Fossil Fuel Subsidies Deter Innovation

Fossil Fuel Subsidies Deter Innovation
AP Photo/Matthew Brown, File

It's uncommon for a dry, data-heavy research paper to make the news, but researchers at the International Monetary Fund and the University of California, Davis, bucked the trend. Their analysis of fossil fuel subsidies has been covered in news and science outlets across the world. In the paper they determine that more than $5 trillion dollars was spent in 2015 by governments in subsidies to fossil fuels. To put that in perspective, that's 6.5 percent of global GDP, which means more than one out of every 20 dollars in the world was handed to fossil fuel interests by the world's various governments. Considering the challenges climate change presents, and the relationship between fossil fuel use and climate change, it's a mind-boggling practice. The research also estimates the costs to society from fossil fuel subsidies and what could be gained by ending them, but it misses something vital in its calculations. Government support for certain types of energy sources also creates barriers to competition for new energy sources. Ultimately these subsidies undermine the fight against environmental challenges by deterring innovative ideas from ever coming to market.

This is especially problematic since much of the funding for energy is intended to produce new ideas and solutions to these environmental problems. For example, in June, the Department of Energy announced several new investments totaling more than $127 million in funds for research on energy technologies. Of that sum, $28 million was in grants for advanced energy systems for fossil fuels.

All of these handouts to favored energy sources are problematic not only because they’re ultimately paid for by the average taxpayer, but because they entrench existing interests and deter competition. Renewable energy, for example, has struggled to break into a market dominated by fossil fuels. In fact, according to another recent report on US energy subsidies from a consulting group based in DC, until 2011, almost all federal energy incentives went to fossil fuels. Now the tides have turned. From 2011 to 2016, renewable energy received three times more in federal incentives than did oil, natural gas, coal, and nuclear combined.

Even though commentators often focus on criticizing those renewable energy subsidies, whether they are for green energy or the blackest fossil fuels, this support is a barrier to competition. That's because they are largely handed out to the politically connected, and not to to those who have the best ideas. Established companies routinely collect more of the funding than do new companies. This shouldn't surprise anyone since the funds are given out via a political process where those bigger firms likely have more weight to throw around when lobbying government officials.

Take the Department of Energy’s Section 1705 Loan Guarantee Program. One analysis showed that it was guaranteeing 90 percent lower-risk power plants backed by companies with huge resources to draw from. So much for helping the little guy. The same analysis showed that just four companies received 64 percent of the nearly $35 billion guaranteed through the program. Anytime funding is allocated through political means it is common for the outcomes to resemble this. Those with lobbying prowess ensure they benefit while taxpayers foot the bill. 

But loan guarantee programs don’t just pad large corporation’s bottom lines by protecting them from risk, they also create barriers to entry. Investors are rational people who, when they see that an investment is guaranteed by the government, know their investment is now effectively risk-free and they see little reason to not invest. The unintended consequence here is that government funding becomes a necessity to attract private funding. Since most of that government funding goes to large companies, small startups are often crowded out.

Experience in the industry confirms that smaller companies struggle to find funding. As Daryl Siry, a former marketing officer for Tesla, noted about the Department of Energy’s loan guarantee program, several startup companies looking for funding “have admitted that private fundraising is complicated by investor expectations of government support.”

Instead of trying to outsmart the market and allowing politicians to dole out benefits to their supporters, energy policy should be focused on fostering experimentation and innovation. Such permissionless innovation provided the framework for the recent explosion in the information technology industry, and there is little doubt that it can provide similar gains if applied to energy technology. Coal powered the industrial revolution, but that was a different time and now energy and environmental challenges are different. Instead of trying to breathe life into the dying coal industry, governments should consider how their policies can instead foster experimentation. It's likely the only way to find solutions to the environmental problems of today.

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