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Three policy issues related to the commercialization of solar energy
Energy Vol. 7, No. 1, pp. 61-72. 1982 Printed in Gnat Britain.
0~5442/82/01w61-12103.wi0 Pergamon Press Ltd
THREE POLICY ISSUES RELATED TO THE COMMERCIALIZATION OF SOLAR ENERGY F. T.
SPARROW
School of Industrial Engineering, Purdue University, West Lafayette, IN 47907,U.S.A. Abstract-The fundamental policy questions that require some resolution before the next steps are taken to speed solar commercialization are (1) Are present energy prices so biased by government action as to make “free competition” unfair to solar energy? (2) To what extent should solar energy be encouraged because it contributes to other less economic goals, such as maintenance of full employment and improved environmental quality? (3) What criteria should be used to evaluate any new solar incentives? The purpose of this paper is to summarize these issues and then draw conclusions from the entire body of research as to the “proper” role of the federal government in speeding the commercialization of solar energy. The organization of the paper follows the order of the points mentioned. Major conclusions are that (I) present pricing practices and government policies seem to result in energy prices already favoring solar energy in tow of the three locations studied; (2) solar energy seems to require more unskilled labor than the technologies it replaces and seems to be less polluting; and (3) although present incentives appear to be effective, i.e. they have the potential to generate the market impact expected of them, they do not fare particularly well when measured against the standard externality, efficiency, and equity criteria suggested by the economics profession.
INTRODUCTION
In several other articles, the author and his colleagues have raised a series of what appear to be fundamental policy issues that require some resolution before the next steps are taken to speed solar commercialization.1 (1) Are present energy prices so biased by government action as to make “free competition” unfair to solar energy? (2) To what extent should solar energy be encouraged because it contributes to other less economic goals, such as maintenance of full employment and improved environmental quality? (3) What criteria should be used to evaluate any new solar incentives? The purpose of this paper is to draw together and summarize these previous efforts and then to draw conclusions from the entire body of research as to the “proper” role of the federal government in speeding the commercialization of solar energy. The organization of the paper follows the order of the points mentioned. Each will be summarized, followed by a section presenting the general conclusions reached from a consideration of all the issues. PRESENT
ENERGY PRICES
Are present energy prices so biased by government action as to make “free competition” unfair to solar energy? Proponents of solar energy have maintained that efficient allocation of resources may not result from open competition between solar and conventional fuels because of (1) the methods used by utilities to charge the consumer for gas and electricity; (2) the history of favorable government treatment of the energy industries, which reduces the prices of conventional fuels; and (3) the nature of the tax laws, which among other things, allows businesses to deduct expenses whereas home-owners cannot and allows firms to expense fuel cost even though they must depreciate the capital cost of solar. A recent article and a report analyzed the current economic feasibility of both solar water heating systems and-combined water and space heating systems. Table 1 integrates the results of their analysis for three cities in the United States. The assumptions that underlie their analysis are (1) a real discount rate of 9%, which approximates a IO-year payback period; (2) a 2% annual real increase in electricity costs; (3) an installed cost of the solar system of $400 plus $22 per square foot of installed collector; (4) annual maintenance costs for the solar systems equal to 1.5% of installed cost; (5) optimal sizing of the installations; and (6) 1977 dollars used throughout.
37
Wisconsin
New Mexico
:
1,214
3,040
1,940
cost
(2)
849
2,232
1,358
After subsidy
cost
(31 (5) Average Elec. Price First Year ($ kWh3)
55.00 53.00 41.50
% Load Solar
66 78 71
(4)
147
206
181
Value of Elec. Saved, First Year (S)
(6)
1,688
2,368
2,074
(7) Present Value Of Elec. Saved, over 20 Years ($1
18.20
45.60
29.10
Maint. (S/YK.)
(8)
181
453
289
Present Value Maint. cost ($1
(9)
+293
-1,124
-155
(10) Present Vcilue C(7)(9)-(4)J NO Subsidy
+658
-317
+427
,9K:;1 with Subsidy
(11) Presenf Value
value of $100 annuity at 9%.
discount rate = 9%; column (81, (0.015)(2); and column (9), (8jc9.952
where 9.95 = 1
Column calculations and sources are as follows: column (2), 400 + 22[(l)], from Ref. B2; column (3). (2) minus the NEA tax credit of 30% of first $2,000, 20% of next $8,000; column (5), based on present tariffs that reflect average costs of electricity; column (6). (5)[5.0 x (417, where 5.0 kWh3/yr is the estimated hot water heating 19 g = real growth of electricity price = 2%, r = real load; column (71, (6)cl1.467, where 11.46 = c t=o
120
New York
:
70
Location
Note
Size (ft2)
(1)
Table 1. Present value of electricity saved using current tariff schedules.
Three policy issues related to the commercializationof solar energy
63
As Table 1 indicates, the National Energy Act (NEA) solar tax credits (30% of the first $2000 and 20% of the next $8000) make solar water heating competitive in two of the three locations. As the footnotes of Table 1 indicate, the value of the electricity saved by solar systems in column (7) was calculated using the present average cost tariff structures now in effect in each area. Suppose a tariff structure that better reflected the “true value” of the energy freed were substituted; how would the present value calculation change? “True values” are here taken to mean the value of the goods and services given up by society when additional units of electricity are purchased (or as the case here, received when additional units are not consumed). Such true values, or opportunity costs, can differ from the average prices listed in column (5) of Table 1 for a number of reasons. Of primary interest here are (1) departures due to differences between the cost of new and old generating capacity and (2) departures due to differences between the cost of generating peak and off-peak power. Both play a role in correctly valuing the electricity freed by the solar systems. In this calculation, it will be assumed that both the conventional hot water heating systems and the solar systems replacing them are equipped with devices that allow off-peak pre-charging. This is a reasonable assumption since by the mid-1980s the earliest period when solar equipment is likely to achieve any substantial market penetration, it is very likely that many new hot water heaters will have this capability, given the encouragement for such systems contained in the National Energy Act and current interest shown in such load management systems by the electric utilities. Since conventional and solar systems allow off-peak precharging, the value of both the electricity saved and the cost of backup electricity is the off-peak value. The calculations must be done with some care, since the off-peak value may be larger than the simple short-run, marginal cost of electricity (usually the fuel and operating costs) now in use as a basis for off-peak tariffs. This can come about if the block of off-peak electricity freed by solar is large enough to allow the utility to postpone its expansion plans. In such circumstances, the present value of the delay in capacity expansion plans should be credited to the solar system. The impact of the solar systems on goth the operating and expansion plans has been calculated for the cities in Table 1 using an algorithm, “WASP II”, developed for this purpose. This program provided data necessary to calculate the value of electricity freed and the cost of backup electricity for both cases, for a given level of market penetration in the systems studied. Columns (1) and (2) of Table 9 give the pertinent data. The “all-electric” cost per kilowatt-hour gives the value per megawatt-hour of electricity freed by the solar system, while the “solar” cost per kilowatt-hour gives the cost per megawatt-hour of electricity used for solar backup. Columns (3) (4) and (5) use these data to compute the present value of electricity saved. In every instance, the results are the same: the value of electricity freed by solar, given in column (5) of Table 2, is reduced below that in column (7) of Table 1. Thus, moving to off-peak replacement cost pricing when precharging is available would discourage the use of solar energy in the cases examined. Even though the growth rates of long-run off-peak power are all higher than that assumed for average costs, they cannot offset the lower initial cost of generating off-peak power. Indeed, the conclusion implied is that solar energy, when it replaces all-electric off-peak hot water systems, far from deserving a subsidy because of present (avarage embedded cost) electric utility pricing practices is already receiving such a subsidy. If tariffs were put into effect that allowed the price of electricity to better reflect true electricity costs for the utilities studied, solar hot water heating would have a more difficult time competing economically than is now the case. Thus, for the cases studied, requiring the value of electricity freed by solar energy utilization to reflect its long-run marginal cost in the loadmanaged case reduces the economic viability of solar water heating. Proponents of additional subsidies for solar in those regions must look elsewhere than the inefficient pricing practices of utilities for support of their cause. Underpricingof conventionalfuels Advocates of solar energy development assert that conventional energy sources are sys-
F.T. SPARROW Table 2. Present value of electricity saved using marginal costs.
