Energy Challenge for the Obama Administration: The Economics of Going Greener

December 17, 2008

For decades, the message sent by American companies to their customers could be likened to an old TV commercial for corn chips with Jay Leno. "He'd say, 'Crunch all you want. We'll make more,'" said Ed Fox, chief sustainability officer for Arizona Public Service.  

Utilities make their money from generating power and selling it. More power consumed means more revenue. While utilities are encouraged to make modest efforts to promote conservation, under the current regulatory and business model, they have little economic incentive to make it a reality.

But the landscape may be changing for investor-owned utilities and their customers. There are immense political and social pressures to reduce carbon emissions from power plants and from vehicles.

Barack Obama becomes President in January, and he campaigned on reigning in CO2 emissions and making the United States less dependent on foreign sources of oil. He hopes to create jobs by jump-starting alternative energy industries -- all of which makes it look as though business as usual won't continue in the energy industry.

On the other hand, the country's economic engine threw a rod in September. At the same time, utilities' finances are feeling the strain. Alternative energy is more expensive -- that is if you don't calculate what economists call the "social costs" of conventional power generation.

What energy policies can Obama implement that will reduce emissions and allow for economic growth? How can the next administration make us greener and still keep the lights on?

Arizona State University's Global Institute of Sustainability, the W . P . Carey School of Business, and Arizona Public Service played host to a panel discussion Dec. 3 at ASU's Tempe campus to look at the policies available to the President elect.

Campaign Consensus

In the 2008 presidential campaign, the candidates from the two major political parties were largely in agreement over energy policy.

"The candidates for both parties were talking about fairly aggressive environmental policies and fairly aggressive energy policies," said Charles Cicchetti, a USC professor of economics and a former utility regulator in Wisconsin. "The differences were relatively small."

For example, both Obama and his opponent John McCain proposed some sort of "cap and trade"  system, in which a ceiling is set for overall carbon emissions but companies (if this system is international in scope this means from around the globe) would be allowed to trade credits in order to meet the limit.

About six weeks before the election, the economy -- which had been wobbling -- fell off the table. In quick succession, an old-line Wall Street investment bank failed, the world's largest insurance company had to be rescued by the United States government, the credit markets seized up, unemployment shot up and the stock market began a wild, bumpy, and mostly downward journey.

"Just about the time both political parties, both presidential candidates, started to say some pretty sensible things about climate change and energy, about alternative energy, about renewable energy, we get hit with an economic problem we're still trying to work through," Cicchetti said.

The economy supplanted energy and environment on the campaign trail, and during the transition before taking office, most of Obama's public remarks have focused on the economy.

Lost opportunity

That's not all bad, said Cicchetti, who described himself as a radical Democrat who turned into a conservative Republican. "The good thing about a bad economy is it prevents you from doing a lot of dumb things," he said.

Cicchetti said the pessimist in him said that when the economy is bad, people tend to be more concerned with their jobs and the immediate future than what will happen 20 or 30 years down the line.

The solutions to our energy problems won't come cheaply, he added.

For example, cap and trade on generating electricity under a widely discussed proposal would be equivalent to a price on C02 emissions at $30-$50 a ton. A $40 a ton tax would translate into a 50 percent jump in residential electricity bills for customers of utilities that generate primarily from coal.The increase would be slightly less for electricity from nuclear and natural gas.

"That's not an insignificant amount," he said.

No free light

The sun and the wind are free but harnessing them for electricity isn't.

Moderator Kerry Smith, an economist at the W. P. Carey School, gave figures from a soon-to-be-released major study that show solar photovoltaic electricity costs almost 5 1/2 times as much as electricity generated from pulverized coal. Wind power is about 1 1/2 times as expensive as coal power, the study will show.

It's generally reported that alternative sources of energy are more expensive and less rliable. A wind turbine generates no electricity on a still day, solar generates nothing at night, and battery technology needs to improve. Still, almost everyone agrees that if alternatives and renewables could become more reliable and their costs be brought in line, the world would be a better place. The question is how.

One way would be to tax commodities such as fossil fuels, but economists generally oppose such taxes. "Economists say, 'My God-- you're distorting the market," Smith said.

