Topic: Energy and Environment

Bush’s Energy Pablum

Last night, President Bush unveiled what he calls his “20-by-10” plan, a program that he claims would reduce America’s gasoline consumption by 20 percent within 10 years. You can find my critique of the alternative fuels madness that he proposed last night here, a more thorough critique of ethanol subsidies in general here, my complaint with his $60 billion plan to massively expand the Strategic Petroleum Reserve here and here, and a call to dismantle – not revise – federal automobile fuel efficiency standards here.

By the way, you know that a plan was dreamed up by politicians and pollsters – and not by, oh, anyone who knows what they are talking about – when the numbers are nice and round with a catchy ring to them when put together.

How Large are Federal Oil Subsidies?

Yesterday, I co-authored an op-ed with Peter Van Doren on the Democrats’ energy bill scheduled for a vote today in the House.  The bill is advertised as an exercise to eliminate the subsidies going to “Big Oil” and to use that money instead to subsidize renewable energy (the fact that “Big Oil” is also in the renewable energy business and will simply find that the federal checks are going to different corporate in-boxes has apparently not occurred to anyone, but I digress).  But did the Democrats wipe out all the subsidies, or did they leave some big subsidies behind?

A lot of people think that the Democrats left a lot of money on the table.  Today in the Christian Science Monitor, for example, economist Doug Koplow argues that the biggest subsidy left untouched by Pelosi & Co. relates to the military protection of oil producing facilities and shipping lanes abroad, a mission which costs the taxpayer at least $19 billion a year. 

While the Ds certainly were less than thorough in their anti-oil-subsidy crusade, I’m not so sure that the subsidies are anywhere near as large as many people think.

Quantifying the national security costs associated with ensuring the safe and reliable delivery of foreign oil is difficult.  The Congressional Research Service estimated in 1997 that those costs may be anywhere between $0.5-65 billion, or 1.5 cents to 30 cents per gallon for motor fuel from the Persian Gulf.  Agreement about the extent of the military’s “oil mission” is difficult because military and foreign policy expenditures are generally tasked with multiple missions and objectives, and oil security is simply one mission of many.  Analysts disagree about how to divide those missions into budgetary terms. 

Debate about the size of the U.S. military’s oil mission and related foreign policy expenses, however, is not particularly relevant to a discussion about whether and to what extent oil companies are subsidized by this kind of thing.  From an economic perspective, the key question is whether an elimination of U.S. military and foreign aid expenditures dedicated to “the oil mission” would result in (a) greater corporate expenditures to secure oil from abroad, and/or (b) an increase in the price of oil, and, if so, how much?  That is the true measure of the subsidy if it indeed exists.  That’s because, if the oil mission provides no value to multinational oil companies or oil consumers - as I maintain - than it is not a subsidy.  Measuring the subsidy by the amount of money government spends on the oil mission is at best a measure of how much politicians believe the national security externalities might be.  Political assessments may or may not be accurate.            

To be sure, if the termination of the American “oil mission” implied the termination of all military, police, and court services in the region, petroleum extraction investments would become more risky, extraction of oil might decrease, and prices would increase.  But remember that oil companies in the Middle-East are creatures of government.  So the question is really whether Middle-East governments would produce less oil because the United States ended its oil-related military mission and foreign aid.  Or would oil producing states provide – or pay others to provide – military services to replace those previously provided by the United States?           

I strongly suspect that a cessation of U.S. security assistance would be replaced by security expenditures from other parties.  First, oil producers will provide for their own security needs as long as the cost of doing so results in greater profits than equivalent investments could yield.  Because Middle-Eastern governments typically have nothing of value to trade except oil, they must secure and sell oil to remain viable.  Second, given that their economies are so heavily dependent upon oil revenues, Middle-Eastern governments have even more incentive than we do to worry about the security of production facilities, ports, and sea lanes.  