LO&
managed
All electric Solar
Load managed All electric Solar
19.15
30.78
__
32.20
56.50
135.91
17.30
22.90
--
--
__
New Mexico Load managed All
electric
Solar
Note:
249 _-
1,595 --
times (3) where r = 9%, and g calculated (5) calculated by 'f g=l from (3) and (4): gNy = 1.033; gwISC = 1.029; gNMEX = 1.031.
column
tematically underpriced due to a variety of government programs; hence, the competition between solar energy and electricity is unfair, since electricity prices are subsidized. For the nuclear industry, they cite the enormous research and development investment made by the government in the civilian reactor development program, the indirect subsidy received by the industry because enrichment plants sold (and sell) their services below cost, and the nonquantiflable cost of the Price Anderson Act. A recent study by the Battelle Institute estimated that such subsidies amounted to $18 billion through 1977.*The same study estimated that the hydroelectric power industry received $15 billion in subsidies, that the oil industry received $101billion, that natural gas subsidies amounted to $16 billion, and that another $51 billion in subsidies have been granted for electric power generation, transmission, and distribution. This study represents the most comprehensive effort, to date, to consistently measure federal subsidies for energy development. The task here is to convert those historical subsidies into estimates of how much these subsidies reduce current energy prices paid by investorowned utilities below their true opportunity cost. This presents several difficulties. In another article the author has argued that to convert these past subsidies into a measure of current underpricing of fuels for utilities, several adjustments must be made: (1) Elimination of subsidies that do not affect the cost of electricity generation. (2) Separation of “proper” subsidies from “improper” ones and elimination of the “improper” subsidies. Thus, the subsidy arising from the expensing of intangible drilling costs should be kept, since it encouraged exploration and increased reserves. The subsidy arising from the depletion allowance should be eliminated since it tended to draw down reserves, a now inappropriate motive. (3) Elimination of past, or “sunk”, subsidies, leaving only those subsidies that allow current energy sources to be sold below current cost. After adjustment for these factors, the degree of underpricing for nuclear power was estimated at 7% of the current cost, while the underpricing of the purchase cost of coal, oil, and gas to the utilities was estimated at 3, 27, and 13%,respectively. Given recent events, it is not convincing to argue that a 7% increase in the cost of nuclear power will fully cover the degree of underpricing now present. The cost of the Three Mile Island incident is already estimated at $1 to $2 billion, and still growing. To err on the
Three policy issues related to the commercialization of solar energy
65
conservative side, the assumption was made that none of the utilities considered is allowed to construct any new nuclear plants. Table 3 presents the results of the analysis of the value of electricity freed using the unsubsidized costs of the previous analysis in the WASP II algorithm. This table presents some interesting results. Most importantly, a comparison of column (4) in Table 2 with column (2) of Table 3 reveals the highly counterintuitive result that inserting the higher unsubsidized fuel and nuclear costs lead to lower off-peak costs and, hence, lower values of electricity freed for the late 199Os,rather than higher off-peak costs. The reason for this is instructive and serves as a warning for *‘intuitively obvious” conclusions in this highly complex area.
Table 3. Present value of electricitv saved using unsubsidized marginal costs.
$ value of Electricit
Load managed All electric Solar WisconsTn Load managed All electric Solar New Mexico Load managed All electric SOl.XK
Note:
Column
(5) calculated as before except gNy = 1.01; gwIsC = 1.017; gNMEX = 1.019.
In the case of the New York utility, Long Island Light Company (LILCO), higher fuel costs induced a revamping of capacity expansion plans, which led to more capital-intensive methods of generating electricity. The generating mix shifted to more baseload plants and less peaking plants, plus moved forward in time the date of expansion of baseload capacity. While this change shows increased average cost per megawatt-hour from $81.50 to $87.50 in 2000, the off-peak marginal cost shows a decrease from $41.00 to $36.00 for the all-electric load-managed case and from $33.20 to $31.70 for the solar load-managed case. The reason is that once the more capital-intensive expansion plan was in place, containing as it did more new low variable cost base plants earlier than was previously the case, the marginal off-peak cost of operating the new mix of plant was less than before. This was because the off-peak optimal mix of fuels changed in response to the more capital-intensive generating mix induced by the increase in fuel cost. The adjustment in the mix was more than enough to offset the increase in off-peak cost caused by the fuel price rises. Does the use of unsubsidized marginal costs increase or decrease the present value of energy saved when current tariff schedules are used? A comparison of the results of column (5) of Table 3 with the present value of fuel saved in column (7) of Table 1 indicates that for two of three localities, net effect of (1) use of marginal, not average, costs; and (2) the removal of subsidies now currently given, oil, coal, gas, and nuclear power result in a decrease in the value of electricity freed by solar. Only in the New Mexico cases does the value increase from $1,688 to $1,930. Thus, we conclude that present pricing practices in two of the three sites studied produce a hidden subsidy for solar energy, even if the value of the energy freed is corrected for
66
F.T.SPARROW
the supposed biases in both the pricing practices of utilities and the subsidies to conventional fuels.
SOLARENERGYANDNATIONALGOALS
Support for subsidies above and beyond those to which solar is “entitled” can be found to a differing degree in solar energy’s contribution to a variety of “national goals”. “Project Independence”-the title originally given the massive effort started in 1973 to reduce U.S. dependence upon foreign oil for national security and balance of payments reasons-is still a major focus of U.S. energy policy. Thus, programs that reduce oil imports, such as the solar energy program, can be justified but only to the extent that they are cost-effective means of achieving the independence goal. If additional solar subsidies are to be justified by an appeal to this national goal, it must be determined that such subsidies are a more cost-effective way of achieving energy independence than the more direct methods of import quotas or strategic oil reserve strategies. Solar programs can also appeal to the often stated but seldom quantified resource conservation national goal-to minimize the use of nonrenewable resources to preserve them for the use of future generations. Again, the issue here is whether or not solar energy programs are more cost-effective than, say, direct energy conservation programs in achieving this end. The same goes for the potential contribution solar energy might make to a cleaner and safer environment, or to the extent that solar energy might promote competition in an industry dominated by monopolies and corporate giants, reduce U.S. dependence on large centralized technologies, reduce inflation and unemployment, or whatever. The key point is that solar must be shown to be more cost-effective in achieving these goals than other federal programs that are also scrambling for such blessings. Blessings are a scarce resource; they should be allocated wisely. All the above is not to say that solar energy is not the most cost-effective way of achieving these goals. It is only to make the perhaps obvious point that a simple listing of the set of national goals that solar energy is consistent with is only a necessary, but hardly sufficient, condition for further soar subsidies. Employment and pollution eflects of solar energy Two of the foregoing national goals-reduction in pollution and reduction in unemployment-have received so much attention by solar researchers that they deserve special consideration. The methodologies used to analyze both issues distinguish between three types of effects: (1) Direct, or short-run, pollution and employment effects are changes that arise immediately from the substitution of solar energy for conventional energy-the change in the labor or pollution levels associated with the direct manufacturing, construction, and operation of the energy system. The critical assumption here is the specific form of the substitution scenario: (1) the choice of the common demand, e.g. hot water, heating, cooling, etc.; and (2) the form of the displaced energy, e.g. gas, oil, or electricity and if electricity, is it peak, intermediate, or baseload that is displaced, and for how long. (2) Indirect, or long-run, pollution and employment effects are changes that arise elsewhere in the economic system as a result of the substitutions. The focus here is on the impact on industries that supply the solar and conventional energy industries. The copper industry, which supplies the pipes for solar collectors, is stimulated, while industries that provide the raw materials for the capital equipment for conventional fuel plants-steel for the turbines, boilers and the like-see output decreasing. The changes in employment and pollution caused by the readjustment of the outputs of these and all the other industries affected by the substitution must also be calculated. The methodology usually adopted involves the use of an input/output table with both labor and environmental sectors (or models that can be attached to such tables) that can be used to capture all the ripple effects of any postulated change in the composition of final demand. (3) The macroeconomic, or “income”, effects of the substitution are the initial substitution and its ripple effects that may set in motion changes in the aggregate level of economic activity because of increased spending and increased use of otherwise idle resources. This may change
67
Three policy issues related to the commercialization of solar energy
the demand for all goods and services, which starts yet another round of ripple effects, here based not on substitution effects but on net increases in all factor uses. The first, and most crucial, aspect of the problem is to specify the exact substitution scenario that is to take place. No single substitution scenario is really adequate, since the actual substitutions that take place will vary depending on the particular economics of each geographic region. In California, the immediate substitution will be between solar energy and gas to serve the hot water heating needs, while for the nation it will more likely be the substitution of solar for electric resistance heating of hot water or space heating. Turning first to the employment impact of solar energy substitution, Table 4, taken from Mason et al.,3 emphasizes the importance of the previous point-that the employment impact differs, depending upon what substitution scenario is assumed. Because the bulk of early market penetration will be concentrated in the substitution of solar water heaters for electric heaters, and because such a substitution will involve displacement of baseload (provided by coal or nuclear plants), the appropriate direct and indirect increase in jobs is between 2.5 and 2.8 new jobs per job displaced. Note, however, that any substitution scenario will lead to an increase in jobs, since all solar options have higher labor requirements than their conventional counterparts. Thus, the substitution scenario governs only the magnitude but not the sign of the change. Table 4. Unit labor requirements of conventional and solar energy technologies.
