Obama Woos the Corporate 1%

[1] You really can't make this stuff up. On February 11th, the Wall Street Journal reported that (sub. required):

The Obama administration is attempting to persuade U.S. corporations about the benefits of investing in renewable energy, in an effort to help the industry after a government grant program expired.

The Energy Department-led effort includes a planned March 13 meeting at which senior financial-firm executives and Energy Secretary Steven Chu would speak, documents viewed by The Wall Street Journal show. The 79 invitees include some of the largest companies in the U.S., from Exxon Mobil Corp. to Walt Disney Co., according to the documents.

Yes, crony capitalism at its best. Team Obama sings a populist tune for its cheerleaders on the political left. Most of the time, someone needs to stand up for the "99%" against the big, bad "1%". But, ahem, there are some exceptions. A big exception involves the much touted "green jobs agenda." Guess what? The "green jobs agenda" can really use some help from the Corporate 1%.

The existing tax subsidy regime for renewable energy development is dysfunctional. Team Obama needs cash from big U.S. businesses with big U.S. tax bills. Without cash from the Corporate 1%, renewable energy development will continue to limp along. Hopefully, the "most transparent administration" in history will release a transcript of the March 13 meeting. But we can be assured that the real "action" will occur behind the scenes. Crony capitalism at its best.

[2] Back in August 2011, I wrote a series of posts describing the relationship between tax subsidies and renewable energy development. See Part 1, Part 2, Part 3, Part 4. The political left wants to subsidize renewable energy through federal spending. The political right favors the magic of "tax expenditures" over direct outlays. Together, they devised a laughably flawed regime that provides tax credits for certain types of renewable energy.

Why is the regime laughably flawed? A quick summary of my August posts. I'm focused on wind and solar development, although the same principles apply in other contexts.

Congress wants more development of wind and solar projects. But generating electricity from wind and solar resources costs more than generating electricity from coal and natural gas ("bad" fossil fuels). Because wind and solar are "uneconomic," no rational actor would develop wind or solar projects without some kind of subsidy regime. Put another way, a rational consumer would not choose to purchase expensive, unsubsidized electricity from wind and solar projects.

There are various ways to subsidize energy development. For example, Congress could have passed a direct subsidy for electricity produced by wind and solar projects. The direct subsidy would have been, say, 1.0 cent per kilowatt hours of electricity produced by a "qualified" energy facility for a given number of years. The entire program could have been administered by the Energy Department ... which is, after all, responsible for our national energy policy. Under a direct subsidy regime, a wind or solar project would merit development if (a) sales of electricity to utilities or other unrelated customers, plus (b) the 1.0 cent/KwH subsidy from the Energy Department, exceeded the cost of debt and equity required to finance development. Nice and easy.

Instead of a direct subsidy, Congress enacted a complicated tax subsidy. Actually, a series of slightly different, complicated tax subsidies. For wind, Congress enacted a "production tax credit" or "PTC." For solar, Congress enacted an "investment tax credit" or "ITC." In addition, wind and solar property qualifies for accelerated tax depreciation. Suffice to say, a taxpayer must have positive income tax liability to use PTCs, ITCs and accelerated depreciation. (Unless extended, the PTC regime will expire on December 31, 2012, adding more complexity and uncertainty into the mix.)

Importantly, a taxpayer with positive tax liability cannot simply "purchase" tax credits. On the flip side, a developer without tax liability cannot "sell" tax credits or excess depreciation. Instead, taxpayers with cash and tax liability must invest cash (so-called "tax equity") into qualifying wind and solar projects.

In exchange for its financing commitment, a tax equity investor receives tax credits, accelerated depreciation and some cash until the project satisfies an agreed IRR "hurdle." After the IRR hurdle is satisfied, somewhere down the road, the tax equity or common equity/sponsor exercises a put or call to close the transaction. Under the put/call arrangement, the common equity/sponsor purchases the tax equity investor's position based on its residual value.

[3] And that's why the regime is laughably flawed. It is complex and impenetrable for most taxpayers and most tax advisors. Plus, the commitment of cash to a renewable energy development project is absolutely "non-core" to most corporate treasurers and CFOs. Meanwhile, administering the subsidy regime falls into the lap of the IRS. Why not administer energy subsidies through the Energy Department?

In practice, there are only 15-20 active participants in the tax equity market. The market is dominated by large national banks, some regional banks, and a few other taxpayers in the financial services business (GE; insurance companies).