In short, whatever security our presence provides (and many analysts think that our presence actually reduces security) could be provided by other parties were the United States to withdraw.  The fact that Saudi Arabia and Kuwait paid for 55 percent of the cost of Operation Desert Storm suggests that keeping the Straits of Hormuz free of trouble is certainly within their means.  The same argument applies to Al Qaeda threats to oil production facilities.           

If oil regimes paid for their own military protection and the protection of their own shipping lanes, would U.S. Middle-East military expenditures really go down?  The answer might very well be “no” for two very different reasons.  First, the U.S. Middle-East military presence stems from our implicit commitment to defend Israel as well as the region from Islamic fundamentalism, and those missions would not likely end simply because Arab oil regimes paid for their own economic security needs.  Second, bureaucratic and congressional inertia might leave military expenditures constant regardless of Israeli or petroleum defense needs.              

Thus, U.S. ”oil mission” should not be viewed as a subsidy that lowers oil prices below what they otherwise would be.  Instead, the expenditures are a taxpayer-financed gift to oil regimes and the Israeli government that has little, if any, effect on oil prices or corporate profits.  Now, I’d be happy to see the oil mission go, but “Big Oil” won’t be any poorer for it.

Plug-In Pablum

One can’t swing a dead cat in Washington these days without hitting someone who’s ranting about how plug-in hybrid vehicles (part gasoline engine, part battery-powered engine, but rechargeable like a wall appliance) are the wave of the future.  Of course, if they really were the wave of the future, there would be no need for ranting in Washington - automobile manufacturers would be busy making them as we speak.  It’s only when corporate America is cool to an idea that the prophets turn to the taxpayer or the regulator.  This illustrates Taylor’s law - “the commercial merit of any particular technology is inversely related to the degree of political tub-thumping heard in Washington for said technology.”

Which brings us to plug-in hybrids.  Noted automobile engineers James WoolseyFrank Gaffney, and Gal Luft, among others, have been going into overdrive of late to demand federal action to compel the manufacture and sale of these sorts of cars, which they assure us perform so splendidly and can be so wildly profitable for both buyer and seller that only some sort of inexplicable insanity explains their absence from car lots all across America.  This “Neo-Cons for Neo-Cars” alliance is picking up steam and is increasingly embraced by all sorts of smart opinion leaders who can barely program a VCR, much less design an engine.

An invaluable reality check, however, can be found in the Sunday New York Times.  There, reporter Lindsay Brooke notes that, while automobile companies are busily developing plug-in prototypes, there remains one little problem - the battery necessary to make such a car go from here to there has yet to be invented.  While the industry is optimistic that something will come along in the near future, industry executives confess when pressed that the cars would be so expensive to manufacture that they probably wouldn’t sell without government subsidies or consumption mandates.

Why are Neo-cons and other assorted hawks so obsessed with automotive powertrains?  My guess is that they fear U.S. foreign policy is being terribly constrained by our need to import oil.  Plug-in hybrids would liberate the country from worrying about how our actions play on the Arab street, freeing Uncle Sam to act even more uninhibitedly around thew world.

Look, if the auto industry wants to make these things and consumers want to buy them, fine with me.  But before we start bossing Detroit or their customers around and turn over automobile manufacturing to the very same crowd that manufactured the war in Iraq, consider yourself warned.     

Solar-Powered Welfare

In the “House & Home” section of yesterday’s New York Times, reporter Gregory Dicum tells what’s obviously intended to be a feel-good story about the rapid growth of roof-top solar energy systems in California homes. Ah-nold, you see, has decreed that 3,000 megawatts of the stuff be installed in California over the next decade — a 20-fold increase over the amount of solar power installed at present — and, gosh darn it, those Golden Staters are apparently on pace to do the governor proud. Interviews with enthusiastic manufacturers, installers, and homeowners follow, and not one discouraging word finds its way into a happy, by-golly feature piece that might as well have been written by Ned Flanders.

