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The Renewable Electron Economy XII: The “Cheap Energy Contract”…Bedrock or Dinosaur? January 14, 2008

Posted by Michael Hoexter in Energy Policy, Green Marketing, Renewable Energy, Sustainable Thinking.
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Other than functional differences between renewable and fossil fuel generators, one of the main issues related to green and renewable energy are the capital and the per unit energy costs of new, cleaner energy systems. While the prices of oil and natural gas will certainly go up, the comparison with more plentiful coal remains the most challenging. The target or acceptable price for market entry of clean energy is a subject of heated debate among people who agree that we should move to renewable energy. Clean energy debates mirror most discussions of energy in this regard, as the decisive argument for the commercial value of an energy source is in most contexts its cost per unit energy to the buyer.

At the OpenEco camp/un-conference last week in San Francisco sponsored by Sun Microsystems, activists in the area of sustainability came together to brainstorm, discuss and network around a number of issues. One of the topics that came up frequently in different contexts was the target price or acceptable cost for energy, though there were other worthy topics discussed in parallel at this generally excellent multi-focus un-conference.

Among those presenting, Ted Nordhaus and Michael Shellenberger, the authors of the new, fairly controversial book BreakThrough, covered a range of topics, one being that government and technology companies should be working together to make clean energy cheap. In other contexts, the price of energy came up again in a discussion about whether the new cap and dividend idea (distributing the proceeds of selling carbon credits as dividends to people to offset the impact of energy costs) works. In still other sessions, the issues of subsidies for energy were discussed as both a political and an economic issue.

These discussions have resonated with concerns that I have had about whether we are pricing energy correctly given our very legitimate interest in switching from polluting to non-polluting forms of energy production. Can the United States and other industrialized nations, afford a new energy infrastructure if we continue to value energy at the price levels we are used to? For a long time, particularly since WWII, we in the US have been operating under a society-wide “Cheap Energy Contract.”

What is the “Cheap Energy Contract”?

The Cheap Energy Contract is an unwritten multilateral contract between the governments, citizens, and energy companies in industrial countries, but is in particular force in the United States. What the Cheap Energy Contract says in approximation is:

1) Government, Consumers, and Energy Producers are parties to this Contract

2) Energy costs for consumers and industry must be negligible for all but the most energy-intensive industries (think aluminum or logistics).

3) Per unit energy costs must be low enough to allow temporarily doubled or tripled rates of energy use not to “bust the bank”.

4) Real or artificial energy shortages are unacceptable

5) Government is ultimately responsible for guaranteeing that energy is cheap and available; elected officials risk being voted out of office if energy prices rise substantially or energy availability is reduced either through government action or independent of government action.

6) Depending on which political ideology vis-à-vis regulation is currently dominant, government subsidy of energy may need to be hidden in indirect forms.

7) Dominant players in energy markets sacrifice some freedom to set prices for political influence and subsidies: oil companies have more pricing power though more competition than electricity retailers who are regulated by public utilities commissions.

It is surprising how durable and pervasive the Cheap Energy Contract is, even though no one has written it down, nor is there an official enforcement procedure. Though the word “entitlement” is usually used to describe official government sponsored programs, cheap energy is generally considered to be an entitlement by American consumers and American businesses.

The founders of the oil business realized that their business depended upon scaling up rapidly and defeating whale oil and other competitors in the marketplace. In addition to canny business calculation, John D. Rockefeller believed he had a mission of bringing cheap illumination via kerosene to the masses by keeping prices low and pushing competitors out of the business. Recognizing the political sensitivity of electricity’s natural monopoly, the founders of the electricity business, in particular Samuel Insull, tried to pre-empt anti-trust actions by transparently negotiating the cost of electricity with public officials and keeping it low. To reach economies of scale in both businesses required mass acceptance and therefore low prices. Maintaining the low prices and supply of these energy sources however was sometimes beyond the power of private corporations, which led to more active involvement of the US government.

The Cheap Energy Contract is one of the “third-rails” of American politics: if you touch it, you risk (political) “death”. While the price of electricity has been heavily regulated, the price of oil is more variable and also potentially more capable of inflicting economic pain on consumers. Observations of the outcomes of Presidential elections in the last 40 years indicate that one-term Presidents Ford, Carter, Bush Sr., lost their re-election bids during a time of higher oil prices. Political manipulation of oil prices to win or lose elections through direct or indirect means is one topic of conspiratorial theories that may or may not have a basis in reality.