Before the financial meltdown in 2008, tax equity yields ranged from 6-8% on an after-tax basis (10-12% on a pre-tax basis). Then the financial system flirted with Armageddon. All of a sudden, market facilitators (the banks and insurance companies and GE) began running tax losses. Without taxable income, facilitators didn't need tax credits, so the market effectively froze up. This didn't bode well for Team Obama's "green jobs agenda." So the administration's Congressional allies quietly created a program to bail out the developers. During 2010 and 2011, qualifying projects could elect to receive Treasury grants (so-called "1603 grants") in lieu of tax credits. The 1603 grant program permitted the industry to survive the turbulence of the Great Recession.

Time flies, and we're in 2012. The Treasury grant program has expired, and Congress recently declined to renew it. Renewable energy development again hinges on 15-20 banks and insurance companies. Because there is a massive supply/demand imbalance (more renewable energy developers than tax equity), tax equity yields have skyrocketed. Yields for reputable developers have jumped from the 6% range to the 12% range. Yields for marginal developers are in the 15-20% range.

[4] Now we come full circle. The tax equity market is dysfunctional, and would make an interesting study for an economics PhD dissertation. Plenty of corporate taxpayers outside the financial services business (think retail, domestic services) have (a) large U.S. tax bills, and (b) stockpiles of cash earning 1% or less in ultra-secure investments. But tax equity yields are running 12-20% after-tax.

As evidenced by Team Obama's pending meet-and-greet, many of those large corporate taxpayers are probably put off by the complexity of the tax subsidy regime. But many of them routinely invest in other tax credit schemes, including low-income housing tax credits. Team Obama loves to demonize big business and large corporate taxpayers. Can it persuade those "big bad corporations" to commit cash in support of Obama's "green jobs agenda"?

In the world of crony capitalism, anything can happen. It's always a good time when you're rolling in the Corporate 1%.

If You Talk the Talk...

On Wednesday, I examined a Monday post by James Maule. See The Tax and Spending Stalemate: Can It Destroy the Nation?, MauledAgain (Nov. 7, 2011).

Maule blamed Republicans for the legislative gridlock surrounding competing infrastructure proposals. The Democrats are pushing a $60 billion spending measure, "funded" by tax surcharges on "millionaires and billionaires." The Republicans are pushing a $40 billion spending measure, "funded" by unused outlays for other programs.

Maule was nominally venting about our crumbling infrastructure and jobs crisis. In substance, he was channeling the anxiety of the political left. If Maule were serious about infrastructure spending and economic stimulus, he would have lectured the Democrats for rejecting the $40 billion measure. A compromise starts with common ground. As between $60 billion and $40 billion in spending, $40 billion is the "common ground."

I'm sure that Maule is genuinely concerned about the current unemployment crisis. As such, I'm guessing that he'll be disturbed by a recent setback to energy infrastructure development.

On Thursday, Team Obama delayed the proposed Keystone XL oil pipeline until after the 2012 election.

The proposed Keystone XL Project (click here for map) consists of a 1,700-mile crude oil pipeline and related facilities that would primarily be used to transport [oil] from an oil supply hub in Alberta, Canada to delivery points in Oklahoma and Texas. The proposed Project would also be capable of transporting U.S. crude oil to those delivery points. The proposed project could transport up to 830,000 barrels per day and is estimated to cost $7 billion.

The announcement marked a sharp reversal by Team Obama. The State Department had previously supported the pipeline on national security grounds. Obviously, importing oil from Canada reduces our dependence on Middle Eastern oil imports. The $7 billion project would upgrade the nation's energy infrastructure; a Democratic priority until yesterday. It was expected to created tens of thousands of jobs during the midst of a national unemployment crisis. And it was funded with private capital, thus avoiding Congressional gridlock entirely.

Unfortunately, the end run around Congress ran into the brick wall of regulatory delay. Environmental activists were particularly hostile to the Keystone XL project, because the pipeline would transport oil from Canadian tar sands. (Never mind that Canada could route the oil from tar sands to the Pacific coast for export to Asia.) As noted by the LA Times, the decision exposes Team Obama "to the same criticism the White House has leveled at congressional Republicans regarding deficit reduction: delaying a tough call in hopes that the politics will be better after next November's election."