But there are plenty of facts that wander out of the mouths of these enthusiasts, and they should have given the reporter a reason to pause. For instance, a Mr. Nicky Gonzalez Yuen tells us that he spent $16,000 on his “modest, 3 kilowatt” solar energy system, but that it would have been $26,000 without a generous federal tax credit and state rebate check. A Dr. William Leininger tells the reporter that he spent $39,000 on a solar energy system for his 2,400 square foot home, but that it would have cost $63,000 without those federal and state rebates and tax credits. And then there’s a Mr. Robert Fenton, who tells the reporter that he spent $225,000 on a solar energy system to cut back on his $2,500 a month (!) electricity bills, but that federal and state taxpayer generously pitched in to relieve Mr. Fenton of the extra $134,000 that his system would have cost without government help.

Now, I have nothing against solar power or photovoltaic panels. But if they are such a great investment, why do we need to subsidize them? 

The decision a homeowner is asked to make when considering a residential solar energy system is a very common one in the business world; to whit, whether to invest an initial sum of money in a project that reduces annual costs over a long period of time. Take Mr. Fenton’s case, for example. He could invest $225,000 in a solar energy system that reduces his electricity costs (now at a staggering $2,500 a month) for the next 30 years, or he could invest the $225,000 somewhere else and use the principal and returns on that money over the same time period to pay his monthly electricity bills. 

Which is the better decision in strict financial terms? The amount of money he would need to invest now to pay electricity bills at the rate of $30,000 a year for the next 30 years is $434,571 [a calculation that assumes investment in a mixture of securities and bonds that earned 7% per year, but 5.53% after federal taxes (15%) and California state taxes (9%, reduced to 6% after the federal deduction for state tax payments)]. To achieve the same result through a residential solar energy system, Mr. Fenton only has to invest $359,000, of which taxpayers pay $134,000. Thus, the solar system makes financial sense for Mr. Fenton without the subsidies. The $134,000 subsidy is simply a gift from taxpayers to the obviously very wealthy Mr. Fenton.

Mr. Fenton’s result should not surprise. He noted in the article that because California has a tired rate system that charges large users more, his rates are triple the rates for modest residential use. If electricity rates are high enough and they reflect the real costs rather than a tax on large users to subsidize small users, then fine — alternatives to conventional sources of electricity might well make perfect economic sense.

In the case of Dr. Leininger, a more typical residential user, the economic case for the solar investment is doubtful even with the subsidy. His system, remember, cost $39,000 with the subsidy and $63,000 without. He is quoted in the article as saying it would “pay for itself in a dozen years.” I interpret that to mean a savings in electricity costs of $3,250 a year for 12 years. Again, what sum of money would someone have to invest today to yield $3,250 a year for the next 12 years? At an after-tax return of 5.53% (calculated as before), someone would need to invest just under $28,000. Because this is less than the alternative way of achieving the same result (investing $39,000 in a solar system), the solar investment doesn’t make strict financial sense even with the subsidy … and certainly doesn’t without.

If people want to spend their money foolishly — or, put another way, spend their money on environmental status symbols — then fine. But they don’t have a right to force other people to underwrite their extravagant indulgences. While I’m not aware of any data telling us what the average household income is for buyers of this stuff, I’ll bet you a roof-top solar energy system that it’s a heck of a lot more than the household income of the average or mean taxpayer. Simply put, federal and state solar energy subsidies amount to little more than welfare for the trendy well-to-do.

Of course, rich and trendy Californians have a million reasons for why some shmoe at Wal-Mart ought to be underwriting their killer solar energy panels. Mr. Felton, for instance, tells us that “solar is certainly a way to get off foreign oil,” a claim echoed by Dr. Leininger. But only about 3 percent of all the oil used in the United States goes toward generating electricity, heating homes, or what-not. And most of that consumption occurs in the Northeast, not the Pacific coast. So even if every house in America was plastered over with photovoltaic panels, foreign oil imports would continue to increase pretty much as they would under a business-as-usual scenario. Residential solar energy systems will displace domestic coal, natural gas, hydroelectric power, or nuclear energy — but not oil (foreign or otherwise).

