Incentives and Subsidies In the Energy Sector

1. Prepared by: Marc W. Goldsmith and Karen Hamilton Marc Goldsmith & Associates LLC 289 School Street, Belmont, MA 02478 December 2, 2008 Incentives and Subsidies In the Energy Sector

2. This report and the Executive Summary reflect research conducted by MGALLC and are intended to serve as an impartial resource for those involved in the subsidies and incentives debate. The contents reflect only the view of the authors. Any mistakes, errors, biases or omissions contained herein are their exclusive responsibility.

3. Executive Summary There is a strong bias in both the federal and state legislatures to enact statutory changes or enable new regulations to address perceived challenges in the energy market. These actions, in the form of incentives or subsidies, could have significant impacts, favorable and unfavorable, on states and the nation. This paper . . . • Examines the history of subsidies and incentives in the energy sector, their form, historic use, and successes and failures. • Establishes an intellectual basis for policy dialogue to constructively shape energy policy. • Develops principles for evaluating subsidies and incentives, balancing desire for a particular change with impact on customers, markets, rates and taxpayers. • Applies principles to legislative initiatives that could accelerate technology or fuel development, speed to market and value to customer. 2

4. Executive Summary Definitions Subsidies and incentives are: • Tools for policy makers to advance the public interest in areas where the private sector cannot act or is reluctant to act. • The narrowest definition is a grant, rebate or tax treatment that directly influences a producer or a consumer to engage in a different behavior. • A broader definition includes an action such as a regulation that lowers consumer price, reduces producer cost or skews the market in favor of a particular technology or fuel. • Indirect factors influence decision making as well. Examples include: • Unrelated regulations or programs that impact labor costs, public acceptance, or confidence. • Appliance efficiency standards that, through consistent labeling, provide confidence to the customer about paying a higher cost for an appliance to obtain a lower operating cost. • Federal insurance or guarantee programs that provide investor confidence relative to capital expenditures but don’t cost the government money. 3

5. Executive Summary Goals of Subsidies & Incentives Lower producer and/or consumer cost Advancement of new technologies • Promotion of environmental quality • CO2 reduction • Ozone SIP compliance • Reduced water and/or land use Energy security (promote a long term and reliable source of fuels) Improved energy efficiency Remove barriers created by regulatory uncertainty or other factors Improve reliability of energy delivery to end users. Improve consumer, producer or market confidence in the product or service. Subsidies and incentives induce changes in specific markets by creating opportunities and influencing motivation. They can transform markets at various stages of the product cycle (below). 4

6. Executive Summary Principles for Incentives & Subsidies Incentives and subsidies are tools that can, if used correctly, induce changes in specific markets by creating opportunities and influencing motivations. Specifically they must be: Targeted • Based on careful analysis of the importance of the outcome and the ability to provide the necessary focus • Remove specific barriers that hold a potentially valuable resource back from being economically viable • Certainty of reaching those for whom it is intended • Should not be duplicative or allow double-dipping • Balance the costs of administration against expected benefits • Minimize errors of inclusion and exclusion • Encourage service at least cost • Create transparency so that stakeholders can see costs and benefits • Not undermine efficient use of a product or service by suppliers, providers or consumers • The duration should be established at the outset so investors know what to expect • Ensure that market actors (producers, providers, customers) do not expect it as a right • Subsidy should expire as the technology becomes commercial (no free riders) • Related subsidies should be considered as a portfolio of investments for the future • Subsidies for the development of future commercial technologies should be considered on an interrelated basis (not in isolation) and managed like an investment account Cost- effective Time- limited Portfolio- based 5

7. Executive Summary Application of Principles • The principles can be used to create a broad range of legislative proposals to support reduced costs, improve the environment, promote energy security and facilitate other legislative needs and voter wants. • Incentives and subsidies have been both spectacularly successful and unsuccessful in the energy area. The best have leveraged subsidy support for economic benefit. Principles help steer thought processes toward what has been shown to be successful and is good public policy. • The following is an example of principles applied to solar or other non-wind renewable power technologies and production tax credits (PTC). Targeted • Solar PTCs can be targeted to potential owners. Germany has been effective in moving the technology toward commercial maturity by targeting customers to pull the technology. • PTCs have been a successful tool (one of several) for solar, and can be a cost-effective intervention to accelerate commercialization of other renewable technologies. Cost-effective • Resources devoted toward solar PTCs are useful in accelerating commercialization. However, there needs to be a phase-out provision in any solar subsidy legislation so that resources can be re-directed later toward commercialization of other promising energy technologies. Time-limited 6

8. Executive Summary Uses of Principles • Principles are used to provide the basis for an informed dialogue and disciplined evaluation of options. They orient the discussion toward policy goals that maximize social well being. • Principles also optimize value by providing a framework for considering technologies and fuels in a portfolio context. • Market intervention can occur at different stages of the development cycle—from funding that accelerates early R&D at one end of the spectrum to increasing market penetration of commercially available products at the other. • In recent years the main interest has been in the late development and early commercialization stage in order to generate near term consumer benefits. • The proper use of principles leads to effective legislation and regulation that influences energy markets. The portfolio approach assures consistency as intervention is introduced either in groups of energy legislation or individually over two or more legislative sessions. 7

9. Executive Summary Use of the Principles: Portfolio Management • Federal and state subsidies have historically overlapped or been in conflict, thus diminishing their impact. • Consequently, new subsidies and incentives should not be evaluated in isolation, but rather through synchronized federal and state interventions to achieve an optimal result. Wind energy has been subsidized in multiple ways with minimal coordination State Utility Mandated Programs Permitting and Land Use WIND State Renewable Portfolio Standard Rebates Local • Principles need to be applied across a portfolio of technologies, fuels and activities to ensure that resources are optimally allocated. • This means that some technologies that might individually be approved will not be funded, while others will be scaled up and/or phased out. Production Tax Credit for Wind Federal 8

10. More Information For more information: Marc Goldsmith MGALLC 289 School Street Belmont, MA 02478 Telephone: 617-484-4664 Email: marc@mgallc.net Website: www.mgallc.net or Karen Hamilton MGALLC Email: karen@mgallc.net 9