The building trade unions, whose members have been disproportionately hurt by the Great Recession, condemned the decision:

Terry O'Sullivan, general president of the Laborers' International Union of North America, said the move would "inflict a potentially fatal delay to a project that is not just a pipeline, but is a lifeline for thousands of desperate working men and women. The administration chose to support environmentalists over jobs—job-killers win, American workers lose."

Mr. O'Sullivan's comments are right on the mark. The political left talks the talk about infrastructure and jobs. But they don't walk the walk, as evidenced by the flip flop on the Keystone XL project. It boils down to a question of priorities. We're in the midst of a national unemployment crisis. Do we want a government that responds flexibly to balance environmental, labor and other considerations while fostering public and private infrastructure spending? Or do we want a government that prioritizes environmental or other regulatory considerations above infrastructure upgrades and job creation?

A cynic might take a hard look at the Keystone XL decision and allege that Team Obama is trying "to do everything they can to drag down this economy." But I'll leave that commentary to Harry Reid and left-wing academics.

Solar Trade War: Collision Ahead

Back in August, before the Solyndra news broke, I discussed the bankruptcy filings of two U.S. solar manufacturers.

As I remarked in the August post:

The price of solar panels has fallen dramatically as China ramps low-cost manufacturing. That's good news for U.S. energy consumers and the environment, because the cost differential between solar power and power generation from fossil fuels is narrowing. If the trend continues, solar power will become a competitive alternative energy source without government subsidies.

Yesterday, the New York Times reported that seven of the surviving U.S. solar manufacturers have filed an anti-dumping case against the Chinese solar industry. The case seeks tariffs of more than 100% on the wholesale price of solar panel imports from China. Obviously, such an action would increase the cost of solar power development projects (by increasing the cost of solar panels). Higher-cost solar power projects would translate into higher costs for U.S. energy consumers (because the cost of renewable energy is "passed through" by utilities to consumers). Moreover, higher-cost solar panels would slow the transition in our energy infrastructure away from fossil fuels.

The result is a collision of political, economic and environmental priorities.

The U.S. solar manufacturers and many politicians will argue that this is about jobs. We need a strong manufacturing base and we have the capacity to lead the development of renewable energy technologies in the coming decades. As a leader in development, we should be able to exploit our technological advances by manufacturing solar panels "at home." If China really is dumping panels below cost to gain market share, we should enact tariffs to "level the playing field" so that U.S. manufacturers can compete with Chinese manufacturers.

All fair points; one might quibble with the details, but the broad principles hang together.

From an economic perspective, however, we might be better off permitting China to dump its solar panels on us below cost. Sure, that might cost us U.S. manufacturing jobs. But China's dumping policies would effectively be subsidizing U.S. solar development projects. To some extent, then, we'd simply be shifting jobs between industrial activities. We'd need less individuals fabricating and assembling solar panels. We'd need more individuals working on construction projects and, upon completion, operations and maintenance of solar facilities.

Big picture, why shouldn't we permit China to subsidize our solar development projects? By subsidizing our solar development, China would be reducing costs to U.S. energy consumers. Our businesses would be more competitive (due to lower energy costs), and individual consumers would have more disposable income. Let's say that a Middle Eastern country decided to "dump" oil into the U.S. market, reducing U.S. oil production and decreasing the number of U.S. oil drilling jobs. Would we view that as a negative development? Would the U.S. support an anti-dumping case against the Middle Eastern country to save American jobs? Or would the U.S. take the Middle Eastern energy subsidy and run with it?

Finally, how does the environment fit into this picture? Solar power is unequivocally "cleaner" than power generated from fossil fuels. Should environmental considerations "tip the balance" in a situation where economic and political objectives do not align? In this case, for example, does the threat of global warming and environmental catastrophe outweigh concerns about a few hundred (or few thousand) U.S. manufacturing jobs? Should we make the transition to a cleaner power generation footprint the highest priority? For politicians on the left and right, time to pick your poison. Which is the higher priority: protecting U.S. jobs; economic growth; or environmental protection?

Energy Tax Subsidies for "Fat Cats" (Part Four)

My fourth and final post on the U.S. energy sector. I'm finally getting around to the topic that motivated this series of posts: U.S. tax subsidies to encourage the development of renewable energy.

In my last post, I described a hypothetical wind farm development in Iowa. Wind and solar are currently "non-economic" without some type of government subsidization. In other words, the returns to an investor in a renewable energy project do not justify the risk associated with the investment.