Technology Conventional electric utilities Coal LOW Btu High Btu Oil GdS Nuclear Solar nonelectric applications Water heating Water and space heating Water heating, space heating, and cooling Passive Solar-electric applications Wind Photovoltaic Solar thermal Biomass
source:
Person-Hours Direct Labor
per MMBtu of Oil Displaced Indirect Labor Total Labor
0.65 0.56 0.55 0.85 0.46
0.46 0.39 0.33 0.48 0.54
1.11 0.95 0.88 1.33 1.00
0.93 1.43
1.87 2.87
2.80 4.30
1.67 0.57
3.33 0.93
5.00 1.50
0.26 1.41 0.73
1.23 2.22 1.96
1.49 3.63 2.69
0.25
0.87
1.12
Ref. 3.
Several points are in order concerning the table. First, it does not indicate how the skill mix changes as a result of the substitution-only total jobs. While no definitive study has been reported, one survey paper indicates that “most of the solar and conservation projects examined in this section represent systems with lower skill requirements than conventional alternatives”.4 Second, the table does not indicate the timing of the impact, being a static, long-run analysis. In fact, the increase in employment associated with solar energy will take place well ahead of the decrease caused by the displacement effects. This is due to two facts; the labor involved in solar is concentrated in the manufacture and installation of the unit, with only minor labor demands (chiefly maintenance) over the rest of the life of the equipment. Conventional energy sources have their labor requirements spread out more evenly over the lifetime of their energy delivery systems; the labor bill of the fuel naturally dominates these lagged effects. Second, since most solar systems will use off-peak power, the mix of energy replaced in the case of hot water will probably not contain much peak, although some peak reductions are expected in certain utilities. The bulk of the decrease will be felt in the postponement of the capital expansion of baseload plants, and those are well into the future. Thus, in the near term, little if any reduction in the construction of new power plants can be expected, thus increasing the tendency for the solar labor effects to precede the conventional fuel labor displacement effects.
68
F. T. SPARROW
Third, the same learning curve effects that solar advocates are counting on to reduce the cost of solar over time must inevitably reduce the labor inputs, thus reducing the ratios implied in Table 4, since no such reductions are to be expected from the mature technologies that characterize conventional energy systems. Turning to the indirect labor market impact of the substitution of solar for conventional levels, only two studies are important to mention; others with severe methodological problems are discussed by Schachter.4 Peterson augmented an input/output matrix with solar heating and cooling technology activity that had inputs from the other industrial sectors as well as the labor sector; the fixed coefficients were obtained by questionnaires sent to solar system manufacturers and dealers.5 Next, a new vector of final demands that reflected the substitution of solar energy for electrical energy to satisfy a given space and water heating demand was specified; an estimate of $1 billion in solar sales by 1985 was assumed with a savings in electricity of $500 million. Absolute changes in employment cannot be obtained from the Peterson work; only Peterson’s relative direct and indirect employment impacts are of interest. In this regard, Peterson’s model shows that modest (-1%) changes in employment as sales can be expected in only four sectors-increases in copper ralling and drawing, primary copper metals, and copper ore mining, and a 1% decrease in electricity sales and employment.5 Clearly, more work is required in this area before a definitive answer can be given to the question of whether or not indirect employment effects will tend to reinforce or counteract solar’s direct employment advantage. The Energy Information Agency (EIA) 1978 effort addresses the issue of both the indirect and the induced employment impact of solar energy; another study is just getting underway that will cover much of the same ground in more rigorous fashion. The EIA study6 assessed the impact of 2.2 million solar heating and hot water installations by 1985; unfortunately, it is hobbled by .two unfortunate assumptions: (1) cost competitiveness of solar with conventional sources, i.e. the substitution of solar for conventional heating and cooling is done on a dollar-for-dollar basis, leaving total expenditures on HVAC unchanged; and (2) the reduction in electricity consumption is assumed to be reflected only in a proportionate reduction in fuel oil, all of which is assumed to be imported. The second part of point (I) is not unrealistic, but to assumed that solar displaces only fuel-oil-fired electric generators is unrealistic. In any event, using a macromodel to reflect changes in consumption and investment spending, the EIA report shows that the full (direct, indirect, induced) impact of the 2.2 million installations by 1985 will be to increase the gross national product (GNP) by 1 billion in 1985, increase investment by 0.7 billion, lower exports by 0.3 billion, and reduce unemployment by 0.1% (60,000 net new jobs). Reductions in employment due to the decline in electricity consumption amount to 7000 jobs, while the induced reduction in employment due to declines in personal consumption expenditures (solar expenditures are treated as new long-term investment) amounts to 14,000 jobs. While the microassumptions of both studies are suspect, the macroeconomic methodology is first rate. Nonetheless, the conclusion that the known direct employment advantage of solar is not offset by the indirect and induced employment effects is not contradicted by either study. Envjro~menfal impact of solar energy The environmental impact of solar energy has been approached in much the same way as its impact on the labor force. First, the immediate or direct impact of the substitution of solar for conventional power is calculated. Here the environmental impact of solar energy depends heavily on the type of solar energy being substituted. Heating, ventilation, and air conditioning (HVAC) is generally benign, except for accidental water pollution due to leakage of the anti-freeze in the system or other minor malfunctions of the heat recovery system. There was some concern expressed over the impact ofincreased surface reflectivity on the microclimate, but this appears to be a problem only in situations where there are large concentrations of reflective surfaces, such as in solar thermal “power tower” applications. Next, the form of the electric energy displaced is determined. The direct environmental improvement associated with the substitution of solar for conventional fuels is determined by what mix of peak, intermediate, and baseload is displaced and the characteristics of the generating plants providing the mix. Most utilities use nuclear or coal-fired baseload plants, with gas and oil used for intermediate
Three policy issues related to the commercialization of solar energy
69
and peak demand. The actual mix of nuclear, coal, gas, and oil will vary by region and within each region by the characteristics of the utilities providing the energy. In addition, since the regional market penetration of solar will differ, it is clear that the assessment of environmental impacts must be carried on at the regional, rather than on a national, level. The indirect or lagged impact of the substitution on the environment has been estimated using a regional (county level) input/output model of the economy augmented with an environmental sector.’ Other efforts, using a regional input/output framework developed by Almond are underway, but to date their results are not known. In addition, the Domestic Policy Review (DPR) estimated the environmental impact of solar, using the same methodologies, A MITRE Resources for the Future (RFF) study concluded that the environmental impact, measured by changes in residuals, is roughly the same with and without solar (or more properly, the observed change is within the margin of error at the measuring system). The fact that the residuals are shifted away from heavily populated regions means that pollution damages decrease with the substitution. This conclusion holds for the entire DPR mix of the various types of solar energy-biomass, solar thermal, wind, as well as solar heating and cooling, which is the focus of this paper. Unfortunately, the work to date does not allow the attribution of the environmental impact to the various forms of solar energy, but it can be safely assumed that since the substitution effect of solar heating and cooling is initially to improve the residuals picture, the indirect environmental effects will not offset this advantage. This result is in sharp contrast to the study reported on in Science. which indicates that the “risks from non-conventional energy systems can be substantially higher than those of some conventional system”.8 Specifically, the study concluded that solar space heating will produce a higher number of man-days lost per megawatt-year than nuclear (by a factor of IO), natural gas (by a faotor of 12). or hydropower (by a factor of 20) but less than coal( by a factor of 30) and oil (by a factor of 20). However, it is not clear whether solar space heating was assumed to require backup or not, Since it is well established that it will require backup, assessing the results of the paper must await clarification of this point.
CRITERIA
FOR EVALUATING
NEW SOLAR INCENTIVES
What criteria should be used for evaluating any new solar incentives? The evaluation of the various incentive packages now planned or in effect at the federal, state, and local levels must await history; nonetheless, it is instructive to consider the criteria that have been suggested for evaluating the options: (1) Is the incentive effective as to the total impact and the timing of the impact? (2) Is the incentive Qcient, in that the impact is achieved in a cost-effective manner? (3) Is the incentive equitable in that it does not unduly discriminate between “equals”? (4) Does the incentive reflect the underlying reason for government intervention? The issue of the effectiveness of a particular incentive hinges practically on whether or not it alone is capable of achieving some target solar market penetration, such as the stated goal of 2.5 million solar systems in 1985 as set forth in President Carter’s April 1977 energy program. In theory, the issue of effectiveness should be related to the degree the incentive corrects a known market deficiency. If conventional system prices are underpriced by 10% due to externalities, government controls, or whatever, then solar incentives should reduce solar prices by 10%. The only thing that would prevent any particular financing incentive from achieving a given goal would be that the dollar rebate required would exceed the total income from the particular tax source. In practice, problems develop (in the form of programs sacrificed that are financed by the tax) well before such levels are reached. Thus, the achievement of a solar goal through reliance on state and local property tax rebates would so vastly reduce the funds available for activities traditionally financed by such taxes (schools, police and fire protection, etc.) as to make it a political impossibility. This does not mean that some of the subsidy should not be paid from these funds, particularly if some of the benefits of solar accrue to those who pay such taxes. (If only solar energy would reduce fires and crime!) In fact, at one time it was proposed that only citizens of states or municipalities that had passed some form of tax rebate would qualify for the federal tax rebate, since it was argued that a portion of the benefits (lower pollution) of solar do accrue to those in the immediate vicinity of the solar equipment.