Carbon Pricing and the Cheap Energy Contract

As both buyers and sellers of energy were happy with the Cheap Energy Contract in an era of abundant fossil fuels and government was happy that they were happy, there has historically been little opposition to the Contract. The first full-scale assault on the Cheap Energy Contract has come recently as concern over global warming has led to first environmental leaders then broader sectors of our society questioning the wisdom of using fossil fuels to power our civilization. Most concerned politicians and activists now agree that assigning some price on carbon emissions and therefore on energy consumption may slow the consumption of fossil energy and support the development of greener, largely renewable energy.

Carbon pricing therefore threatens to break the Cheap Energy Contract and this has ignited a firestorm of controversy from energy producers, energy-intensive businesses, as well as elements of government that see the maintenance of the Contract as their fundamental duty or in their own political self-interest. While most proposals currently being aired are on the side of modest or low prices for carbon ($20-$30/tonne), the institution of mechanisms for pricing carbon set up a means by which future increases might seriously boost the price of energy. Even in countries where the Kyoto protocol is in force, the effect of the cap-and-trade system has not significantly affected the price of energy due to mistakes made in administering the system in its first iteration.

While one can expect political resistance from the energy industry and mass consumers of energy, the Cheap Energy Contract has shown its durability even among those concerned about the planet’s future. Google’s recent announcement of RE<C takes as its target a price of electricity equivalent to that of depreciated coal plants or at least a price that would compete in China or India with coal. Shellenberger and Nordhaus advocate government subsidies for clean energy research and development until it is “cheap”. In this they are following the early pricing strategy of John D. Rockefeller in requiring that the new energy be as cheaper or cheaper than the old energy (though Rockefeller was always concerned that pricing would dip below his costs “drowning” his enterprise). While it is not clear that these supporters of clean energy are opposed to carbon pricing, there is clearly a different focus than those who see a carbon price as the entering wedge in pushing out fossil fuels. While it might be argued that those who seek to promote research and development into cheaper clean energy and those who seek to raise the price of dirty energy can work together, there is implicitly and explicitly a disagreement about the future of the Cheap Energy Contract and therefore what will be an acceptable price for clean energy.

Post-Carbon Pricing Rebate Systems

It is conceivable that carbon pricing can be instituted that raises energy prices for those who can afford it and compensates more economically vulnerable individuals and sectors for the increased prices at least on a national level. One such idea, cap and dividend, has been put forward by UMass Amherst’s James K. Boyce and Matthew Riddle, a plan that suggests distributing the proceeds of carbon permit auctions to the population in payments that will lessen the impact of increased energy prices especially on those who use less energy. One can imagine other systems of attempting adjustments in which exceptions can and will be made in various forms for vulnerable industries, critical sectors and the poorest. On the other hand, to make an exception of whole nations such as China in a carbon pricing system would seem to defeat a good portion of the intention of that system.

Fuel Taxes and the Cheap Energy Contract

In certain areas of the world, particularly Europe and Japan, the Cheap Energy Contract has never been in force to the degree that it has been in the United States and Canada. While the American and Canadian industrial economies grew in an environment of cheap, domestically produced energy, Europe and Japan have had to fight and bargain more for fossil energy sources, in particular oil, from the beginning. Compact settlement patterns have also enabled greater use of public transportation in Europe and Japan, so automobile use can be viewed as a luxury in those countries.

Fuel taxes while they exist in the US and Canada, have been for many years much higher in Europe and Japan leading to pump prices for the same petroleum products to be almost twice as expensive as they are in the US and Canada. Along with market factors that boost the price of energy, Japanese and European consumers and citizens have never shown the sensitivity to energy pricing that Americans have. Additionally the Europeans and Japanese have accepted taxation as an instrument to fund government services more readily than Americans have in the last 3 decades. Thus it is difficult to assert that a Cheap Energy Contract now exists in those countries, though there are clearly political and economic upper bounds to the pricing of energy set at higher levels per unit energy than in North America.

Clean Energy Incentives and the Cheap Energy Contract

While taxes function as a disincentive, many countries with aggressive goals for renewable energy have now adopted premium price controls for renewably generated electricity. Advanced feed in tariffs or premium payments for renewable energy, were introduced in Germany in 1992 and have since been adopted in other European countries, Ontario, and are under consideration in several US states. Not a tax or a source of revenue for government but a pay for performance premium, an advanced feed-in tariff for electricity sets a menu of higher prices per kWh for different renewable technologies that decrease gradually over the years to encourage innovation and efficiency. As the price of electricity is already regulated, feed-in tariffs are folded into existing regulatory structures for energy. Retail customers pay slightly more for their electricity, as the electric utility is charging them for a mixed bundle of electricity generated from conventional and renewable sources. When the pricing of these tariffs is set accordingly, investment in renewable energy becomes a solid long-term investment for individuals and energy investors, as a favorable return on investment can be projected for 20 years into the future. Though utilities may have concerns that they will be left holding the bag with regard to paying higher prices for clean energy and then not being able to pass the cost on to ratepayers, these laws allow all related increases in cost to be passed on to the consumer.