In typical fashion, Congress decided to "solve" the economic obstacles to renewable energy development through the tax code. Investors in qualified renewable energy projects are entitled to two types of tax subsidies. The first type of tax subsidy involves tax credits linked to electricity generation by qualified facilities (wind farms, solar projects, etc.). The second type of tax subsidy involves accelerated tax depreciation for equipment deployed in qualified facilities.

As I described in my last post, the tax subsidies may convert an otherwise non-economic project into a project that will attract private financing.

In a logical world, we would assume that Congress would want to maximize the amount of private capital that would flow into renewable energy projects. After all, new renewable energy facilities require construction activities before COD (jobs), and operations/maintenance activities after COD (jobs) (jobs, jobs, jobs). In fact, there would be a sort-of multiplier effect; we would need to upgrade the nation's outdated transmission "grid" to accommodate more wind and solar power. Moreover, renewable energy provides obvious benefits by reducing pollution, improving air quality, etc.

Unfortunately, Congress isn't subject to the constraints of a logical world. Instead of providing broad eligibility to use credits (and depreciation) against taxable income, Congress effectively limited participation to corporate taxpayers. By limiting participation to corporate taxpayers, Congress kept individual investors (taxpayers) out of the market. This decision may have been predicated on a political judgment that uber-wealthy individuals would create "blowback" by using energy tax subsidies to shelter income. However, it starved the renewable energy developers of one source of capital following the 2007 financial meltdown (as discussed below).

Let's get back to my Iowa wind-farm development. Our developer friend needs $100 million, for a project that is not economic unless the developer can "monetize" the tax subsidies available to the project. The developer cannot reach out to individuals; only corporations can use the tax subsidies in practice. Which corporations are providing "tax equity" to these projects?

There are currently 15 tax equity investors active in renewable energy development. The list is a "who's who" of TARP recipients. Bank of America, JP Morgan, GE Capital, Citi, Wells Fargo, Northern Trust. In addition, at least one insurance company is participating in the sector (MetLife). The only non-financial institution on the list is Google, which has recently entered the sector with a couple high-profile investments.

As you can see, most "tax equity" for renewable energy is provided by financial institutions (banks and, to a lesser extent, insurance companies). Financial institutions are logical participants in the sector. They generate steady taxable income from U.S. sources, and thus can offset U.S. tax liabilities with tax subsidies from renewable energy projects. They are also in the business of underwriting loans to borrowers, i.e., evaluating the quality of a borrower's income stream in determining whether to advance cash to the borrower.

Unfortunately, Congress built the tax subsidies for renewable energy with Wall Street in mind. During the "boom boom" years of the real estate bubble, financial institutions were flush with profits and taxable income, and they surged into the renewable development space. The surge of capital pushed down the cost of "tax equity" into a range of 6-7%, promoting development. As we all know, the real estate bubble burst with devastating consequences on the economy at large, and concentrated pain within the banking sector. Financial institutions updated their business models to reflect lower profits and lower taxable income (or tax losses). The surge of capital into the renewable energy sector became a trickle and then a drought. Under current market conditions, the cost of "tax equity" has climbed into a range of 10-15% (depending on type of project, among other things).

I keep expecting other corporate taxpayers to join the party. In fact, the reluctance of non-financial institutions to commit "tax equity" to renewable energy projects leaves me scratching my head. (Again, the mad geniuses at Google are a notable exception.) I understand that industrial and technology and service-oriented businesses do not have the same underwriting experience as the large banks. However, many of these companies have large cash stockpiles, and "tax equity" investors are seeing pre-tax returns of 20-25%. Industry sources tell me that, notwithstanding the economics, CFOs get hung up on the fact that "tax equity" investments are non-core activities.

Why has Google decided to be a trailblazer, where others dare not tread? I don't have a good theory. I'm surprised that other large corporate taxpayers are not taking advantage of the rich "tax equity" yields to invest in the space. I'm guessing that the marketing advantages for "going green and socially responsible" would tend to outweigh the benefit of the tax subsidies.

So where does that leave our wind farm developer? Maybe Google will be interested; more likely, the developer will join the line of developers seeking capital from the TARP recipients.

Where does that leave us as electricity consumers (ratepayers)? No surprise here. The cost of renewable energy development has increased, and utilities pass through costs to consumers. We'll be paying higher electricity costs as utilities source more electricity from (higher cost) renewable facilities. Unless other corporate taxpayers start participating in the "tax equity" market, electricity consumers (ratepayers) and taxpayers will pitch in to repair the balance sheets of the financial institutions participating in the market. But you probably won't see this story in the New York Times.