70
F.T. SPARROW
Even if a given incentive has the capability of achieving a given goal, the question remains as to the timeliness of the achievement; is the goal achieved quickly, or does it take place only after considerable time has elapsed? Thus, an incentive program focused on new home installations is a prisoner of housing start projections; few homes will be built earlier because of the subsidies. (Indeed, the current slump in the U.S. housing market has been blamed for the absence to date of any major solar sales response of the passage of the National Energy Act and its contained solar subsidies.) If immediate response was desired, an incentive program that gave special attention to the retrofit market or one that gave the subsidy at the time of the sale and not at income tax time would be expected to be preferred. While on the topic of timing, the inordinate delay in the passage of the NEA has been blamed for the minirecession in the solar industry that took place in late 1977 and early 1978 as prospective buyers delayed their decision to purchase until the subsidy went into effect. Finally, the effectiveness of an incentive should be in part determined by how well it is tied to the achievement of a given goal. The ideal incentive is one that automatically disappears when the goal is achieved. Most studies have concluded that only income tax rebates or low-interest loans are effective enough to achieve the stated goals of the U.S. solar commercialization program. Although other incentives have significant advantages (in particular, in their ability to reflect the underlying reason for government action, i.e. avoidance of solar due to the risky nature of solar equipment could be remedied by government warranties), none appears to have the financial clout necessary. The Housing and Urban Development hot water experience indicates that incentives in the 1520% range do not stimulate the market, although the effect of the then impending NEA act clouds the issue. Once the given incentive has passed the effectiveness, or adequacy, test, it remains to determine if it achieves the goal in a more efficient and equitable manner than the other possibilities. The efficiency of a given incentive is determined by several factors. First, does it have the ability to mobilize bias and focus public attention? Here, the perceptions of the target group to be mobilized are the key. Is the target group more interested and aroused by tax credits than by low-interest loans? Unfortunately, there has been little research outside of one study, now two years old, on the relative leverage of the various incentives. This is primarily because most of the incentive research has been carried out by models that cannot distinguish between how a dollar’s worth of incentive is packaged; a dollar reduction is a dollar reduction, whether it is achieved through low-interest loans or tax subsidies. Nonetheless, there is considerable evidence that such “packaging” makes a real difference. A RUPI, Inc., study included a survey that asked potential solar purchasers to rank various incentive programs as to which they would prefer.’ The results indicated that federal rebates were preferred to tax reductions by a significant amount, while a tax rebate was slightly preferred to low-interest loan programs. One can only speculate on why the packaging of the subsidy seems to make a difference. The author’s own view is that interest rates are still considered by some as unjustified (even if they do not violate the usury laws, whose existence, incidentally, is the most telling evidence that the premise is true), and a reduction in an unjustified expense is not a very satisfying experience. In any event, low-interest loans do not seem to be as efficient per dollar in generating target group interest as tax subsidies or outright grants. A second aspect of the efficiency of a given incentive relates to the administrative costs associated with the program. The Internal Revenue Service will bear the brunt of the administrative cost of the tax incentive, while the administration of an interest subsidy program (or a direct loan program) would involve the creation of a new REA-like agency or an extension of the Small Business Administration, an agency with a history of dealing with subsidized loans. At this point, it is not clear which of the various incentive plans would have the lowest administrative costs. The efficiency of a given incentive is determined more than anything else by the degree of windfall gains it generates-the percentage of the target group who would have purchased solar even without the subsidy, during the period of the subsidy, or after the subsidy expired, but moved up their purchase date. (For instance, the example of New Home Tax Credit of 1975, which apparently had a windfall factor of 90% or more and cost taxpayers $750 million, is to be avoided at all costs.) Pure transfer effects-money taken from one taxpayer’s pocket and put
Three policy issues related to the commercialization of solar energy
71
into another’s with no attendant change in the actions of the beneficiary-are always present in any government program designed to change the behavior of the population. It is important to recognize that windfall effects illustrate two types of costs associated with any government subsidy, the solar subsidy in particular: (1) transfer costs, which represent transfers of income from one class of taxpayers to another but, in terms of the nation as a whole, cancel themselves out; and (2) real costs, which represent the value of the bundle of goods and services foregone or used up as a result of the particular subsidy. Both costs are important to the policy maker, but the real costs of the solar incentive are the key to evaluating the efficiency of the solar subsidy. Windfall effects are pure transfers of income to one class of citizenry (those who would have purchased solar without the subsidy) from another (the average taxpayer). Real costs include administrative cost, which measures the value of administrative and bureaucratic services the nation must do without as a result of the subsidy, and the value of the additional resources diverted from other uses in the form of labor and material. To the extent that such resources were idle, they do not represent real costs; hence, the great interest in the deskilling aspects of solar vis-a-vis nuclear or fossil energy. Conversely, the real benefits of a solar subsidy should measure the value of the bundle of goods (energy in particular) and services conserved by the action. Finally, the efficiency of a given incentive should relate real benefits achieved to real costs and ignore the various transfer effects associated with the action. This is not an easy task; it is quite difficult to measure the real costs and benefits and extremely easy to measure transfer costs. Nonetheless, it should be attempted, unless the nation wants to delude itself into thinking that the cost of an incentive is the dollar value of the subsidy times the number of installations. The issue of the fairness of a solar incentive-in the sense that it is “just’‘-has received much attention. Claims have been made that the bulk of the solar subsidies now benefit the wealthier segment of the population, since only they can afford (even with the subsidy) the luxury of solar-equipped homes or, worse, solar-heated swimming pools. Tied up in the equity issue is the question of who really receives the subsidy-the homeowner, the solar installer, the contractor, the developer, or the solar manufacturer? In the first instance, the owner receives it; but to what extent will a portion of the incentive be passed on up the production chain in the form of higher prices as the incentive strengthens the demand for solar systems? As some have suggested, is one man’s solar incentive another man’s tax loophole? The Solar Energy Industries Association correctly identified the equity issue as a major problem that would surface as soon as the incentives in the NEA began to have an effect. To their credit, their incentive package called for the tax credits to be treated as taxable income, thus reducing their impact on the higher levels of income and reducing the amount of regressivity in the tax. Further, their package included actions that would allow the lower and middle classes to share in the benefits. These provisions were not included in the final form of the NEA, and the act runs the risk of being labeled regressive. Only time will tell; when the studies planned on the impact of the subsidy are released, the full degree of regressivity will become apparent, as will the degree to which the subsidy was passed back to the installer or manufacturer in the form of higher prices. Finally, to the maximum extent possible, the amount and packaging of a particular incentive should be tied to the original reason behind the need for the whole program in the first place. As mentioned previously, solar subsidies for the most part have been put forth as a corrective action to alter the relative prices of solar and conventional fuels so they more accurately reflect national costs and benefits. It follows then that a fundamental criterion for such subsidies is their relation to the gap between national, or public, costs and benefits and private costs and benefits. For example, it is expected that with deregulation of oil and gas and the expected modifications in the pricing of electricity; that the true price, or replacement cost, of all forms of conventional energy will be close to the average price charged by 1985. Thus, if these were the only factors, an ideal solar subsidy would decrease in proportion to the narrowing of the gap and disappear completely in 1985 or whenever the gap disappeared. Similar arguments could be made concerning the necessity of regional variability of solar subsidies, to reflect regional differences in the gap. However, the administrative costs of such variable amount subsidies can be substantial, thus the NEA decision for a “one-step” decline from the full amount to zero in 1985.