Social costs

Another school of thought says the relative prices of conventional fuels fail to reflect their social costs, such as the impacts generating technologies have on air quality, global warming, damage from strip mining and oil spills, and the political insecurity caused by our dependency for oil on the Middle East.

Smith wonders if it might be better to alter consumer behavior by bringing the prices of fossil fuel based sources of energy in line with their full social costs. This makes the alternative and renewable sources look more cost effective.

Of course it's difficult to say what exactly the social costs are.

"There's an extreme position that says in 50 years there'll be no one left on the planet unless we do something," said Tim James, Director of Research and Consulting at the Seidman Research Institute in the W.P. Carey School of Business and a former advisor on economic and energy policy in the United Kingdom. "To be sure we engender change in behavior we could set an infinite price for emissions … the other forms of generation -- solar and wind -- then become completely acceptable in terms of their costs."

Sunny disposition

James likes an idea that took hold in Germany, which has emerged as the world leader in solar generation. German power customers with solar photovoltaic units can sell power back to the grid at big multiples of the cost of the electricity they can buy from it. Other consumers see a small increase in their electric bill in order to pay for the program.

"This becomes an investment decision," James said. "Private consumers can get solar power to pay for itself in a few years."

Today there are 1.2 million homes in Germany with solar photovoltaic units feeding into to the power grid. James said the Germans have a robust solar related manufacturing and service sector founded on their renewable generation.

Costs of manufacturing photovoltiac equipment has dropped since the 1970s and would continue to plummet on per unit basis if demand were higher. James said Arizona is natural to be a world leader in solar generation, given the state's weather.

"I tell people that being a weather forecaster in Arizona has to be easiest job in the world," he said. "Tomorrow is always sunny and one or two degrees different from what was today."

But even with all the sunshine, Arizona can't meets its future energy needs. Solar generation would probably work best in concert with other forms of generation, James said. Given the state's high population growth rates, solar can only be part of the solution, he said. "We need more of everything," James said.

Another resource

Arizona and the United States need more emphasis on conservation, said Fox of Arizona Public Service.

"We make a mistake in this country by not thinking of conservation as another resource -- not just as a program to help customers control their costs. But truly as a resource," Fox said. We are incredibly inefficient in our energy use."

Fox added that it's often cheaper to acquire a kilowatt hour through conservation than through any kind of generation. Having said that, Fox speculated whether it might be better to replace the inadequate insulation in homes throughout United States than to spend billions on a program to prime the alternative fuel industries. For one thing, it wouldn't involve re-training workers in a new industry.

Fox added that power generators need to change their culture, but regulations should be looked at as well.

"The regulatory model we've lived under the past 50 years has been to provide cheap electricity," Fox said. "The way you make money is sell as much as you can. Build the resources that are necessary to sell it."

Investor-owned utilities make no money from persuading customers to use less energy or from using renewables. "The regulatory structure needs a hard rethinking," Fox said.

Oil trap

Most of the economic news this fall has been bad, but American enjoyed a respite with moderating oil and gasoline prices. The price of oil dropped from about $150 a barrel last summer to below $50 recently. Gas prices have fallen from more $4 to under $2.

But don't expect that to last, said Stephen Brown -- recently retired form the Dallas Federal Reserve Bank, where he was director of energy economics. Brown said a price of $70 to $100 is sustainable for the next 20 years once the recession is over.

In fact, there is a danger that when the shock of out-of-control gas prices is forgotten, Americans will resume their gas-guzzling ways.

But not all energy inefficiency can be blamed on consumers' wasteful habits, Brown said.

"Consumers often lack the information to make intelligent choices," he said. "Price features are often the factor determining what appliances to buy or what kind of apartment to rent."

Bottom Line:

  • Despite some differences, the Republicans and Democrats generally were united in a need for smarter energy and environmental programs during the past campaign. The economic meltdown pushed those issues out of the spotlight.
  • The conventional pricing of fossil fuels doesn't take into consideration the social costs in terms of environmental damage and limited foreign policy options. The hidden costs may make them less of a bargain than other sources of energy.
  • Solar energy might be more viable from private consumers perspective if utilities or the government offered an incentive for consumers similar to the program used in Germany.
  • Conservation is underrated as a tool in the fight to meet the demand for power while somehow reducing CO2 emissions.