Natural gas fracking well in Louisiana, (c) 2013 Daniel Foster
NYT on subsidy stacking at the NRG's California Valley Solar Ranch Facility
Eric Lipton and Clifford Krauss are winning no friends in the renewable energy industry with their article "A Gold Rush of Subsidies in Clean Energy Search." I understand some of the upset. After all, even with the most positive interpretation possible of the negligence that led to vast amounts of publicly-owned oil and gas in the Gulf of Mexico being taken for zero royalties, we are still talking a loss to the Treasury of $53 billion over the next 25 years (and quite well described in this link in the Economist). That is, shall we say, quite a lot of solar panels. Yet, this legislative and policy implementation ineptitude has not gotten nearly the level of scorn as the Solyndra default; in fact, attempts to role back the resource giveaways have been blocked in Congress. Lipton and Krauss have singled out a solar facility even though nuclear plants, coal with CCS, ethanol plants, or all sorts of other subsidized industrial infrastructure have similar subsidy stacking attributes, conflicts of interests, and policy shortfalls, and could have selected instead. These are critical points to remember, because too often libertarian and fiscal conservative groups who weigh in forcefully on subsidies to solar or ethanol remain uncomfortably silent when polite conversation shifts to decades-old subsidies to fossil fuels.
But content-wise, I think Lipton and Krauss did a nice job. Given the secrecy that often surrounds the acquisition of subsidies at all levels of government like treats on Halloween eve, I would not have expected any reporter to be able to get everything right. But there were lots of things they did get right, some of which are rarely captured in subsidy reviews. If their detractors are angry at their selection of solar subsidies, I'd encourage them to direct their energies to applying a similar approach to uncover the full range of subsidies to selected conventional energy facilities.
Let's leave the solar element aside for a moment, and focus instead on the article as a case study for what is wrong with the US' competitive marketplace today. First, it is clear that absent a major investigation by skilled analysts (in this case, the NYT even brought in the energy group at Booz & Company to estimate some values), nobody outside of the boardroom knows all of the subsidies flowing to any particular industrial facility. This is not a useful way to run what is supposed to be a market economy. Second, industry claims on job creation or economic contributions to the local economy are not vetted at the outset of a project and verified over time. Rarely are at least some of the subsidies held in escrow pending delivery of these promised benefits. Escrows or other forms of guarantees that promised benefits will be realized are commonly used in all sorts of less expensive transactions; they ought to be a central part of these deals as well. Third, the authors point out some of the problems that can arise if investors have little of their capital at risk, or can pull that risk off the table too quickly.
All of this is bad policy, whether applied to solar or to nuclear. It leaves taxpayers more or less in the dark on how much they've put into a facility, and how much of this was above the minimum incentive needed to get the project off the ground rather than simply a transfer to investors or plant owners in the form of reduced risk or increased return. Finally, when so many government entities are offering subsidies, we can enter a twilight-zone like scenario where one jurisdiction is merely bidding against another for who can give out the bigger slice of incentive pie. The original goal of providing the smallest boost possible for a risky project with significant public benefits to tip from non-viable to viable is lost.
The Lipton and Krauss article brings to the forefront the issue of subsidy stacking, a term that appears to go back at least to the 1980s (thanks to Ron Steenblik for this link), but is finally entering the realm of routine policy evaluation. Too often subsidies are evaluated based on national numbers for a single incentive. Looking at the pool of incentives to specific projects is extremely important, however, as it is at the project level that the subsidies alter production decisions and distort markets for competing providers of goods and services.
A good way to look at the difficulty in shining the light on subsidies is to review the rebuttal on the NYT article put out by NRG, the current owner of the California Valley Solar Ranch project. I've reprinted it in its entirety below, along with some of my own commentary.
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NRG’S LARGE SCALE SOLAR PROJECTS: GETTING THE FACTS STRAIGHT For those of you who have read the New York Times’ November 11 (online) article, “A Gold Rush of Subsidies in Clean Energy Search,” below are some of the facts that the article got wrong or didn’t include at all. The California Valley Solar Ranch (CVSR) is an ambitious, important project with a national purpose and NRG is proud of our efforts to help put people back to work building a more sustainable energy future. The NYT says: “When construction is complete, NRG is eligible to receive a $430 million check from the Treasury Department — part of a change made in 2009 that allows clean-energy projects to receive 30 percent of their cost as a cash grant upfront instead of taking other taxbreaks gradually over several years.”