12
F. T. SPARROW
REFERENCES 1. R. Bezdek and F. T. Sparrow, “Are Subsidies for Solar Energy Development Justified on the Basis of Economic Efficiency’?”Submitted for publication, April 1980. 2. F. T. Sparrow, “Critique of an Analysis of Federal Incentives Used to Stimulate Energy Production”, Proc. Federal Incentives Used to Stimulate Energy Production, Battelle Northwest Laboratories, Battelle Memorial Institute, Richland, Washington (June 1978). 3. B. Mason et al., “Solar Energy Commercialization and the Labor Market”, SERI/TP-53-123 (Dec. 1978). 4. M. Schachter, “The Job Creation Potential of Solar and Conservation: A Critical Evaluation”, DOE Internal Rep. (Nov. 1978). 5. C. Peterson, “Sector Specific Output and Employment Impacts of a Solar Space and Water Heating Industry”, National Science Foundation/Research Applied to National Needs Report (Dec. 1977). 6. “Macroeconomic and Sector Impacts of Installing 2.2 Million Residential Solar Units”, EZA Analysis Memorandum, Draft (1978). 7. M. D. Yolkell, Untitled SERI Draft Report on social benefits and costs of solar energy (Jan. 1979). 8. H. Inhaber, “Risk with Energy from Conventional and Non-Conventional Sources”, Science (23 Feb. 1979), pp. 718-723. 9. RUPI, Inc., “Federal Incentives for Solar Homes”, Final Report to the U.S. Department of Housing and Urban Development (July 1977). BIBLIOGRAPHY 1. Bennington G., et al., “An Economic Analysis of Solar Water and Space Heating”, Rep. M76-79, MITRE Corporation, Metrek Division, McLean, Virginia (Nov. 1976). 2. Bezdek, R., A. Hirshberg, and W. Babcock, “Economic Feasibility of Solar Water and Space Heating”, Science (23 Mar. 1979),pp. 1214-1220. 3. Bright R. and H. Davitian, “The Marginal Cost of Electricity Used as Backup for Solar Hot Water Systems: A Case Study”, Energy in press. 4. Cone B. W. and R. Bezdek, Energy 5,389 (1980). 5. Sparrow F. T., “Solar Energy Economics in the United States”, Proc. Znt.Symp., Non-Technical Obstacles to the Use of Solar Energy, Brussels (May 1980). 6. Yokel1M. D., “Economic Measurement of Energy Related Environmental Damages: A Workshop Summary”, SERZ/TP 52-058(Dec. 1978).
0~5442/82/01w61-12103.wi0 Pergamon Press Ltd
THREE POLICY ISSUES RELATED TO THE COMMERCIALIZATION OF SOLAR ENERGY F. T.
SPARROW
School of Industrial Engineering, Purdue University, West Lafayette, IN 47907,U.S.A. Abstract-The fundamental policy questions that require some resolution before the next steps are taken to speed solar commercialization are (1) Are present energy prices so biased by government action as to make “free competition” unfair to solar energy? (2) To what extent should solar energy be encouraged because it contributes to other less economic goals, such as maintenance of full employment and improved environmental quality? (3) What criteria should be used to evaluate any new solar incentives? The purpose of this paper is to summarize these issues and then draw conclusions from the entire body of research as to the “proper” role of the federal government in speeding the commercialization of solar energy. The organization of the paper follows the order of the points mentioned. Major conclusions are that (I) present pricing practices and government policies seem to result in energy prices already favoring solar energy in tow of the three locations studied; (2) solar energy seems to require more unskilled labor than the technologies it replaces and seems to be less polluting; and (3) although present incentives appear to be effective, i.e. they have the potential to generate the market impact expected of them, they do not fare particularly well when measured against the standard externality, efficiency, and equity criteria suggested by the economics profession.
INTRODUCTION
In several other articles, the author and his colleagues have raised a series of what appear to be fundamental policy issues that require some resolution before the next steps are taken to speed solar commercialization.1 (1) Are present energy prices so biased by government action as to make “free competition” unfair to solar energy? (2) To what extent should solar energy be encouraged because it contributes to other less economic goals, such as maintenance of full employment and improved environmental quality? (3) What criteria should be used to evaluate any new solar incentives? The purpose of this paper is to draw together and summarize these previous efforts and then to draw conclusions from the entire body of research as to the “proper” role of the federal government in speeding the commercialization of solar energy. The organization of the paper follows the order of the points mentioned. Each will be summarized, followed by a section presenting the general conclusions reached from a consideration of all the issues. PRESENT
ENERGY PRICES
Are present energy prices so biased by government action as to make “free competition” unfair to solar energy? Proponents of solar energy have maintained that efficient allocation of resources may not result from open competition between solar and conventional fuels because of (1) the methods used by utilities to charge the consumer for gas and electricity; (2) the history of favorable government treatment of the energy industries, which reduces the prices of conventional fuels; and (3) the nature of the tax laws, which among other things, allows businesses to deduct expenses whereas home-owners cannot and allows firms to expense fuel cost even though they must depreciate the capital cost of solar. A recent article and a report analyzed the current economic feasibility of both solar water heating systems and-combined water and space heating systems. Table 1 integrates the results of their analysis for three cities in the United States. The assumptions that underlie their analysis are (1) a real discount rate of 9%, which approximates a IO-year payback period; (2) a 2% annual real increase in electricity costs; (3) an installed cost of the solar system of $400 plus $22 per square foot of installed collector; (4) annual maintenance costs for the solar systems equal to 1.5% of installed cost; (5) optimal sizing of the installations; and (6) 1977 dollars used throughout.
37
Wisconsin
New Mexico
:
1,214
3,040
1,940
cost
(2)
849
2,232
1,358
After subsidy
cost
(31 (5) Average Elec. Price First Year ($ kWh3)
55.00 53.00 41.50
% Load Solar
66 78 71
(4)
147
206
181
Value of Elec. Saved, First Year (S)
(6)
1,688
2,368
2,074
(7) Present Value Of Elec. Saved, over 20 Years ($1
18.20
45.60
29.10
Maint. (S/YK.)
(8)
181
453
289
Present Value Maint. cost ($1
(9)
+293
-1,124
-155
(10) Present Vcilue C(7)(9)-(4)J NO Subsidy
+658
-317
+427
,9K:;1 with Subsidy
(11) Presenf Value
value of $100 annuity at 9%.
discount rate = 9%; column (81, (0.015)(2); and column (9), (8jc9.952
where 9.95 = 1
Column calculations and sources are as follows: column (2), 400 + 22[(l)], from Ref. B2; column (3). (2) minus the NEA tax credit of 30% of first $2,000, 20% of next $8,000; column (5), based on present tariffs that reflect average costs of electricity; column (6). (5)[5.0 x (417, where 5.0 kWh3/yr is the estimated hot water heating 19 g = real growth of electricity price = 2%, r = real load; column (71, (6)cl1.467, where 11.46 = c t=o
120
New York
:
70
Location
Note
Size (ft2)
(1)
Table 1. Present value of electricity saved using current tariff schedules.
Three policy issues related to the commercializationof solar energy
63
As Table 1 indicates, the National Energy Act (NEA) solar tax credits (30% of the first $2000 and 20% of the next $8000) make solar water heating competitive in two of the three locations. As the footnotes of Table 1 indicate, the value of the electricity saved by solar systems in column (7) was calculated using the present average cost tariff structures now in effect in each area. Suppose a tariff structure that better reflected the “true value” of the energy freed were substituted; how would the present value calculation change? “True values” are here taken to mean the value of the goods and services given up by society when additional units of electricity are purchased (or as the case here, received when additional units are not consumed). Such true values, or opportunity costs, can differ from the average prices listed in column (5) of Table 1 for a number of reasons. Of primary interest here are (1) departures due to differences between the cost of new and old generating capacity and (2) departures due to differences between the cost of generating peak and off-peak power. Both play a role in correctly valuing the electricity freed by the solar systems. In this calculation, it will be assumed that both the conventional hot water heating systems and the solar systems replacing them are equipped with devices that allow off-peak pre-charging. This is a reasonable assumption since by the mid-1980s the earliest period when solar equipment is likely to achieve any substantial market penetration, it is very likely that many new hot water heaters will have this capability, given the encouragement for such systems contained in the National Energy Act and current interest shown in such load management systems by the electric utilities. Since conventional and solar systems allow off-peak precharging, the value of both the electricity saved and the cost of backup electricity is the off-peak value. The calculations must be done with some care, since the off-peak value may be larger than the simple short-run, marginal cost of electricity (usually the fuel and operating costs) now in use as a basis for off-peak tariffs. This can come about if the block of off-peak electricity freed by solar is large enough to allow the utility to postpone its expansion plans. In such circumstances, the present value of the delay in capacity expansion plans should be credited to the solar system. The impact of the solar systems on goth the operating and expansion plans has been calculated for the cities in Table 1 using an algorithm, “WASP II”, developed for this purpose. This program provided data necessary to calculate the value of electricity freed and the cost of backup electricity for both cases, for a given level of market penetration in the systems studied. Columns (1) and (2) of Table 9 give the pertinent data. The “all-electric” cost per kilowatt-hour gives the value per megawatt-hour of electricity freed by the solar system, while the “solar” cost per kilowatt-hour gives the cost per megawatt-hour of electricity used for solar backup. Columns (3) (4) and (5) use these data to compute the present value of electricity saved. In every instance, the results are the same: the value of electricity freed by solar, given in column (5) of Table 2, is reduced below that in column (7) of Table 1. Thus, moving to off-peak replacement cost pricing when precharging is available would discourage the use of solar energy in the cases examined. Even though the growth rates of long-run off-peak power are all higher than that assumed for average costs, they cannot offset the lower initial cost of generating off-peak power. Indeed, the conclusion implied is that solar energy, when it replaces all-electric off-peak hot water systems, far from deserving a subsidy because of present (avarage embedded cost) electric utility pricing practices is already receiving such a subsidy. If tariffs were put into effect that allowed the price of electricity to better reflect true electricity costs for the utilities studied, solar hot water heating would have a more difficult time competing economically than is now the case. Thus, for the cases studied, requiring the value of electricity freed by solar energy utilization to reflect its long-run marginal cost in the loadmanaged case reduces the economic viability of solar water heating. Proponents of additional subsidies for solar in those regions must look elsewhere than the inefficient pricing practices of utilities for support of their cause. Underpricingof conventionalfuels Advocates of solar energy development assert that conventional energy sources are sys-
F.T. SPARROW Table 2. Present value of electricity saved using marginal costs.