An advanced feed-in tariff arrangement is then a new Energy Contract that expresses that consumers are to pay more for clean energy to support its growth. Though this new form of agreement originated in countries where low energy prices have not been viewed as an entitlement, they may yet be applied in the US and Canada on a broader scale. Feed-in tariffs are not taxes but price controls so may be more politically palatable in the US but they are a departure from the Cheap Energy Contract. They also have the advantage of stimulating supply and demand simultaneously and therefore jobs and investment in the area of renewable energy.

Government Subsidy and Energy Pricing

Though the image of the oilman is that of a rugged individualist, the energy business is a business where some form of help from the government has become an historical norm. The recent defeat of the attempt to switch subsidies away from the fossil fuels to renewable energy in the Energy bill of 2007, lead to a net loss of support for renewable energy. Among the negative consequences that the oil industry’s lobby group the American Petroleum Institute raised was the potential for shortages of oil if subsidies did not continue.

It makes sense that as the government is on the hook for keeping energy prices low and cheap energy available, that energy subsidies would be part of the game. Furthermore, finding and protecting energy resources, in particular oil and gas fields, is a risky business that would ordinarily lead to unacceptably high fuel prices if the government did not cover many of the externalities.

While many politicians have been pursuing or holding up a “free” market, libertarian style ideal of autonomous market functioning, the reality of energy markets and the Cheap Energy Contract leads to a state of consistent energy subsidy to keep energy prices at politically acceptable levels. An open recognition of the costs of energy both those currently recognized and unaccounted-for environmental costs, might allow political debates about direct and indirect energy subsidies to be carried out in a more transparent way. Furthermore a recognition that paying those costs will ultimately come through some form of taxes or through the price of energy may allow the public to consider what kind of subsidy it prefers at this point in time.

The Cheap Energy Contract and the Built Environment

As noted above, America’s physical infrastructure in the 20th Century was designed upon the basis of the Cheap Energy Contract, something that Peak Oilers have been pointing out for some time. Urban and suburban sprawl as well as widely dispersed settlement in rural areas is based on cheap energy. Likewise, cheap energy subsidizes the long distances between production and consumption of goods as well as a particularly widely dispersed distribution network for those goods. While Peak Oilers predict the collapse of this way of life as petroleum gets scarcer, it is not clear what efficiency measures and clean and/or “alternative” energy solutions might help to ease the transition to an oil-independent way of life. When these solutions may emerge, what their political and market appeal would be, and at what price, remains to be determined.

The Cheap Energy Contract and Energy “Addiction”

The above suggests that Americans and Canadians in particular are compelled to demand cheap energy, in particular cheap transport fuels, or face the possible collapse of many sectors of the economy and population shrinkage. Uncharacteristically for a former oilman, President Bush declared that America is “Addicted to Oil” in his State of the Union address of 2 years ago. The addiction metaphor has been overused to describe a whole variety of social and psychological ills but it may very well be appropriate in relationship to cheap fossil energy. Unlike various mood-altering substances, the elements of individual choice and behavior are not as decisive as society-wide trends and decisions that can change our economy and way of life. On the other hand, the addiction metaphor might help individuals to be able to see how energy use supports their lifestyle and thus make more intelligent decisions about lifestyle based on the realization that our historical patterns of living are overdependent upon unsustainable fuels.

The Cheap Energy Contract: Pro and Con

There are intelligent people of good will on both sides of this sometimes stealth and sometimes open debate about what is an acceptable price for clean energy. It makes sense then to outline what are the factors that speak for and against accepting the energy pricing status quo and what speaks for and against breaking the Cheap Energy Contract.

Continuing with the Cheap Energy Contract

Pro

  • “Guaranteed” cheap energy enables energy-dependent economic and social activity
  • “Guaranteed” cheap energy maintains the current infrastructure in the US and Canada
  • Cheap energy keeps energy markets accessible to most economic players, discourages formation of a segmented energy market.
  • Clean cheap energy would be affordable for developing countries
  • Clean cheap energy may address traditional objections to it in the current market
  • Cheap energy maintains an abundant food supply and low food prices
  • Cheap energy pricing encourages economies of scale, technological development in the area of cost-reduction, and/or business efficiency in the energy business
  • The Cheap Energy Contract attunes government and energy producers to the economic needs of energy consumers.