Energy Subsidies for "Fat Cats" (Part Three)

My third post on the U.S. renewable energy sector. I'm finally getting to the tax policy angle, where the "fat cats" on Wall Street are enjoying the good times, again. [I originally intended to finish this off in three posts. I realized that it will take four.]

As I described in my last post, "traditional" power plants burn coal and natural gas to satisfy most of our electricity demand. In the past decade, policymakers have begun pushing the development of "renewable" energy resources (primarily wind and solar) through a carrot and stick approach. The "carrot" involves tax subsidies for the development of wind and solar generation facilities. The "stick" involves a government mandate, often labelled a renewable portfolio standard ("RPS"), that requires utilities to source a fraction of their electricity from renewables. In the U.S., various states have enacted RPSs with various degrees of "teeth," but there is no national standard.

I'm focusing on the "carrot," but a quick observation on the "stick." Regulated utilities pass along costs to their customers. If a utility pays higher costs to source higher-cost "renewable" energy, then utility ratepayers (me, you, your kids, your grandma, your landlord, your employer, your local mall) will see the increased costs on their electric bills. Ultimately, higher utility costs are borne by individuals, directly or indirectly. Public Utility Commissions ("PUCs") exist to "protect" ratepayers from higher costs. Because renewable energy is still higher cost than energy from fossil fuels, PUCs will serve as a natural "check" on demand for renewables.

Back to the "carrot." Congress has enacted a set of tax subsidies to encourage renewable energy development. If you've done any interstate driving lately, you've probably seen "wind farms" (clusters of wind turbines on towers) popping up like dandelions. Those wind farms, and solar generation facilities currently under development, could not get off the ground without tax subsidies.

So why can't renewable energy developers get their projects into commercial operation without tax subsidies? Because an investment in renewables is non-economic under current market conditions. By non-economic, I mean that an unsubsidized renewable energy project would have negative risk-adjusted returns to its investors. For example, assume a wind farm or solar generation facility costs $10 million to develop. Based on current technology costs, financing costs and electricity rates, the investment might only yield a 2% average return over its operating life. But an investor can get a risk-free 3% return by investing in 30-year Treasuries. No rational investor would invest $10 million in a highly risky start-up venture (a wind farm or solar generation facility) with lower expected returns (2%) than a risk-free return (3%). [Note that 2% is a hypothetical number for easy discussion purposes.]

As I discussed in my last post, policymakers could tackle this issue using one of two approaches. The first approach would involve an across-the-board increase in electricity rates. For example, Congress could impose a carbon tax, which would increase utility costs for coal and natural gas. This would increase rates for electricity from traditional power plants (because the cost of coal and natural gas are passed through to electricity consumers). In turn, utilities could pay higher rates for renewable energy without causing "green rate shock" to electricity consumers.

Congress has rejected this approach for political reasons (higher electricity rates are politically unpopular; and higher costs for coal will decrease investment and union jobs in the coal mining industry). Instead, Congress has enacted tax subsidies for renewable energy development. The tax subsidies, when added to prevailing electricity rates, are sufficient to motivate investors to allocate capital to renewable energy projects.

The tax subsidies historically included tax credits and accelerated depreciation. This is where things get tricky and interesting. I've been talking about "tax subsidies" very loosely. Let's get into the anatomy of a deal.

So how do developers make these deals work?

Let's say you are a wind developer. You have identified a strip of windy farmland in Iowa, and you want to lease the land and install a series of towers and wind turbines. Of course, the farmer in question probably doesn't need much electricity; you'll need some infrastructure (converters and transmission cables) to connect your generation facility to the regional "grid" and transmit the electrons to Des Moines or Omaha. On the cost side of the ledger, you have (i) cost of land, (ii) cost of equipment (wind turbines, converters, hardware and integrated software), (iii) cost of infrastructure (towers, transmission), (iv) cost of financing, and (v) "soft costs" (attorneys, engineers, consultants and accountants necessary to get permits, conduct environmental studies, project wind patterns, draft leases, arrange financing, and pay the bills). Let's assume the total cost, from the planning phase to commercial operation, is $100 million.

How about revenues?