LO&
managed
All electric Solar
Load managed All electric Solar
19.15
30.78
__
32.20
56.50
135.91
17.30
22.90
--
--
__
New Mexico Load managed All
electric
Solar
Note:
249 _-
1,595 --
times (3) where r = 9%, and g calculated (5) calculated by 'f g=l from (3) and (4): gNy = 1.033; gwISC = 1.029; gNMEX = 1.031.
column
tematically underpriced due to a variety of government programs; hence, the competition between solar energy and electricity is unfair, since electricity prices are subsidized. For the nuclear industry, they cite the enormous research and development investment made by the government in the civilian reactor development program, the indirect subsidy received by the industry because enrichment plants sold (and sell) their services below cost, and the nonquantiflable cost of the Price Anderson Act. A recent study by the Battelle Institute estimated that such subsidies amounted to $18 billion through 1977.*The same study estimated that the hydroelectric power industry received $15 billion in subsidies, that the oil industry received $101billion, that natural gas subsidies amounted to $16 billion, and that another $51 billion in subsidies have been granted for electric power generation, transmission, and distribution. This study represents the most comprehensive effort, to date, to consistently measure federal subsidies for energy development. The task here is to convert those historical subsidies into estimates of how much these subsidies reduce current energy prices paid by investorowned utilities below their true opportunity cost. This presents several difficulties. In another article the author has argued that to convert these past subsidies into a measure of current underpricing of fuels for utilities, several adjustments must be made: (1) Elimination of subsidies that do not affect the cost of electricity generation. (2) Separation of “proper” subsidies from “improper” ones and elimination of the “improper” subsidies. Thus, the subsidy arising from the expensing of intangible drilling costs should be kept, since it encouraged exploration and increased reserves. The subsidy arising from the depletion allowance should be eliminated since it tended to draw down reserves, a now inappropriate motive. (3) Elimination of past, or “sunk”, subsidies, leaving only those subsidies that allow current energy sources to be sold below current cost. After adjustment for these factors, the degree of underpricing for nuclear power was estimated at 7% of the current cost, while the underpricing of the purchase cost of coal, oil, and gas to the utilities was estimated at 3, 27, and 13%,respectively. Given recent events, it is not convincing to argue that a 7% increase in the cost of nuclear power will fully cover the degree of underpricing now present. The cost of the Three Mile Island incident is already estimated at $1 to $2 billion, and still growing. To err on the
Three policy issues related to the commercialization of solar energy
65
conservative side, the assumption was made that none of the utilities considered is allowed to construct any new nuclear plants. Table 3 presents the results of the analysis of the value of electricity freed using the unsubsidized costs of the previous analysis in the WASP II algorithm. This table presents some interesting results. Most importantly, a comparison of column (4) in Table 2 with column (2) of Table 3 reveals the highly counterintuitive result that inserting the higher unsubsidized fuel and nuclear costs lead to lower off-peak costs and, hence, lower values of electricity freed for the late 199Os,rather than higher off-peak costs. The reason for this is instructive and serves as a warning for *‘intuitively obvious” conclusions in this highly complex area.
Table 3. Present value of electricitv saved using unsubsidized marginal costs.
$ value of Electricit
Load managed All electric Solar WisconsTn Load managed All electric Solar New Mexico Load managed All electric SOl.XK
Note:
Column
(5) calculated as before except gNy = 1.01; gwIsC = 1.017; gNMEX = 1.019.
In the case of the New York utility, Long Island Light Company (LILCO), higher fuel costs induced a revamping of capacity expansion plans, which led to more capital-intensive methods of generating electricity. The generating mix shifted to more baseload plants and less peaking plants, plus moved forward in time the date of expansion of baseload capacity. While this change shows increased average cost per megawatt-hour from $81.50 to $87.50 in 2000, the off-peak marginal cost shows a decrease from $41.00 to $36.00 for the all-electric load-managed case and from $33.20 to $31.70 for the solar load-managed case. The reason is that once the more capital-intensive expansion plan was in place, containing as it did more new low variable cost base plants earlier than was previously the case, the marginal off-peak cost of operating the new mix of plant was less than before. This was because the off-peak optimal mix of fuels changed in response to the more capital-intensive generating mix induced by the increase in fuel cost. The adjustment in the mix was more than enough to offset the increase in off-peak cost caused by the fuel price rises. Does the use of unsubsidized marginal costs increase or decrease the present value of energy saved when current tariff schedules are used? A comparison of the results of column (5) of Table 3 with the present value of fuel saved in column (7) of Table 1 indicates that for two of three localities, net effect of (1) use of marginal, not average, costs; and (2) the removal of subsidies now currently given, oil, coal, gas, and nuclear power result in a decrease in the value of electricity freed by solar. Only in the New Mexico cases does the value increase from $1,688 to $1,930. Thus, we conclude that present pricing practices in two of the three sites studied produce a hidden subsidy for solar energy, even if the value of the energy freed is corrected for
66
F.T.SPARROW
the supposed biases in both the pricing practices of utilities and the subsidies to conventional fuels.
SOLARENERGYANDNATIONALGOALS
Support for subsidies above and beyond those to which solar is “entitled” can be found to a differing degree in solar energy’s contribution to a variety of “national goals”. “Project Independence”-the title originally given the massive effort started in 1973 to reduce U.S. dependence upon foreign oil for national security and balance of payments reasons-is still a major focus of U.S. energy policy. Thus, programs that reduce oil imports, such as the solar energy program, can be justified but only to the extent that they are cost-effective means of achieving the independence goal. If additional solar subsidies are to be justified by an appeal to this national goal, it must be determined that such subsidies are a more cost-effective way of achieving energy independence than the more direct methods of import quotas or strategic oil reserve strategies. Solar programs can also appeal to the often stated but seldom quantified resource conservation national goal-to minimize the use of nonrenewable resources to preserve them for the use of future generations. Again, the issue here is whether or not solar energy programs are more cost-effective than, say, direct energy conservation programs in achieving this end. The same goes for the potential contribution solar energy might make to a cleaner and safer environment, or to the extent that solar energy might promote competition in an industry dominated by monopolies and corporate giants, reduce U.S. dependence on large centralized technologies, reduce inflation and unemployment, or whatever. The key point is that solar must be shown to be more cost-effective in achieving these goals than other federal programs that are also scrambling for such blessings. Blessings are a scarce resource; they should be allocated wisely. All the above is not to say that solar energy is not the most cost-effective way of achieving these goals. It is only to make the perhaps obvious point that a simple listing of the set of national goals that solar energy is consistent with is only a necessary, but hardly sufficient, condition for further soar subsidies. Employment and pollution eflects of solar energy Two of the foregoing national goals-reduction in pollution and reduction in unemployment-have received so much attention by solar researchers that they deserve special consideration. The methodologies used to analyze both issues distinguish between three types of effects: (1) Direct, or short-run, pollution and employment effects are changes that arise immediately from the substitution of solar energy for conventional energy-the change in the labor or pollution levels associated with the direct manufacturing, construction, and operation of the energy system. The critical assumption here is the specific form of the substitution scenario: (1) the choice of the common demand, e.g. hot water, heating, cooling, etc.; and (2) the form of the displaced energy, e.g. gas, oil, or electricity and if electricity, is it peak, intermediate, or baseload that is displaced, and for how long. (2) Indirect, or long-run, pollution and employment effects are changes that arise elsewhere in the economic system as a result of the substitutions. The focus here is on the impact on industries that supply the solar and conventional energy industries. The copper industry, which supplies the pipes for solar collectors, is stimulated, while industries that provide the raw materials for the capital equipment for conventional fuel plants-steel for the turbines, boilers and the like-see output decreasing. The changes in employment and pollution caused by the readjustment of the outputs of these and all the other industries affected by the substitution must also be calculated. The methodology usually adopted involves the use of an input/output table with both labor and environmental sectors (or models that can be attached to such tables) that can be used to capture all the ripple effects of any postulated change in the composition of final demand. (3) The macroeconomic, or “income”, effects of the substitution are the initial substitution and its ripple effects that may set in motion changes in the aggregate level of economic activity because of increased spending and increased use of otherwise idle resources. This may change
67
Three policy issues related to the commercialization of solar energy
the demand for all goods and services, which starts yet another round of ripple effects, here based not on substitution effects but on net increases in all factor uses. The first, and most crucial, aspect of the problem is to specify the exact substitution scenario that is to take place. No single substitution scenario is really adequate, since the actual substitutions that take place will vary depending on the particular economics of each geographic region. In California, the immediate substitution will be between solar energy and gas to serve the hot water heating needs, while for the nation it will more likely be the substitution of solar for electric resistance heating of hot water or space heating. Turning first to the employment impact of solar energy substitution, Table 4, taken from Mason et al.,3 emphasizes the importance of the previous point-that the employment impact differs, depending upon what substitution scenario is assumed. Because the bulk of early market penetration will be concentrated in the substitution of solar water heaters for electric heaters, and because such a substitution will involve displacement of baseload (provided by coal or nuclear plants), the appropriate direct and indirect increase in jobs is between 2.5 and 2.8 new jobs per job displaced. Note, however, that any substitution scenario will lead to an increase in jobs, since all solar options have higher labor requirements than their conventional counterparts. Thus, the substitution scenario governs only the magnitude but not the sign of the change. Table 4. Unit labor requirements of conventional and solar energy technologies.
