eco­nomic security.

Cur­rent energy pol­icy hasn’t achieved any of these goals and pol­icy fail­ures are becom­ing more and more dan­ger­ous for the United States. A suc­cess­ful energy pol­icy must achieve each of the above objec­tives and be self sus­tain­ing. Ini­tia­tives that spend money on “green” energy, con­ser­va­tion and domes­tic pro­duc­tion but which aren’t sus­tained by the pri­vate mar­ket when the sub­sidy goes away don’t work.

How­ever, before “good” energy pol­icy can be enacted, three unpop­u­lar incon­ve­nient “truths” need to be rec­og­nized and dealt with. Dis­re­gard­ing any of these three energy truths will result in energy pol­icy that won’t work.

Incon­ve­nient Energy Pol­icy Truth #1

There is no magic bul­let that is going to make the U.S. energy inde­pen­dent. Suc­cess­ful energy pol­icy requires a decen­tral­ized multi-strategy approach.

Large, sim­ple solu­tions to the energy prob­lem don’t work. Break­ing the imported oil addi­tion requires mass par­tic­i­pa­tion in decen­tral­ized energy pro­duc­tion and con­ser­va­tion. Unfor­tu­nately, the Amer­i­can pub­lic has never embraced decen­tral­ized energy solu­tions. Vir­tu­ally every major energy ini­tia­tive gen­er­ates oppo­si­tion from groups that are ded­i­cated to the sta­tus quo and are able to block or slow wide­spread adop­tion of energy solu­tions. Even wind­mills and pas­sive solar pan­els are resisted by inter­est groups that fre­quently kill projects.

Renew­able energy pro­duc­tion and con­ser­va­tion is decen­tral­ized because renew­able energy sources are incred­i­bly spread out. Wind, tides and sun­shine (some of the more promis­ing renew­able energy sources) aren’t con­cen­trated in one place and require a lot of wind­mills, water tur­bines and solar pan­els to have a mean­ing­ful effect. And, con­ser­va­tion requires the com­mit­ment of every indi­vid­ual to suc­ceed. Energy inde­pen­dence will only be achieved through the accu­mu­lated results of a lot of lit­tle things under­taken by many peo­ple at the same time.

Energy pol­icy needs to rip down the local bar­ri­ers, soci­etal prej­u­dices and zon­ing rules that pre­vent decen­tral­ized solu­tions. A “kitchen sink” approach to domes­tic energy pro­duc­tion and con­ser­va­tion is needed because every­thing that can be done needs to hap­pen at the same time. Envi­ron­men­tal laws and other reg­u­la­tions need to be imme­di­ately mod­i­fied so that inter­est groups that “don’t want that thing in my neigh­bor­hood” can’t mount irrel­e­vant chal­lenges to pre­vent renew­able energy alter­na­tives. While cheap imported oil was great while it lasted, until every­one decides to be part of the national energy solu­tions, the U.S. won’t be energy independent.

Incon­ve­nient Energy Pol­icy Truth #2

Energy pol­icy needs to make every­one a win­ner. Poli­cies that make losers out of exist­ing energy sup­pli­ers, investors and work­ers will fail.

His­tor­i­cally, the pol­icy debate has been insen­si­tive to the peo­ple, investors and com­pa­nies that man­u­fac­ture, dis­trib­ute and deliver energy. Vir­tu­ally all energy ini­tia­tives have the unin­tended effect of leav­ing large invest­ments to be writ­ten off because of obso­les­cence or lower demand. Pol­icy mak­ers don’t think about the vested inter­est groups that stand to lose from new and dif­fer­ent fuels and con­ser­va­tion and, not sur­pris­ingly, exist­ing energy pro­duc­ers have gen­er­ated silent but deadly oppo­si­tion to change.