You've identified a Midwestern utility that is willing to sign a long-term power purchase agreement ("PPA") and pay slightly above-market prices for the electricity from your windfarm. They'll take all the electricity you can generate, but the amount of electricity generated depends on the technology (the efficiency of the wind turbine) and the wind itself. If the wind blows more than expected, the project will generate more electricity, more revenue and more earnings for its owners. If the wind blows less than expected, the project will generate less electricity, less revenue and less earnings for its owners. Ultimately, you know that you'll have a revenue stream from the project, but you can't predict the operating cash flows with precision (because they depend on wind flows).

To recap: you need $100 million to get your project past its commercial operation date ("COD"). You have a long-term PPA, which is expected to generate sufficient revenues over time to generate an average 5% cash yield on the project. (For example, the owner will receive $5 million in net cash from the project annually, measured in today's dollars.) That yield may be higher, or it may be lower, depending on how much the wind blows after COD.

Where do you get the $100 million?

You probably don't have that cash lying under your mattress. You can't borrow from a bank, because a bank is not comfortable with your credit profile (a developer with no assets). You need equity from somewhere. But as noted, the cash yield on your risky new wind farm (5%) is not attractive relative to a risk-free yield (3%).

Our developer friend needs a dose of "tax equity." Remember, Congress has chosen to subsidize renewable energy development through tax credits and accelerated depreciation. As a developer, you don't have sufficient taxable income to absorb the tax credits and depreciation from the project. However, plenty of large corporate taxpayers have U.S. taxable income, i.e., "tax appetite" that would permit them to reduce their own tax liabilities by tax credits and depreciation from the project. Some of these large corporate taxpayers are even willing to participate in the renewable energy space, despite the risks. Never fear, "tax equity" may be here!

Why is "tax equity" willing to participate in a deal that a "normal" investor would not touch?

A normal investor may not be interested in a risky start-up business that yields 2% more than a risk-free return. However, a "tax equity" investor can use the credits and depreciation from the project to offset taxes that it would otherwise pay to federal and state tax authorities. The decrease in cash-tax liability is economically equivalent to an increase in operating cash flow. For example, if the project generates $5 million in tax credits and $20 million in depreciation expense in Year 1, the effective yield for that year would be 18% ($5 million operating cash flow, plus $5 million in tax credits that save $5 million in taxes, plus $8 million in tax savings from depreciation expense ($20 million times 40% assumed tax rate)).

Who is actually participating as "tax equity" in renewable energy deals?

Stay tuned for my next post.

Energy Subsidies for "Fat Cats" (Part Two)

This is the second of four posts discussing the tax subsidies for renewable energy development that have been captured by large financial institutions (and Google!).

A quick overview of the energy sector, from “traditional” electricity generation to renewables:

We are a nation of gadget junkies, and our appliances, computers, TVs, cell phones, pads, pods and more essential infrastructure needs (subways, hospitals, refrigerators) are powered by electricity. We satisfy most of that electricity demand with supply from “traditional” electrical generation facilities. Traditional power plants mainly run on fossil fuels -- coal and natural gas -- which are abundant and cheap. Unfortunately, burning coal results in a parade of horribles (smog, soot, acid rain, air toxins, and greenhouse gas emissions). Natural gas is cleaner, but still a greenhouse gas. Finally, nuclear energy, although a “clean” alternative to fossil fuels, has always been controversial (and even more so following the tsunami in Japan).

Unlike fossil fuels, which are abundant in the United States but ultimately finite, “alternative” sources of energy are renewable. Our primary sources of “renewable” energy include hydro, solar, wind and biomass. Hydroelectric power is relatively cheap, but derived from rivers and dams, which limits generation capacity. Sunlight and wind are free and abundant in some places, but the technology required to convert sunlight and wind into electricity is expensive. Biomass generation technology is cheaper than solar/wind, but utility-scale development is limited to areas where the underlying fuel supply is abundant.

The policy dilemma is to formulate a coherent energy policy that balances the costs and benefits of “traditional” energy (coal, natural gas and nuclear), with the costs and benefits of “renewable” energy (primarily solar and wind). Throw politics into the mix, and it’s easier said than done. However, most everyone can agree that the cost of energy has a huge impact on our individual and collective standard of living. It has an equally dramatic impact on the competitiveness of U.S. manufacturers and exporters.

Thus, low-cost energy is better than high-cost energy. Although a simple concept, execution is tricky, because it is not always clear how to define the “cost” of electricity generation.