But aren’t we reducing our “carbon footprint” and thus saving the planet from global warming? Maybe, maybe not. Manufacturing photovoltaic panels is a very energy intensive process and the materials necessary to put these things together are likewise products of heavy industry. Absent a comprehensive life-cycle analysis of the carbon energy involved, we can’t say for sure. I’m not aware of any such study in the literature.

What we can say for sure, however, is that there are far more cost-effective ways to go about reducing greenhouse gas emissions than putting solar panels on rooftops. If global warming is worth addressing, put a tax on carbon and let consumers decide for themselves how best to live under that regime. Having the government tell us exactly how to go about reducing greenhouse gas emissions is a bad idea.

This brings us back to the article. Did it ever occur to the reporter to ask whether taxpayers should foot the bill to light up, heat, and cool Mr. Fenton’s sprawling, high-tech mansion (the NYT’s picture of his house is really something to behold)? Or to double-check all of the wild claims made about how cost-effective these systems are? Or to double-check the ridiculous claim that solar energy will have any significant impact on foreign oil imports? Did it ever occur to Mr. Fenton’s editor? OK, this was a “House & Home” piece — not a place one might expect rigorous journalism — but the New York Times has a habit of parking stories about solar energy, energy efficiency, and related matters in that section. They deserve to be a cut above something out of People magazine.

Amazing: An Intelligent Article about Oil

As a general rule, don’t believe a word you read in the popular press about the oil market. With the exception of Matthew Wald at the New York Times, reporting on oil-related matters is so badly underinformed that it’s worse than useless to pay any attention to what the major newspapers and magazines are telling us.

That’s why it’s worth stopping for a moment and flagging one of the rare intelligent pieces on oil-related issues. Stop, right now, and go read Leonardo Maugeri’s “What Lies Below?” at Newsweek

An Oil Royalty Mystery

With oil prices still above $60 a barrel, do oil companies need inducements to find and produce more oil? That’s the underlying question of today’s NYT front-page article about an Interior Department report questioning the value of royalty rebates and tax breaks for gas and oil production.

The rebates are targeted at expensive and difficult exploration, usually in deep water or that requires deep drilling. The intention is to incentivize that exploration, allowing the United States to increase its domestic reserves using “unconventional oil.”

But it’s unclear how effective the incentive is, given the expense of producing such oil. Here’s the article’s punchline:

[The report] estimates that current inducements could allow drilling companies in the Gulf of Mexico to escape tens of billions of dollars in royalties that they would otherwise pay the government for oil and gas produced in areas that belong to American taxpayers.

But the study predicts that the inducements would cause only a tiny increase in production even if they were offered without some of the limitations now in place.

The article notes that royalties and corporate taxes deliver into federal coffers about 40 percent of the revenue produced from oil and gas extracted from federal property. The worldwide average government take is about 60–65 percent. A 40 percent federal take may have been fair at a time when oil prices and profits were lower, the article suggests, but the government should be getting a much higher cut from today’s prices.

Reading the article, I thought about a question that my colleague (and boss) Peter Van Doren has often asked: Why do we have federal royalty payments at all? Why not, instead, use the initial mineral rights auction as the sole source of government revenue from extracting oil or gas? 

A switch to auction-only taxation would yield much more money to the federal government up-front, as oil and gas companies would bid heavily for the leases. (I’ll be agnostic on whether the government receiving more money is a good thing.) An auction-only process would also be much more transparent and would do away with the “gaming” of royalty payments. And, perhaps most importantly, an auction-only process would better align oil companies’ incentives with consumers, vis-a-vis the current system.

In essence, the federal government uses a two-step tax process on oil and gas: up-front payment from the auctioning of the right to extract from a certain reserve, and ongoing royalty payments calculated from the amount of hydrocarbons extracted. To participate in the auction, oil and gas companies must estimate the value of the hydrocarbons they expect to extract over time, subtract the royalty payments they would have to make, and then determine how much of the remainder they would be willing to offer to the government as an auction price.

