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Memo to next president: Here’s how to avoid our history of energy policy mistakes

Domestic energy production, both fossil fuels and renewables, has surged in the past decade, yet policy priorities haven’t. dingatx/flickr, CC BY-NC

Memo to next president: Here’s how to avoid our history of energy policy mistakes

With all of the hubbub surrounding this year’s presidential election, something important has slipped by with little notice: Despite the fact that it affects our economy, environment and national security, the candidates aren’t really talking much about energy.

In many ways their relative silence reflects the sign of the times: Most voters are happy with cheap gasoline and so their attention has turned elsewhere. But, gas prices won’t stay low forever, and other long-lived energy challenges such as energy imports and climate change aren’t going away. Also, trillions of dollars of investment are needed over the next one to two decades to decarbonize the energy system, maintain its infrastructure, integrate renewable energy and upgrade the power grid.

So far, the back-and-forth between the campaigns has focused on coal and whether it should be allowed to continue its decline, but coal is one part of a much bigger picture. We need a suite of policies that span different forms of energy and address multiple goals.

To achieve that, the candidates need to address a crucial question: What does government do well and what does it handle poorly when it comes to energy policies?

From worst to best

Looking backwards, the energy debate that raged from the early 1970s until the late 2000s broke down, broadly speaking, into two ideological camps: those who believed in low energy production and low consumption (Democrats), and those who believed in high production and high consumption (Republicans).

What America ended up with was the worst of both – high consumption combined with low production. That meant we suffered the national security and environmental impacts of high energy consumption, but reaped few economic benefits because of low production.

During the past 40 years, our energy situation only worsened: Energy consumption, CO2 emissions and imports (oil, natural gas, uranium and refined fuels) grew, while oil production fell. Every president from Nixon onwards pledged to reduce oil imports, but imports kept rising. As a nation, we plunged headlong into a pursuit of substitutes for petroleum, such as synthetic oil from coal and ethanol from corn, thinking it would be better to enrich Great Plains industrialists and Midwest farmers rather than Mideast autocrats.

Gas rationing in the 1970s, a result of the OPEC oil embargo, has shaped U.S. energy policy for years even though the picture on geopolitics, domestic energy and environment has changed dramatically since then. Library of Congress

But over the last decade, things have turned around. Now we’re getting the best of both worlds: Production of oil, gas and renewables is up, while consumption, emissions and imports are down. Our energy situation has flipped on its head.

This has completely changed the geopolitical discussion around energy. In the 1970s national security concerns led us to argue that energy exports should be banned, as they would put us under the thumb of Saudi Arabia. Today, national security concerns lead us to argue that energy exports should be accelerated, as they would help our European allies get out from under the thumb of Russia.

Picking winners

With new fundamentals in our energy outlook, it’s time to develop a new framework for energy policy for the next decade.

In doing so, it’s useful to reflect on the role of government when it comes to energy. U.S. energy policy is littered with a tortured history of bad decisions so it is tempting to conclude that the government should just butt out. But mixed in with these bad policies are some really good decisions, too.

Generally speaking, the government is really bad at setting energy prices and selecting fuels or technologies. Many people forget that in the 1970s, the gasoline shortages were partly a consequence of fixed fuel prices, which meant that even though wholesale prices for petroleum went from US$3 to $14 per barrel, the prices at the pump stayed the same. Had the prices gone up when supplies were short after OPEC cut off exports to the U.S., then demand would have softened, as we routinely see happen with oil and other globally traded commodities.

Electricity in many places costs the same price all year round, rather than varying in price based on supply and demand. scarequotes/flickr, CC BY-NC

While gasoline prices in the U.S. are now set by market forces, in many states electricity prices are still set by the government in the form of state utility regulators. In many of these regulated markets, the price for electricity is the same every hour of the year. Instead, the prices should move up and down based on supply and demand, which is fundamental to an effective market.

From an economist’s point of view, the idea that electricity prices on a hot summer afternoon when demand is high and supply of wind and hydroelectric power is low should be the same as a cool, spring morning when demand is low and supply of wind and hydropower is high is nonsense.

The government also has a checkered history picking winners and losers in the energy sector. Mandates to use biofuels, for example, upend global food markets and lead to deforestation.

Another classic example was a 1978 law that banned construction of new natural gas power plants because policymakers, concerned about energy shortages, tried to limit domestic natural gas use. Consequently, we built 80 gigawatts of coal plants, which spewed out twice as much CO2 as natural gas plants would have. With remarkable irony, the same companies asked to build coal plants in place of natural gas a few decades ago are now being asked to prematurely shutter those plants in favor of natural gas.

Lesson learned: Markets are effective at setting prices and picking fuels and technologies, but governments are not. Despite how tempting it is to intervene, those are areas where the government should stay out.

Where government makes sense

Despite those missteps, there are also notable policy successes. In particular, the government is effective when it focuses on setting performance-based standards and fostering a robust innovation system.

While the markets can use competition to efficiently find solutions at an appropriate price, they are not good at setting their own rules. This is where the government is an important player and has a critical role setting environmental and safety standards, which then become the rules of the market.

The energy industry invests a tiny amount in research and development, a place where government should play a much bigger role. high-voltage grid via www.shutterstock.com

The role of the government as standard-setter is firmly established in Article 1, Section 8 of the Constitution, which says “The Congress shall have Power To… fix the Standard of Weights and Measures.”

This power justifies the National Institute for Standards and Technology, building codes, appliance efficiency guidelines and emissions standards from smokestacks and tailpipes. Governmental standards for refrigerator efficiency from decades ago and more recently light bulb efficiency, for example, have reduced energy consumption and saved consumers billions of dollars.

In the early 1990s, governmental standard-setting was combined with market forces in bipartisan legislation that established a cap-and-trade system to reduce acid rain. The government used a cap to limit emissions of acid-forming gases and a market system cost-effectively reduced those emissions. Some power plants added scrubbers to remove the pollutants, others switched to cleaner fuels and some retired early.

This system – government policymakers setting performance-based standards and markets finding a solution – is effective. The George W. Bush administration’s review of the acid rain program concluded that it generated $40 of benefits for every $1 of costs, finding that it achieved dramatic successes more swiftly and cheaply than anticipated.

This success story should give us confidence that putting a price on carbon and allowing the markets to work will achieve similar outcomes for decarbonizing the system faster and cheaper than projected.

Innovation

In addition to setting performance-based standards, the government is effective at fostering a healthy innovation system. It does so in two ways: by funding research and development and protecting intellectual property.

Our innovation system, comprising national labs, university researchers and garage tinkerers, is the envy of the world. Part of that is the federal research funding. Another part is that the constitution guarantees our right to own our intellectual property, which means inventors financially benefit from their creations, earning royalties from those who adopt it.

But, the U.S. Patent and Trademark Office is severely backlogged in processing patent applications, which can be fixed with more resources.

R&D funding also needs to be increased. The energy sector is responsible for well over $1 trillion of annual contributions to our GDP, yet federal funding for energy R&D hovers in the low billions of dollars. It is time to ramp up on R&D investments by an order of magnitude.

Of all the different policy options available to the federal government, R&D investments are among the most benign. In the worst-case scenario, R&D funding is a jobs program for highly educated researchers, but in the best-case scenario, it will lead to real breakthroughs that change the world, while creating new spinoff market sectors and technologies just as the space program of the 1960s did.

American energy policy has languished in a political logjam for decades, producing scattershot, crisis-led policies that take us nowhere. It is time to reject old thinking on energy policy and move toward the sensible solutions we urgently need.