Technology Conventional electric utilities Coal LOW Btu High Btu Oil GdS Nuclear Solar nonelectric applications Water heating Water and space heating Water heating, space heating, and cooling Passive Solar-electric applications Wind Photovoltaic Solar thermal Biomass
source:
Person-Hours Direct Labor
per MMBtu of Oil Displaced Indirect Labor Total Labor
0.65 0.56 0.55 0.85 0.46
0.46 0.39 0.33 0.48 0.54
1.11 0.95 0.88 1.33 1.00
0.93 1.43
1.87 2.87
2.80 4.30
1.67 0.57
3.33 0.93
5.00 1.50
0.26 1.41 0.73
1.23 2.22 1.96
1.49 3.63 2.69
0.25
0.87
1.12
Ref. 3.
Several points are in order concerning the table. First, it does not indicate how the skill mix changes as a result of the substitution-only total jobs. While no definitive study has been reported, one survey paper indicates that “most of the solar and conservation projects examined in this section represent systems with lower skill requirements than conventional alternatives”.4 Second, the table does not indicate the timing of the impact, being a static, long-run analysis. In fact, the increase in employment associated with solar energy will take place well ahead of the decrease caused by the displacement effects. This is due to two facts; the labor involved in solar is concentrated in the manufacture and installation of the unit, with only minor labor demands (chiefly maintenance) over the rest of the life of the equipment. Conventional energy sources have their labor requirements spread out more evenly over the lifetime of their energy delivery systems; the labor bill of the fuel naturally dominates these lagged effects. Second, since most solar systems will use off-peak power, the mix of energy replaced in the case of hot water will probably not contain much peak, although some peak reductions are expected in certain utilities. The bulk of the decrease will be felt in the postponement of the capital expansion of baseload plants, and those are well into the future. Thus, in the near term, little if any reduction in the construction of new power plants can be expected, thus increasing the tendency for the solar labor effects to precede the conventional fuel labor displacement effects.
68
F. T. SPARROW
Third, the same learning curve effects that solar advocates are counting on to reduce the cost of solar over time must inevitably reduce the labor inputs, thus reducing the ratios implied in Table 4, since no such reductions are to be expected from the mature technologies that characterize conventional energy systems. Turning to the indirect labor market impact of the substitution of solar for conventional levels, only two studies are important to mention; others with severe methodological problems are discussed by Schachter.4 Peterson augmented an input/output matrix with solar heating and cooling technology activity that had inputs from the other industrial sectors as well as the labor sector; the fixed coefficients were obtained by questionnaires sent to solar system manufacturers and dealers.5 Next, a new vector of final demands that reflected the substitution of solar energy for electrical energy to satisfy a given space and water heating demand was specified; an estimate of $1 billion in solar sales by 1985 was assumed with a savings in electricity of $500 million. Absolute changes in employment cannot be obtained from the Peterson work; only Peterson’s relative direct and indirect employment impacts are of interest. In this regard, Peterson’s model shows that modest (-1%) changes in employment as sales can be expected in only four sectors-increases in copper ralling and drawing, primary copper metals, and copper ore mining, and a 1% decrease in electricity sales and employment.5 Clearly, more work is required in this area before a definitive answer can be given to the question of whether or not indirect employment effects will tend to reinforce or counteract solar’s direct employment advantage. The Energy Information Agency (EIA) 1978 effort addresses the issue of both the indirect and the induced employment impact of solar energy; another study is just getting underway that will cover much of the same ground in more rigorous fashion. The EIA study6 assessed the impact of 2.2 million solar heating and hot water installations by 1985; unfortunately, it is hobbled by .two unfortunate assumptions: (1) cost competitiveness of solar with conventional sources, i.e. the substitution of solar for conventional heating and cooling is done on a dollar-for-dollar basis, leaving total expenditures on HVAC unchanged; and (2) the reduction in electricity consumption is assumed to be reflected only in a proportionate reduction in fuel oil, all of which is assumed to be imported. The second part of point (I) is not unrealistic, but to assumed that solar displaces only fuel-oil-fired electric generators is unrealistic. In any event, using a macromodel to reflect changes in consumption and investment spending, the EIA report shows that the full (direct, indirect, induced) impact of the 2.2 million installations by 1985 will be to increase the gross national product (GNP) by 1 billion in 1985, increase investment by 0.7 billion, lower exports by 0.3 billion, and reduce unemployment by 0.1% (60,000 net new jobs). Reductions in employment due to the decline in electricity consumption amount to 7000 jobs, while the induced reduction in employment due to declines in personal consumption expenditures (solar expenditures are treated as new long-term investment) amounts to 14,000 jobs. While the microassumptions of both studies are suspect, the macroeconomic methodology is first rate. Nonetheless, the conclusion that the known direct employment advantage of solar is not offset by the indirect and induced employment effects is not contradicted by either study. Envjro~menfal impact of solar energy The environmental impact of solar energy has been approached in much the same way as its impact on the labor force. First, the immediate or direct impact of the substitution of solar for conventional power is calculated. Here the environmental impact of solar energy depends heavily on the type of solar energy being substituted. Heating, ventilation, and air conditioning (HVAC) is generally benign, except for accidental water pollution due to leakage of the anti-freeze in the system or other minor malfunctions of the heat recovery system. There was some concern expressed over the impact ofincreased surface reflectivity on the microclimate, but this appears to be a problem only in situations where there are large concentrations of reflective surfaces, such as in solar thermal “power tower” applications. Next, the form of the electric energy displaced is determined. The direct environmental improvement associated with the substitution of solar for conventional fuels is determined by what mix of peak, intermediate, and baseload is displaced and the characteristics of the generating plants providing the mix. Most utilities use nuclear or coal-fired baseload plants, with gas and oil used for intermediate
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and peak demand. The actual mix of nuclear, coal, gas, and oil will vary by region and within each region by the characteristics of the utilities providing the energy. In addition, since the regional market penetration of solar will differ, it is clear that the assessment of environmental impacts must be carried on at the regional, rather than on a national, level. The indirect or lagged impact of the substitution on the environment has been estimated using a regional (county level) input/output model of the economy augmented with an environmental sector.’ Other efforts, using a regional input/output framework developed by Almond are underway, but to date their results are not known. In addition, the Domestic Policy Review (DPR) estimated the environmental impact of solar, using the same methodologies, A MITRE Resources for the Future (RFF) study concluded that the environmental impact, measured by changes in residuals, is roughly the same with and without solar (or more properly, the observed change is within the margin of error at the measuring system). The fact that the residuals are shifted away from heavily populated regions means that pollution damages decrease with the substitution. This conclusion holds for the entire DPR mix of the various types of solar energy-biomass, solar thermal, wind, as well as solar heating and cooling, which is the focus of this paper. Unfortunately, the work to date does not allow the attribution of the environmental impact to the various forms of solar energy, but it can be safely assumed that since the substitution effect of solar heating and cooling is initially to improve the residuals picture, the indirect environmental effects will not offset this advantage. This result is in sharp contrast to the study reported on in Science. which indicates that the “risks from non-conventional energy systems can be substantially higher than those of some conventional system”.8 Specifically, the study concluded that solar space heating will produce a higher number of man-days lost per megawatt-year than nuclear (by a factor of IO), natural gas (by a faotor of 12). or hydropower (by a factor of 20) but less than coal( by a factor of 30) and oil (by a factor of 20). However, it is not clear whether solar space heating was assumed to require backup or not, Since it is well established that it will require backup, assessing the results of the paper must await clarification of this point.