Using current technology, coal and natural gas are the cheapest sources of energy for electrical generation. They are both abundant natural resources with high energy content relative to cost of extraction, and they can both be used to provide “baseload” power without the “intermittency” problems of wind and solar power. A recent EIA report estimated the average cost of new conventional coal generation at 9.5 cents/kWh; conventional (combined cycle) natural gas at 6.6 cents/kWh; advanced nuclear at 11.4 cents/kWh; wind at 9.7 cents/kWh; solar photovoltaic at 21.1 cents/kWh; biomass at 11.3 cents/kWh; and hydro at 8.6 cents/kWh.

Unfortunately, burning coal and natural gas has negative side-effects (air pollution, smog, acid rain, greenhouse gas emissions, etc). These negative side-effects are not reflected in the price of the underlying commodities. Economists refer to these hidden costs (negative side-effects) as “externalities.” Basically, an externality is a negative consequence of economic activity that is not included in the price for that activity. If the “externality” were included in the price of the economic activity (“internalized”), the cost of the activity would increase, decreasing the amount of the activity.

Back to the energy sector. Although coal and natural gas are the cheapest sources of energy for electrical generation, they are “artificially” cheap. The cost of producing energy from coal and natural gas does not reflect the negative side-effects (the “externalities”). If those costs were “internalized” into the cost of the commodities, renewable energy generation would become more competitive relative to traditional fossil fuels. (Based on our existing “electrical grid” infrastructure, renewable energy also presents an “intermittency” problem. For example, the wind tends to blow more at night, when electricity demand is lower than “peak” business hours. This “intermittency” problem is an externality associated with renewable energy.)

Policymakers could “internalize” the costs of fossil fuels by imposing a tax on coal and natural gas (a “carbon” tax). However, a carbon tax would increase energy costs for residential and industrial consumers (the cost of fuel used to generate electricity would increase). Moreover, it would be impossible to ensure that the proceeds of a carbon tax would be used to defray the societal costs of traditional energy generation. Liberal politicians that advocate for such a tax would be tempted to direct the tax revenues to the liberal policy objective du jour.

In any case, it appears unlikely that Congress will enact a carbon tax while I am still alive to consume electricity. Instead, Congress has tackled the energy-cost differential from the opposite direction. Rather than increasing the cost of fossil fuels, Congress has attempted to decrease the cost of renewable energy through government subsidies. Among other subsidies, Congress has attempted to stimulate renewable energy development through tax subsidies.

In my third post on this topic, I’ll discuss the anatomy of a renewable energy deal. In my fourth post, I'll move to the tax policy angle. As foreshadowed in my first post, the tax subsidies for renewable energy development have primarily flowed to large financial institutions. Perversely, the consequence has been less renewable energy development, at a higher cost, imposing a secondary level of costs on energy consumers. So taxpayers are stuck with higher taxes, energy consumers (for the most part taxpayers) are paying higher costs for energy, while large financial institutions (and Google!) are extracting tax subsidies as intermediaries. The entire fiasco could only have been devised by our political "leaders" in Washington D.C.

Energy Subsidies for "Fat Cats" (Part One)

Among the many failures of the political class, our disjointed, haphazard and inefficient “energy policy” goes high on the list. I hesitate to use the phrase “energy policy,” because there seems to be no concerted effort to steer the U.S. energy sector in a coherent direction (“policy” is non-existent). Decisions about energy policy are dominated by short-term calculations of politicians who are primarily motivated by the next re-election campaign.

The policy mess reflects the influence of bizarre alliances. On the one hand, liberal politicians grandstand publicly about the perils of “climate change” (pandering to environmentalists), while protecting the coal industry against cleaner forms of energy (pandering to unions). On the other hand, conservative politicians trumpet the virtues of smaller government and free markets, while protecting irrational energy subsidies for local constituents (pandering to corporate welfare recipients).

A good example is the one-two punch of import duties on foreign-produced ethanol, and tax credits for U.S.-produced ethanol (see here). Do we want lower-cost ethanol and more ethanol consumption (arguably good for the environment but bad for U.S. farmers)? Or do we want higher-cost ethanol and less ethanol consumption (arguably bad for the environment but good for U.S. farmers)?

Meanwhile, President Obama has fostered a perception that he can ride around on unicorn shooting “green jobs” out of his orifices. (You pick the orifice; credit to Paul Begala for the imagery.) In truth, renewable energy development has slowed dramatically in the past two years. President Obama’s “green jobs” economy is a pipe dream. And, ironically, the “fat cats” on Wall Street are the primary beneficiaries of tax policy intended to subsidize the development of renewable energy production.

