energy

There was very promising motion on subsidy reform contained in this March 2011 letter to Congress signed by a large number of conservative organizations (as well as others).  Since structural reform of subsidies will require a broad political coalition, the variety of groups signing on to this letter is a positive step.  Elements of their letter that I found particularly important are:

1)  Use of an appropriately broad definition of subsidies

"From direct payments and loan guarantees to mandates neither the environment nor the American economy can afford to be hampered by these anti-growth, anti-competitive policies." The inclusion of this mix of instruments is quite important, as it illustrates their understanding that subsidies go well beyond cash transfers, and that no matter the exact form, all can affect market positioning and competitiveness of beneficiary industries. 

Contrast this statement with the position taken by the Nuclear Energy Institute's Marvin Fertel in a recent presentation to Wall Street (page 13).  Fertel stated that "nuclear loan guarantees are actually a revenue generator for the government,"  knowingly glossing over two important facts.  First, revenues and long-term credit performance are quite distinct issues.  After all, mortgage closing fees made lots of money for loan originators until that little problem with borrowers not paying back their loans began to crop up.  Second, even without a default, the politically-selected access to Uncle Sam's line of credit greatly reduces borrowing costs for a lucky few, undermining the market position of competitors (see item 2, below).  The signatories to this letter have steered clear of these types of evasive definitions.

2)  Recognition that political selection of winners via subsidies favors established industries

Such policies provide unfair advantages for some producers, typically the more politically astute, while creating competitive disadvantages to other, often more promising and more nascent technologies. Centrally controlled energy policy has not worked, Washington does not know best, and the law of unintended consequences cannot be vitiated.

3)  Phased approach to level the energy playing field

The Coalition proposes four stages to their reform effort.  They begin with a cessation both of new subsidy creation and of the expansion of existing subsidies (in terms of scope or time frame).  They propose instead that any fiscal savings from eliminating subsidies be redeployed to the general economy through broad-based reductions in the tax rate.  Given that tax expenditures overall are in excess of $1 trillion per year, broad-based reform of tax expenditures alone could provide material reductions in general tax burdens.  The final stage of their plan is to dismantle the existing system of subsidies.

Additional work needed

There are some important limitations to this proposal that need to be addressed to make subsidy reform equitable and effective.  For example, most subsidies to renewable energy include sunset provisions already.  In contrast, many of the core subsidies to conventional fossil fuels are much older, and do not automatically expire.  Thus, unless dismantling of existing subsidies comes very close in time to allowing existing ones to expire, the proposed action plan will generate its own distortions.  A related issue involves externalities such as pollution.  To the extent fiscal subsidies are addressed, but emissions from coal or oil remain unchecked, the playing field will remain skewed.  Finally, the Coalition cites Pew's numbers for the scale of energy subsidies.  This is a good starting point, but even Pew does not believe they have systematically characterized the problem.  The subsidy reform "net" will need to grow wider over time if the the problem is to be fully solved.

When people look for official information on US energy policy and trends, the Energy Information Administration (EIA), part of the US Department of Energy, is one of the first places they look.  I look there too: EIA staff do great work in many areas; they are willing to talk about their work and assumptions; and they have developed a model of data sharing that I wish many more government departments would adopt.

But EIA's numbers on energy subsidies have always irked me, widely cited though they may be.  The subsidy totals have been very low.  The patterns across fuels have been extremely sensitive to estimate shifts in even a single program.  The inclusion rules have often seemed arbitrary.  For example, EIA has sometimes excluded programs based on arguments that applied equally to subsidies the Administration did include.  Other times (e.g., with public power), EIA's reports have carefully developed a theoretical framework on how to evaluate the subsidies, quantified how big they are, and then failed to include the results of all this work in its subsidy tallies. 

The point here is not to cast stones.  There are resource constraints, narrow research mandates from Congressional requestors (with a bit of a political angle, I'm told), and a variety of other factors that have led to the outcomes we see.  But as the role of energy subsidy reform is increasingly recognized as a central tenet in a rational and cost-efficient response to climate change; and as fossil fuel subsidy phaseouts hit the realm of the G20, incomplete or inaccurate subsidy data becomes a big problem.

Today, I've am happy to release a detailed review of EIA's subsidy numbers.  EIA Energy Subsidy Estimates: A Review of Assumptions and Omissions explores EIA's numbers and a variety of the reasons they are so low (see table below).  I have no doubt EIA will continue to be tasked with tracking government energy subsidies; my hope is that this analysis will help them do it better in the future.

I see this Review as a companion piece to a paper I did last summer for the International Institute for Sustainable Development on the strengths and weakness of the "price gap" metric, the most common approach used to measure energy subsidies globally.

There are some important cross-cutting themes: 

First, accurate subsidy measurement is important, but it is also hard.  Political pressure makes that measurement even more difficult.  Fixing this problem will require a signficant commitment by governments, and likely by many other parties as well. 

Second, as was the case with corporate financial reporting, improvements to subsidy data need to be viewed as a process rather than an event.  We will not have comprehensive data on fossil fuel subsidies by the G20 deadline; and likely not two or even five years from now either.  But it also took a very long time to figure out a reasonable way to account for environmental or pension liabilities in corporate financial reports.

Even with the data challenges, and perhaps partly because of them, countries that are serious about reforming subsidies to environmentally harmful activities need to focus much more on building a system and process for doing so.  They need to tackle the problem in a structured way, but in phases. 

What I've seen in international efforts over the past 20 years has mostly been trying to re-task existing institutions to deal with the challenge of subsidy measurement and data collection.  This approach has not be very successful.  Often there is historical baggage, competing demands, or operating rules that impede the task at hand.  There may be an existing skill base that addresses some -- but not all -- of the needs for the new task; but limited will, budget, or expertise to build out the needed areas.  While using existing capacity makes sense in the short-term, I believe over the longer term a specialized and independent structure will need to be set up. 

I think we can gain many insights on what this independent structure should look like by studying relevant institutional structures that have worked in other areas.  Some of the ones I think would offer valuable lessons include: 

• The initiation of systematic collection of macroeconomic statistics throughout the world after the global Depression in the 1930s.
• The accounting standards boards (FASB, GASB, IASB) that iteratively, and substantially independently of government, have evolved standardized rules for corporate reporting.
• The International Standards Organisation that has developed many challenging standards, such as production quality, that have been compelling enough for private firms to go to great lengths to meet iteratively over time.

Finding a handful of failures would also be quite useful in charting the path forward and what might go wrong.

It is inevitable that member governments of the G20 will waste innumerable hours fighting over how to define a "subsidy" and work to extend the number of years they can keep an existing subsidy and still meet the "medium term" phaseout pledge.  But if this is all that happens, we will come up empty.  Less political entities should begin thinking about institutional structure now.  Just as accurate and verifiable information on corporations was a pre-requisite for the development of mature capital markets, the benefits of accurate and verifiable information on subsidies will also be enormous -- not only from fiscal savings, but also through less expensive and large scale gains in environmental quality and poverty reduction.

Related documents on EIA subsidy values and subsidy reform:

Complete Review
Executive Summary only
Extracted table comparing EIA subsidy estimates to other subsidy research
Review of "price gap" approach commonly used internationally to measure energy subsidies
Earlier reviews of EIA subsidy estimates:  2001.  1993.

Expected Bias Resulting from EIA Subsidy Definition and Valuation Conventions