The NYT says: “PG&E, and ultimately its electric customers, will pay NRG $150 to $180 a megawatt-hour, according to a person familiar with the project, who asked not to be identified because the price information was confidential.”
Commentary: EBITDA is often used as a way to evaluate the economics of an investment independent of the influences of capital structure or tax laws. That is why NRG used that value, and not the net profits number, in its call with investors. Among the influences of tax accounting, for example, are very favorable depreciation schedules for solar (up to a 100% write-off in one year, depending on when the plant goes into service). This favorable write-off is both a subsidy, and one that would result in large differences between EBITDA and net profits -- particularly in the earliest years of an investment.
The operations and maintenance assumption is too low by more than half. It does not take into account additional operating costs of the plant such as: replacing inverters, lease payments, operational insurance, and asset management costs - among others. Commentary: All of these factors are relevant, sort of. The fact that the NYT used input from Booz & Company suggests they may have integrated some of this to a greater degree than NRG alleges, as Booz analyzes many, many projects. As noted above, if you have very large tax subsidies, the after-tax return may be a less accurate representation of project economics and returns than looking at pre-tax returns. In terms of leverage, one would want to look at returns based on the capital structure of the project (mostly inexpensive debt because of the loan guarantee) and compare it to the capital structure and capital costs without the government subsidies to benchmark the level of government support. Yes, income taxes paid by the project are relevant -- though may be less significant than the large subsidies through the loan guarantees and grants in lieu of tax credits.
Commentary: The workers should be proud of what they are building, and having people back at work is a good thing. But there are many ways to create jobs, and if jobs are the primary policy driver we ought to be looking for the most efficient ways to accomplish that goal. Public statements on job creation by the recipient company are not a reliable indicator of the efficiency of job creation. It is useful to point out as well that the authorizing language for 1705 in ARRA added a requirement that much of the labor used to build the plant be at prevailing (union) wage levels under the Davis-Bacon Act. This drives up the cost of construction, and may also reduce the number of people employed as a result.
Commentary: There are many reasons why this may be the case, not all of them supportive of an argument that the government should be financing them. There may be high risk relative to other (even other clean) options, for example. Or limited expectations that learning from the initial one or two plants will bring down installed costs for future facilities. One nice element of Renewable Portfolio Standard approaches (assuming they are the only subsidy at play and not added to a slew of other subsidies) is that you can buy clean energy competitively. Even if you need to pay a premium relative to conventional energy resources (perhaps even fair, given that conventional fuels cause large external damages not reflected in their prices), an RPS keeps the delivery risks of building and operating the new facility with the private sector. Further, investors are forced to accept the smallest subsidy possible through a competitive bidding process -- a useful process for "discovering" the real amount they need to achieve target returns. Other programs merely guess at this level, and through subsidy stacking often overshoot what's needed by a large margin.
Commentary: It is good that NRG is putting some of their own capital at risk, and $1 billion is a large number from the perspective of normal consumers. However, in terms of industrial investments (this figure applies to multiple projects, not just CVSR), the gross number may not be that meaningful. I'm more interested in what percentage of each project is long-term risk capital by NRG; and in ensuring that the subsidies that are paid out are given over time based on the successful completion and economic operation of a project rather than front-loaded in the project's life span. Front-loading dilutes the incentives for careful investment and operation over the long-term.
Commentary: No argument that solar power is cleaner. But as with jobs, society needs to buy the most of its desired product that it can with a limited budget. One can agree with the premise that we need to reduce our carbon footprint dramatically (as I do) while not necessarily concluding that the particular investment evaluated by the NYT was an efficient way to do it. Fact: These projects and government support are driving down the cost of solar energy. The cost of solar power is falling dramatically, in large part because innovation, deployment at scale and competition are forcing inefficiencies out of the supply chain, and government support for solar power across the federal, state and local level and across both political parties has been instrumental in achieving those declining costs. Commentary: There are many things that may be driving down the cost of solar energy. If I had to pick the markets I think are most important for this to happen, it would be distributed solar PV and solar hot water. It would not be large scale solar plants, though I recognize others may have a different view. Scaling of production is a good thing, as is the pace of innovation. But it is not clear that dumping so much money on one facility (NYT: "As NRG’s chief executive, David W. Crane, put it to Wall Street analysts early this year, the government’s largess was a once-in-a-generation opportunity, and 'we intend to do as much of this business as we can get our hands on'") is the way to get there.
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