This system gives a decided advantage to oil companies that are willing to “game” the royalty system. Those firms can outbid competitors, because the gamers know their royalty payments would be lower than the other firms’ payments would be.

To get rid of the gamers’ advantage, the feds need only scrap the royalties scheme. That would force oil companies to bid heavily during the lease auction, where cheating is much more difficult. The brilliant feature of an auction is that it forces all parties to reveal exactly how much they value the product that is up for bid.

That feature would do away with the need to incentivize firms to tap into expensive but worthwhile unconventional gas and oil. Suppose there are two gas reserves up for auction: one an easy-to-tap reserve on government land in Wyoming and the other a similar-size reserve in the deep waters of the Gulf of Mexico. Extraction firms would bid heavily on the Wyoming reserves, but they would also bid (albeit not as much) on the Gulf reserve if they thought it worthwhile. No explicit incentive system would be needed — the firms would simply reveal to the auctioneer their own estimates of the Gulf reserve’s value.

Switching from an auction & royalty system to a straight royalty system would also better align oil and gas companies’ interests with consumers. Currently, as a well nears the end of its productive life, royalties would encourage the operator to take the well out of production sooner, because each hydrocarbon produced means more revenue taken from the oil or gas company and given to the government. By changing the tax to an up-front auction payment, oil and gas companies would have the incentive to continue operating the well until every profitable hydrocarbon has been extracted. That incentive change would be especially beneficial to consumers in times of tight supply and high prices.

As the NYT article notes, members of the incoming Democratic congressional majority are declaring that they will cut back on the royalty relief and tax cuts given to oil and gas companies. They would do the nation’s taxpayers and consumers an even bigger service if they would reconsider the royalty system altogether.

C. Boyden Gray on Oil Subsidies

At a high-level, off-the-record meeting concerning energy security that I attended earlier this week in Washington featuring New York Times columnist Tom Friedman, former CIA director James Woolsey, and energy consultant Daniel Yergin, a study came up in the course of discussion that has been bobbling around for a while now just below the radar screen regarding oil subsidies. The study, co-authored by major Republican C. Boyden Gray and published in a conservative law journal out of the University of Texas, alleges that the oil industry is subsidized to the tune of $250 billion a year, and that claim was marshaled to support the case for countervailing ethanol subsidies. If a careful guy like Boyden Gray — no enemy of business community he — has come to this conclusion, then there must be something to it, right? At least, that’s what many of the attendees were telling each other.

Now, this is a pretty remarkable claim given that the most aggressive yet credible oil subsidy estimates I’ve ever seen come from economist Douglas Koplow of Earth Track. He argued in a 1998 study for Greenpeace (not available electronically as far as I know) that total oil subsidies range from $18-40.6 billion if you count not just subsidies targeted at the oil industry but (1) those that help multiple industrial sectors as well, and (2) embrace some pretty ambitious claims about the chunk of defense spending that would disappear if the military’s oil mission were to disappear.

Look, I like Boyden personally. He’s been a generous contributor to the Cato Institute over the years and he’s gone out of his way to help promote many of our scholars here in Washington. But a close look at this paper of his speaks volumes about the poverty of the policy conversation in Washington with regards to energy.

Boyden’s argument boils down to this: chemical substances found naturally in gasoline such as benzene and other aromatic hydrocarbon compounds are imposing severe health costs on society. In a perfect world, the oil companies would have to compensate victims for those harms, but the federal government largely protects those companies from liability. This constitutes an implicit subsidy to the industry.

Boyden alleges that the direct harms from the various toxic emissions from gasoline total about $64 billion a year. But those aromatics also contribute to the formation of particulate matter (PM) in the atmosphere, and the harms from PM that can be traced back to aromatic gasoline emissions totals at least $200 billion a year. Boyden rounds the sum to $250 billion a year (which works out to about $1.78 a gallon in 2005) and argues that “leveling the playing field” would justify an equivalent subsidy to the ethanol industry. Ethanol subsides, he says, amounted to only $1.4 billion a year (the CBO estimate of the lost revenue associated with the federal fuels tax credit which, by the way, represents only a fraction of the total subsidies going to ethanol), so there’s a lot of room left to justify ethanol subsidies to the moon.