Con

  • Cheap “dirty” energy does not price in environmental costs including carbon emissions
  • In the case of oil, the Cheap Energy Contract will be broken or become prohibitively expensive by geophysical realities and rising worldwide demand.
  • A Cheap Energy Contract encourages an attitude of entitlement among consumers and businesses as consumers.
  • A Cheap Energy Contract may discourage investment in more expensive but promising clean energy sources.
  • A Cheap Energy Contract may require high levels of government subsidy
  • Cheap Energy Contract in combination with a lack of government transparency risks corruption or influence of government officials by energy interests in favor of subsidies.
  • The Cheap Energy Contract excludes most clean sources of energy that are as of early 2008 not “cheap”
  • Cheap energy does not encourage consumer energy efficiency
  • Cheap energy maintains the current infrastructure in the US and Canada (which may encourage social fragmentation and discourage community)

Breaking the Cheap Energy Contract

Pro

  • Opens the possibility to price in environmental externalities including greenhouse gas effects
  • May reduce pollution and greenhouse gas emissions
  • Will tend to encourage an attitude of responsibility in energy consumers toward energy use
  • Will encourage investment in energy efficiency
  • Will increase the likelihood that energy investors can recover and profit from their investment in new clean energy infrastructure
  • Allows pricing for cleanly produced energy to be adjusted to more closely reflect its current 2008 costs.
  • May open the discussion to whether energy production can be autonomous from government subsidy.
  • May open the discussion as to which mechanism of paying for energy is most efficient: pure pricing (price controls plus market), taxation (subsidy) plus price mechanisms, etc.
  • May encourage transparency in government energy policy

Con

  • Certain implementations may have negative economic effects on low-income high energy users and industrial sectors without rebate mechanisms or other allowances.
  • May encourage inefficiency in energy production if pricing signals are too favorable to waste and complacency
  • New clean energy technologies may remain in their first generations unaffordable for rapidly developing industrial economies like China and India
  • Certain implementations of a New Energy Contract may encourage accusations of political favoritism.
  • Food prices may require additional subsidy if energy input costs go up.
  • Writing a New Energy Contract will require detailed data collection, hard-headed analysis even wisdom which are sometimes in short supply.

Cheap Energy Contract or New Energy Contract?

Is the future an “Expensive Energy Contract”? Probably not: Expensive energy will shut down much economic activity and is an unrealistic goal in a commodity business. Peak Oil theorists are in some senses projecting an “Expensive Energy” future in the scenarios they paint of the contraction of suburbia and a petroleum dependent economy.

Does this analysis favor the continuance of the “Cheap Energy Contract” in a carbon restricted future? If history is any guide, cheap energy may be able to be maintained with increased subsidy paid via taxes or with less subsidy, in the event of some immediate technological breakthrough or breakthroughs in the area of renewable energy. The latter events cannot be excluded from the realm of the possible and this is certainly a hope. The commitment of private and public funds to clean energy research and development is one prong of any movement towards a clean energy future. On the other hand, maintaining the Cheap Energy Contract with a revolutionary or heavily subsidized clean technology does not bring in the positive effects of higher price that encourage energy efficiency. If the “Cheap Energy Contract” does continue in force, we can all hope for and work towards greater transparency in the area of energy subsidy, so the consuming public understands what they are actually paying for the energy they consume and don’t consume.

Do we need a “New Energy Contract”? Probably. Certainly we need to bring the interests of future generations and the health of our natural environment to the negotiating table that were shut out of the original “Cheap Energy Contract”. It may be that a period of increased energy prices will help finance a transition from a carbon-dependent to a carbon-free energy system that once paid for, will allow for energy prices to once again decrease relative to the overall costs of living and doing business. A full accounting of the probable and actual costs of our current energy system and a future one will be a help in determining how we build a new energy future.

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Comments»

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[...] on tasks that could be much more efficiently achieved through the use of electric drive transport. Cheap oil has enabled individual and family mobility and autonomy at a low price but these uses now compete [...]

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[...] area of our economy.   I have termed the US historical relationship with energy, the “Cheap Energy Contract” which restricts the amount of revenue that the energy sector can charge per unit energy; to [...]

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