As an exam­ple, while every­one agrees that cars need to get bet­ter gas mileage, vir­tu­ally no one has thought about what hap­pens to the peo­ple and com­pa­nies that make and dis­trib­ute gas for us to use. Bet­ter gas mileage has a side effect of hurt­ing the refin­ers, trans­porters, whole­salers and retail­ers of gaso­line. Bet­ter gas mileage destroys demand for gaso­line and will cre­ate lower prices and over capac­ity. It isn’t sur­pris­ing that vested inter­ests in the oil indus­try are quiet but effec­tive oppo­nents of energy pol­icy pro­pos­als. After all, how many indus­try lead­ers sup­port fed­eral ini­tia­tives that are the equiv­a­lent of eco­nomic suicide?

Sim­i­lar issues exist for ports, ships and ter­mi­nals that are used to import oil. Energy pol­icy mak­ers are naïve to assume that work­ers and investors haven’t noticed that gov­ern­ment pol­icy is going to kill their jobs and destroy their investment.

The issue of obso­lete and under­uti­lized resources is the same for own­ers of elec­tri­cal power plants. Solar, wind, tidal and other renew­able resources are a great idea unless you own or work in an exist­ing power plant that isn’t going to pro­duce power when the sun is out or the wind is blowing.

By the way, for­eign oil pro­duc­ers aren’t too happy about los­ing U.S. busi­ness. This week’s edi­tion of 60 Min­utes fea­tured the CEO of Saudi Aramco and the Saudi Oil Min­is­ter. They were clear that they want to keep the U.S. as their largest and best cus­tomer. Saudi Ara­bia isn’t going to give up with­out a fight and we can expect all sorts of trou­ble from for­eign coun­tries if the U.S. is suc­cess­ful in reduc­ing its depen­dence on for­eign oil.

Even worse, it will take years for the U.S. to achieve energy inde­pen­dence. We will need new invest­ment to pre­serve exist­ing infra­struc­ture will be needed. For exam­ple, oil refiner­ies need con­stant invest­ment to oper­ate. Dur­ing the sum­mer, with great fan­fare, the media announced that it had been more than 30 years since the last new domes­tic oil refin­ery was built. Politi­cians acted like it was a national crime when the refin­ery indus­try was caught short of capac­ity. But, what ratio­nal investor would put money into a new oil refin­ery know­ing that it is U.S. pol­icy to reduce demand for their prod­ucts and cre­ate over­ca­pac­ity. And, for that mat­ter, why should Saudi Ara­bia invest in pro­duc­tion capac­ity to serve Amer­i­can demand if our stated goal is to leave their infra­struc­ture stranded with­out its best customer.

The con­cerns of exist­ing energy pro­duc­ers are legit­i­mate and need to be addressed. If Obama’s energy pol­icy for­gets to take care of incum­bent energy inter­ests it will fail. Energy pol­icy needs to make sure that invest­ments in prop­erty, plant and equip­ment that are ren­dered obso­lete or made uneco­nomic because of over­ca­pac­ity are paid for through their use­ful eco­nomic lives.

Incon­ve­nient Energy Pol­icy Truth #3

Reduc­ing America’s depen­dence on for­eign oil causes imported oil prices to drop which makes the U.S. want to burn more cheap for­eign oil. Energy pol­icy needs to break this loop which under­mines policy.

A suc­cess­ful energy pol­icy will reduce oil con­sump­tion which will cause oil prices to fall. Cheap oil kills domes­tic energy pro­duc­tion, renew­able energy ini­tia­tives and con­ser­va­tion. It hap­pened in the late 1980’s and 1990’s and, as prices drop below $40 per bar­rel today, his­tory is repeat­ing itself.