This will be a four-part blog post. In part two, I’ll provide a layman’s overview of the energy sector, from “traditional” fossil fuels to alternative energy sources. In part three, I’ll explain the anatomy of a deal. In part four, I'll describe why the “fat cats” on Wall Street are receiving a tax windfall to finance renewable energy development.

What do you get when incoherent energy policy meets bad tax policy? Energy (tax) subsidies for "fat cats." More to come.

Solar Fizzles; Green Jobs "Pipe Dream"

This week, I'm going to focus on the U.S. energy sector. I'll be discussing the landscape broadly, and then specifically discussing the tax policies intended to subsidize the development of renewable energy.

Before I get into the tax policy angle, a couple recent developments:

[1] Governments Lose Bets on Solar Manufacturing

Two U.S. solar manufacturers have recently filed for bankruptcy (Evergreen Solar and Intel spin-off SpectraWatt). The price of solar panels has fallen dramatically as China ramps low-cost manufacturing. That's good news for U.S. energy consumers and the environment, because the cost differential between solar power and power generation from fossil fuels is narrowing. If the trend continues, solar power will become a competitive alternative energy source without government subsidies.

However, the good news for consumers and the environment is bad news for U.S. solar manufacturers and their stakeholders (investors, employees, government benefactors). Despite federal and state subsidies directed at the solar industry, the cost of manufacturing in the United States far exceeds the cost of manufacturing in China and other emerging markets. Evergreen Solar made a losing bet on the wrong technology. SpectraWatt crumbled under market pricing conditions. Industry analysts predict more consolidation in the industry (i.e., more bankruptcies for U.S. and foreign manufacturers).

Along with investors and employees, taxpayers joined in the pain from the bankruptcy filings. Massachusetts directed $21 million in cash grants to Evergreen (along with tax incentives that are now moot). SpectraWatt's bankruptcy filing reported $6 million in "state economic inducements" as assets.

Talk about skewed incentives. Our politicians get to "bet" on business deals with other people's money. If the "bet" is successful, the politician takes the credit. If the "bet" is a bust, the politician blames China and suffers no consequences (because he or she has no skin in the game). Unlike a private enterprise, the "investment" process is so opaque that it's difficult to identify anyone to hold accountable.

[2] Green Jobs "Pipe Dream"

The collapse of the U.S. solar manufacturing industry is the latest bad news for advocates of a transformative "green" economy. On August 18, the New York Times published an interesting article discussing the dismal growth in the "green jobs" sector. (The article focused on the San Francisco Bay Area and California with some general observations about the sector nationally.)

In a development that will take few of us by surprise:

[T]he green economy is not proving to be the job-creation engine that many politicians envisioned. President Obama once pledged to create five million green jobs over 10 years. Gov. Jerry Brown promised 500,000 clean-technology jobs statewide by the end of the decade. But the results so far suggest such numbers are a pipe dream.... A study released in July by the non-partisan Brookings Institution found clean-technology jobs accounted for just 2 percent of employment nationwide [2.7 million jobs].

I suppose that we get the politicians that we deserve. If voters took these types of "pledges" at face value, they were bound to be disappointed. I have no problem with either politician's attempt to set "lofty" aspirations. However, at some point, a "lofty" aspiration starts to resemble the empty promise of a snake oil salesman. Let's see if anyone in the next election cycle tries to hold President Obama accountable for overpromising and underdelivering on his green jobs "pipe dream."

[3] Your Bus Driver Has A "Green Job"

One note on methodology. I skimmed the Brookings Institution report; the allocation of "green jobs" among industries is surprising. The largest two categories of "green jobs" are Waste Management/Treatment (386,000 jobs) and Public Mass Transit (351,000 jobs), followed by Energy-Saving Building Materials (162,000 jobs), Regulation and Compliance (142,000 jobs), Professional Environmental Services (141,000 jobs), Organic Food/Farming (130,000 jobs), and Recyling/Refuse (129,000 jobs).

I'm sure that many of the individuals working in these industries would be surprised that their position qualifies as a "green job." I understand the methodology, but most of these job "categories" have existed for decades -- long before politicians became obsessed with "sustainability." When you start looking at the numbers, it makes you wonder how President Obama kept a straight face when he pledged to create five million new green jobs over the next decade.