Electricity

While this speech is mostly hogwash, I am surprised and delighted to be able to find one thing to praise in it:

Later this week, I will work with my colleagues at the G20 to phase out fossil fuel subsidies so that we can better address our climate challenge

This is the right thing to do, for reasons I explained in my recent paper co-written with Sterling Burnett of NCPA (extract follows jump).

While many governments of developed nations argue for a worldwide reduction in fossil fuel use in order to combat climate change, those same governments also subsidize energy use and production.

In 2001, the countries of the EU-15 (the “old Europe” nations in the European Union) spent $16.77 billion (in 2009 dollars) subsidizing coal and $11.23 billion subsidizing oil and gas.

The International Energy Agency (IEA) estimates that developing countries spend around $220 billion annually on subsidies for energy production and consumption, of which $170 billion subsidizes fossil fuels [see Figure I]. Including developed countries, subsidies for energy production and consumption worldwide amount to around $300 billion, the majority of which are for fossil fuels.

Such subsidies reduce energy prices below what the market would set, encouraging greater use and raising emissions levels. Direct subsidies include grants to producers and consumers, government investment in research or infrastructure and preferential loans or tax treatment. Indirect subsidies include trade restrictions, price caps and market regulations that guarantee sales volume and restrict competition.

Many signatories to Kyoto subsidize carbon-based fuel use and production. Such subsidies “tilt the playing field,” discouraging research expenditures by private energy companies in developing alternative energy sources. Producers and consumers of other energy sources then demand subsidies to “level the playing field.” Thus, government intervention causes significant distortions in energy markets.

British Petroleum estimates that countries that subsidize transportation fuel use accounted for 96 percent of the increase in oil demand in 2007.13 Many of them are less-developed nations that subsidize both production and consumption of fuels. The IEA estimates that removing domestic price subsidies in China, India, Indonesia, Iran, Russia, Kazakhstan, South Africa and Venezuela would reduce global energy use 3.5 percent and reduce global CO2 emissions 4.6 percent.

U.S. Energy Subsidies.

The U.S. Energy Information Administration (EIA) calculates that federal energy subsidies amount to $16 billion annually [see Table II]:

In 2007, the federal government spent approximately $5.5 billion on subsidies for the coal, oil and natural gas industries— principally tax breaks for investment — including $3 billion for coal and natural gas, and more than $2 billion for research and development of clean-coal technology to reduce greenhouse gas emissions from coal.

The government spent an additional $1.2 billion for electricity production and use (not fuel specific), and $2.8 billion to increase the energy efficiency of homes and businesses.

It spent an additional $5 billion for renewable energy production and use, mostly in the form of tax breaks.

Finally, $1.2 billion went to the nuclear industry.

The EIA found that subsidies doubled from 1999 to 2007, due mainly to expanded subsidies for renewable energy and clean-coal technology.

Policy Recommendations. There are a number of neutral energy policies that could be implemented at the national or international level to reduce subsidized production and use:

International trade talks should include eliminating subsidies for fossil fuel production and consumption.

National budgets should be reviewed with the goal of eliminating programs that encourage energy use.

Subsidies and tax breaks, or tax penalties, for specific energy technologies should be eliminated to remove price distortions in energy markets.

A neutral energy tax policy, for example, would include replacing the federal tax-depreciation schedule for investment in new capital stock with immediate expensing. New equipment almost always produces fewer emissions per unit of output than older equipment.

Changing the depreciation schedule so that new investments could be written off immediately would make it profitable to replace old equipment at a much quicker pace. This simple change could do more to increase energy efficiency throughout the economy than the current complicated expensing regime.

Unfortunately, given the President’s praise for loan guarantees and tax credits elsewhere in the speech, he is failing to pursue a neutral energy tax policy, but I’ll give him due credit for at least addressing half of the market distortion.