Cost-based, cultivated energy policy

It’s a critical moment for energy policymakers. Though the U.N. Climate Conference in Durban, South Africa, which wraps up this weekend, has shown some signs of a potential deal to tackle climate change, the talks could still adjourn without any legally binding agreement at all. Meanwhile, as European Union leaders struggle to save the euro zone from breakup, billions of dollars to tackle climate change and energy efficiency hang in the balance as EU governments contemplate budget austerity measures. All of this uncertainty follows the November publication by the International Energy Agency (IEA) of its 2011 World Energy Outlook, which contains dire warnings of the consequences of policy inaction on climate change and low-carbon energy investment. But in an atmosphere of low economic growth prospects, high energy prices, tightened government purse strings, and weak international carbon-reduction standards, how can policymakers in Europe and the United States craft low-carbon energy solutions?

The energy trilemma

In the 2011 World Energy Outlook, the IEA predicts that global energy demand will increase by 33 percent between 2010 and 2035, with 90 percent of that growth coming from developing countries. The vast majority of energy consumption in 2035 will still be met by fossil fuels, with growth in oil consumption spurred on by an estimated doubling of the world’s passenger vehicle fleet to around 1.7 billion. Even in the short term, amid low expectations for European and U.S. economic growth, global consumption of petroleum, natural gas, and other liquid fuels is expected to grow, according to the U.S. Energy Information Agency (see this chart for a breakdown of that growth). This growth in consumption comes as global oil supplies remain tight for the short term, and BP’s chief economist has told the Financial Times that 2011 will be the first year where the average oil price tops $100 per barrel.

Rising energy costs not only threaten to derail economic recovery in Europe and America, but also place political pressure on policymakers to keep energy affordable, potentially at the expense of more expensive green energy and emissions-reduction policies. These policies have come under fire this year in budgetary debates on both sides of the Atlantic. In the U.S., last month’s breakdown of the congressional “supercommittee” places federal energy and environmental programs on the block for automatic budget cuts, and a major federal grant program for renewable energy is set to expire at the end of this month, with no sign of renewal from Congress. Meanwhile, the euro zone crisis has seen European governments scale back low-carbon energy subsidies while implementing austerity measures. Budget cutbacks in ten of the world’s largest economies could cause global funding for climate change-related investments to fall by $22.5 billion, according to a November report from Ernst & Young, and potentially $45 billion if the euro zone crisis worsens.

In designing low-carbon energy policies, developed world governments are facing what the World Energy Council has called the “energy trilemma:” the difficulty of providing energy security, social equity, and environmental impact policies, or “stable, affordable, and environmentally sensitive energy frameworks.” If low-carbon energy measures are to be successful, they must be designed and implemented in a way that provides both a reliable supply of energy and minimizes the costs of adaptation and adoption by end users. For years, concerns of reliability and particularly cost have been raised by critics of low-carbon energy policies to point out that many such policies are unworkable.

Policy by cost

However, energy policies have long overlooked cost in favor of price, argues resource economist John Laitner. In a recent New America Foundation working paper, Laitner observes that policymakers have historically relied on “price signals”—changing consumption habits in response to changes in fuel prices—to craft energy policy in transportation. For example, raising the cost of gasoline through fuel taxes or carbon fees would be expected to force consumers to change their driving habits, move closer to their workplaces, or buy more fuel-efficient cars. Clean energy measures and technologies, then, would become widespread thanks to price-induced changes in consumption. The problem with this idea of “policy by price” is that the evidence for its success is limited. Instead of reducing consumption, higher energy costs often simply freeze existing consumption levels in place.

According to Laitner, a proper restructuring of energy consumption incentives would focus less on the price of energy than on reducing the cost of more efficient energy alternatives.  He calls for investments in technology and infrastructure that will reduce the energy footprint of consumers and businesses while maintaining access to affordable, cleaner energy.  Such investments could include further access to low-carbon energy sources, “smart grid” upgrades to electrical distribution, or “personal infrastructure” such as expanding broadband to enable telecommuting. Unlike more top-down measures relying on price signals, this cost-based policy approach would engage consumers by improving their choices, and—since affordable, more efficient energy alternatives can also boost disposable income—by tying more efficient alternatives to economic growth.

But how to implement such a policy when international energy and emissions guidelines remain weak and government spending is hampered? Nathan Hultman of the Brookings Institution argues that we should recast the problem of emissions reductions as an opportunity for national economic growth rather than an onerous set of international regulatory issues and standard-setting. For Hultman, a low-carbon energy system should be “cultivated” rather than “steered”, as countries pursue policies that enable private investment to deploy existing low-carbon and energy-efficient technologies while setting the foundations for the emergence of new technological solutions. The goal would be to create, through the right national regulatory and industrial policies, an ecosystem of private-sector development of low-carbon energy solutions, fostering economic growth as well as a transition to a cleaner energy system. Rather than simply setting standards for private firms to follow, national and international policies should go further by closely engaging them in the policymaking process, ensuring that the costs of implementing green solutions be kept viable for businesses and affordable for consumers, both in the developed and developing world.

Solving the energy trilemma need not be deterred by the costs to governments and consumers. If energy and emissions policies are reframed to tackle these costs, all the while enlisting the funds and cooperation of private firms, green policy development can be wedded to economic growth. In the U.S., the Obama administration has enthusiastically backed private-driven energy efficiency initiatives, but governments could go much farther in involving private firms in the policymaking process without compromising the efficacy of green energy or efficiency standards. A global survey by Ernst & Young of 300 business leaders revealed that 77 percent believe that governments have not invested enough in low-carbon solutions, and 54 percent view addressing climate change as a business opportunity. The private sector appears ready to work with policymakers.

A final thought: interestingly, greater business support for low-carbon solutions came from the survey respondents in emerging economies. Perhaps a cost-based cultivation approach towards energy and carbon emissions could not only help cash-strapped developed-country governments meet climate goals, but also help bridge the gulf between developed and developing countries on the importance of energy efficiency and emissions reduction.