Low and volatile oil prices are bad for energy invest­ments because investors can’t rea­son­ably expect to make money on new energy invest­ments. When investors fund energy projects, they cre­ate finan­cial pro­jec­tions that assume dif­fer­ent price lev­els for oil, gas and coal. If energy prices drop below a min­i­mum level, the pro­jec­tions show that the invest­ment won’t make money and the project isn’t funded. Highly volatile prices cause investors to cre­ate pro­jec­tions with wide price swings. There are very few new domes­tic energy invest­ments that make money with oil prices at $40 per bar­rel. And, when investors cre­ate a price sen­si­tiv­ity analy­sis and assume that prices could poten­tially drop from cur­rent lev­els, vir­tu­ally no projects make eco­nomic sense.

The boom and bust his­tory of U.S. energy prices for the last 30 years rein­forces depen­dence on for­eign oil. For­eign pro­duc­ers have lower costs of expor­ta­tion, devel­op­ment and pro­duc­tion and can eas­ily sur­vive large price declines. Even worse, most large for­eign oil pro­duc­tion is gov­ern­ment owned and tra­di­tional invest­ment analy­sis isn’t used to decide upon pro­duc­tion and investment.

Oil prices dis­tort the auto­mo­bile mar­ket. The cur­rent humil­i­a­tion of the Big 3 exec­u­tives because they didn’t invest in energy effi­cient vehi­cles ignores gaso­line price his­tory and the real­ity of con­sumer demand. Gas was cheap and U.S. con­sumers wanted big vehi­cles. For­eign man­u­fac­tur­ers that appear smart because they pro­duce energy effi­cient vehi­cles were forced to pro­duce those vehi­cles because of energy taxes that drove up the price of gaso­line to con­sumers in their domes­tic markets.

The U.S. needs gov­ern­ment man­dated min­i­mum guar­an­teed prices for oil, nat­ural gas and coal. Min­i­mum guar­an­teed prices reduce price volatil­ity and pro­vide some mea­sure of cer­tainty to investors and con­sumers. And, it isn’t only renew­able energy and con­ser­va­tion invest­ments that need price cer­tainty; new domes­tic oil and gas invest­ment needs price floors to be com­pet­i­tive. With price floors, investors can con­fi­dently invest in domes­tic energy projects with­out being wiped out by low prices when for­eign gov­ern­ments dump­ing energy into the mar­ket. Energy pol­icy won’t work until prices are sta­bi­lized so self sus­tain­ing energy invest­ments can take place and won’t be killed by for­eign gov­ern­ment price manip­u­la­tion and production.

Cur­rent “cap and trade” leg­is­la­tion isn’t good energy pol­icy and shouldn’t be relied upon to solve the prob­lem of falling oil prices. Cap and trade leg­is­la­tion is sup­posed to reduce green­house emis­sions and isn’t energy pol­icy. Cap and trade pro­pos­als are envi­ron­men­tal pol­icy ini­tia­tives and that isn’t the same as energy pol­icy. Cap and trade does noth­ing to encour­age domes­tic energy pro­duc­tion and doesn’t address the issue of low and volatile prices.

A gas tax isn’t the same thing as a min­i­mum oil price. While a gas tax will encour­age con­sumers to drive more effi­cient vehi­cles, that doesn’t do any­thing for the sup­ply side of energy. Only min­i­mum oil prices achieve all of the objec­tives of tax policy.

Price floors can be enforced by impos­ing a tax sur­charge on energy that is sold below the min­i­mum price. Through tax sur­charges, the effec­tive price to inter­me­di­ate and final users will be the min­i­mum estab­lished price. And the rev­enue that is raised through min­i­mum price sur­charges can be used to com­pen­sate energy pro­duc­ers who are harmed by energy policy.

The U.S. has too much at stake for a pre­tend debate on energy pol­icy that doesn’t rec­og­nize the three incon­ve­nient energy truths. Fail­ure to deal with real­ity has put the U.S. into the predica­ment of need­ing for­eign and some­times hos­tile inter­ests to sup­port us for our eco­nomic and national sur­vival. This cycle of depen­dency must end. We need a new national con­sen­sus reached for energy independence.

Posted in: economy, Energy, Finance, Obama, Oil, Politics

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