Boyden is right that the aromatics found in gasoline impose human health risks, and the regulatory history he tells about how Congress has dealt with this issue in the past is rather good. But his cost estimates relating to these emissions are drawn essentially from the ether.

His $64 billion estimate for the benefits associated with reducing aromatic emissions is simply the costs associated with reducing past industrial toxic air emissions. Huh? How did costs become benefits? Well, there are no independent estimates of the benefits. But the EPA asserts that the benefits from those previous industrial emission reductions exceed the costs so… . Even if the EPA’s claim were correct, there’s no reason to assume that the cost of reducing toxic air emissions from point-sources x years ago has anything to do with the cost of reducing toxic air emissions from automotive tailpipes today.

Boyden’s estimate for the costs associated with PM formation that can be traced back to gasoline likewise emerges from a problematic set of assumptions. He posits that 40 percent of all fine PM mass is carbon based (which seems fair enough) and then assumes that half of this mass (when adjusted for population exposures) can be attributed to gasoline emissions (which is not so fair enough; his own footnote suggests that only 4-33 percent of PM 2.5 can be traced back to tailpipe emissions). Using the benefit estimates associated with ambient PM concentration reductions from the recently established off-road diesel fuel regulations allows Boyden to come up with about $200 billion in benefits, although it’s unclear how he traces those costs to aromatic tailpipe emissions out of the total universe of motor vehicle tailpipe emissions.

I doubt whether anybody who’s citing Boyden’s study with gusto has ever gotten around to reading this particular sentence on p. 52; “We emphasize that these are, necessarily, speculative estimated, based on various heuristic assumptions that cannot easily be proven (or refuted, given basic uncertainties).” I’ll say. Normally, claims that cannot be proven or disproven are called “baseless opinions” (or, alternatively, “religious beliefs”). Let’s posit that we shouldn’t use either as the basis for public policy.

If Boyden was familiar with the literature on tailpipe emissions, he wouldn’t need to go through such analytic contortions. The man who probably knows more than any other person in the United States about the issues surrounding the environmental cost estimates associated with gasoline consumption is Mark Delucchi, a research scientist at the Institute for Transportation Studies at the University of California at Davis. His own economic calculations based on epidemiological work by others finds that environmental costs associated with toxic air emissions from motor vehicle tailpipes ranges from a lower-bound estimate of $87 million a year to an upper-bound estimate of $1.62 billion a year in 1991 dollars (which translates to $116 million-$2.16 billion in 2005 dollars) – a tiny fraction of the $64 billion estimate coming from Boyden.

Delucchi does not break down the PM emissions associated with gasoline aromatics, but he does report that the environmental costs associated with all the particulate emissions from motor vehicle tailpipes ranges between a lower-bound estimate of 16.7 billion and an upper-bound estimate of $266.4 billion. However, Delucchi reports that “we are uneasy with this result, even as an upper-bound,” because it’s heavily weighted by one study in the literature (Pope et al.) and that study is both anomalous and methodologically problematic. Regardless, keep in mind that Boyden is concentrating his fire not on all the particulate matter coming out of automotive tailpipes, but that subset of particulate matter formed as a consequence of the aromatic emissions. Given the small percentage by weight and volume that aromatics constitute within a gallon of gasoline, it’s clear that Boyden’s estimate is wildly off even if we use Pope et al.

By the way, it’s worth noting that the toxic air emissions associated with ethanol are even greater than the toxic air emissions associated with conventional gasoline, so even if Boyden’s estimates were correct, they do not justify countervailing subsidies for ethanol, the remedy for the problem suggested in Boyden’s paper.

One could spend a lifetime swatting down papers like this. That such weak arguments have no problem gaining currency in Washington demonstrates that policymakers simply cannot differentiate between analytic wheat and chaff. But such is the stuff that policy is made, particularly when the analytic “chaff” is politically convenient.