CRITERIA
FOR EVALUATING
NEW SOLAR INCENTIVES
What criteria should be used for evaluating any new solar incentives? The evaluation of the various incentive packages now planned or in effect at the federal, state, and local levels must await history; nonetheless, it is instructive to consider the criteria that have been suggested for evaluating the options: (1) Is the incentive effective as to the total impact and the timing of the impact? (2) Is the incentive Qcient, in that the impact is achieved in a cost-effective manner? (3) Is the incentive equitable in that it does not unduly discriminate between “equals”? (4) Does the incentive reflect the underlying reason for government intervention? The issue of the effectiveness of a particular incentive hinges practically on whether or not it alone is capable of achieving some target solar market penetration, such as the stated goal of 2.5 million solar systems in 1985 as set forth in President Carter’s April 1977 energy program. In theory, the issue of effectiveness should be related to the degree the incentive corrects a known market deficiency. If conventional system prices are underpriced by 10% due to externalities, government controls, or whatever, then solar incentives should reduce solar prices by 10%. The only thing that would prevent any particular financing incentive from achieving a given goal would be that the dollar rebate required would exceed the total income from the particular tax source. In practice, problems develop (in the form of programs sacrificed that are financed by the tax) well before such levels are reached. Thus, the achievement of a solar goal through reliance on state and local property tax rebates would so vastly reduce the funds available for activities traditionally financed by such taxes (schools, police and fire protection, etc.) as to make it a political impossibility. This does not mean that some of the subsidy should not be paid from these funds, particularly if some of the benefits of solar accrue to those who pay such taxes. (If only solar energy would reduce fires and crime!) In fact, at one time it was proposed that only citizens of states or municipalities that had passed some form of tax rebate would qualify for the federal tax rebate, since it was argued that a portion of the benefits (lower pollution) of solar do accrue to those in the immediate vicinity of the solar equipment.
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Even if a given incentive has the capability of achieving a given goal, the question remains as to the timeliness of the achievement; is the goal achieved quickly, or does it take place only after considerable time has elapsed? Thus, an incentive program focused on new home installations is a prisoner of housing start projections; few homes will be built earlier because of the subsidies. (Indeed, the current slump in the U.S. housing market has been blamed for the absence to date of any major solar sales response of the passage of the National Energy Act and its contained solar subsidies.) If immediate response was desired, an incentive program that gave special attention to the retrofit market or one that gave the subsidy at the time of the sale and not at income tax time would be expected to be preferred. While on the topic of timing, the inordinate delay in the passage of the NEA has been blamed for the minirecession in the solar industry that took place in late 1977 and early 1978 as prospective buyers delayed their decision to purchase until the subsidy went into effect. Finally, the effectiveness of an incentive should be in part determined by how well it is tied to the achievement of a given goal. The ideal incentive is one that automatically disappears when the goal is achieved. Most studies have concluded that only income tax rebates or low-interest loans are effective enough to achieve the stated goals of the U.S. solar commercialization program. Although other incentives have significant advantages (in particular, in their ability to reflect the underlying reason for government action, i.e. avoidance of solar due to the risky nature of solar equipment could be remedied by government warranties), none appears to have the financial clout necessary. The Housing and Urban Development hot water experience indicates that incentives in the 1520% range do not stimulate the market, although the effect of the then impending NEA act clouds the issue. Once the given incentive has passed the effectiveness, or adequacy, test, it remains to determine if it achieves the goal in a more efficient and equitable manner than the other possibilities. The efficiency of a given incentive is determined by several factors. First, does it have the ability to mobilize bias and focus public attention? Here, the perceptions of the target group to be mobilized are the key. Is the target group more interested and aroused by tax credits than by low-interest loans? Unfortunately, there has been little research outside of one study, now two years old, on the relative leverage of the various incentives. This is primarily because most of the incentive research has been carried out by models that cannot distinguish between how a dollar’s worth of incentive is packaged; a dollar reduction is a dollar reduction, whether it is achieved through low-interest loans or tax subsidies. Nonetheless, there is considerable evidence that such “packaging” makes a real difference. A RUPI, Inc., study included a survey that asked potential solar purchasers to rank various incentive programs as to which they would prefer.’ The results indicated that federal rebates were preferred to tax reductions by a significant amount, while a tax rebate was slightly preferred to low-interest loan programs. One can only speculate on why the packaging of the subsidy seems to make a difference. The author’s own view is that interest rates are still considered by some as unjustified (even if they do not violate the usury laws, whose existence, incidentally, is the most telling evidence that the premise is true), and a reduction in an unjustified expense is not a very satisfying experience. In any event, low-interest loans do not seem to be as efficient per dollar in generating target group interest as tax subsidies or outright grants. A second aspect of the efficiency of a given incentive relates to the administrative costs associated with the program. The Internal Revenue Service will bear the brunt of the administrative cost of the tax incentive, while the administration of an interest subsidy program (or a direct loan program) would involve the creation of a new REA-like agency or an extension of the Small Business Administration, an agency with a history of dealing with subsidized loans. At this point, it is not clear which of the various incentive plans would have the lowest administrative costs. The efficiency of a given incentive is determined more than anything else by the degree of windfall gains it generates-the percentage of the target group who would have purchased solar even without the subsidy, during the period of the subsidy, or after the subsidy expired, but moved up their purchase date. (For instance, the example of New Home Tax Credit of 1975, which apparently had a windfall factor of 90% or more and cost taxpayers $750 million, is to be avoided at all costs.) Pure transfer effects-money taken from one taxpayer’s pocket and put
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into another’s with no attendant change in the actions of the beneficiary-are always present in any government program designed to change the behavior of the population. It is important to recognize that windfall effects illustrate two types of costs associated with any government subsidy, the solar subsidy in particular: (1) transfer costs, which represent transfers of income from one class of taxpayers to another but, in terms of the nation as a whole, cancel themselves out; and (2) real costs, which represent the value of the bundle of goods and services foregone or used up as a result of the particular subsidy. Both costs are important to the policy maker, but the real costs of the solar incentive are the key to evaluating the efficiency of the solar subsidy. Windfall effects are pure transfers of income to one class of citizenry (those who would have purchased solar without the subsidy) from another (the average taxpayer). Real costs include administrative cost, which measures the value of administrative and bureaucratic services the nation must do without as a result of the subsidy, and the value of the additional resources diverted from other uses in the form of labor and material. To the extent that such resources were idle, they do not represent real costs; hence, the great interest in the deskilling aspects of solar vis-a-vis nuclear or fossil energy. Conversely, the real benefits of a solar subsidy should measure the value of the bundle of goods (energy in particular) and services conserved by the action. Finally, the efficiency of a given incentive should relate real benefits achieved to real costs and ignore the various transfer effects associated with the action. This is not an easy task; it is quite difficult to measure the real costs and benefits and extremely easy to measure transfer costs. Nonetheless, it should be attempted, unless the nation wants to delude itself into thinking that the cost of an incentive is the dollar value of the subsidy times the number of installations. The issue of the fairness of a solar incentive-in the sense that it is “just’‘-has received much attention. Claims have been made that the bulk of the solar subsidies now benefit the wealthier segment of the population, since only they can afford (even with the subsidy) the luxury of solar-equipped homes or, worse, solar-heated swimming pools. Tied up in the equity issue is the question of who really receives the subsidy-the homeowner, the solar installer, the contractor, the developer, or the solar manufacturer? In the first instance, the owner receives it; but to what extent will a portion of the incentive be passed on up the production chain in the form of higher prices as the incentive strengthens the demand for solar systems? As some have suggested, is one man’s solar incentive another man’s tax loophole? The Solar Energy Industries Association correctly identified the equity issue as a major problem that would surface as soon as the incentives in the NEA began to have an effect. To their credit, their incentive package called for the tax credits to be treated as taxable income, thus reducing their impact on the higher levels of income and reducing the amount of regressivity in the tax. Further, their package included actions that would allow the lower and middle classes to share in the benefits. These provisions were not included in the final form of the NEA, and the act runs the risk of being labeled regressive. Only time will tell; when the studies planned on the impact of the subsidy are released, the full degree of regressivity will become apparent, as will the degree to which the subsidy was passed back to the installer or manufacturer in the form of higher prices. Finally, to the maximum extent possible, the amount and packaging of a particular incentive should be tied to the original reason behind the need for the whole program in the first place. As mentioned previously, solar subsidies for the most part have been put forth as a corrective action to alter the relative prices of solar and conventional fuels so they more accurately reflect national costs and benefits. It follows then that a fundamental criterion for such subsidies is their relation to the gap between national, or public, costs and benefits and private costs and benefits. For example, it is expected that with deregulation of oil and gas and the expected modifications in the pricing of electricity; that the true price, or replacement cost, of all forms of conventional energy will be close to the average price charged by 1985. Thus, if these were the only factors, an ideal solar subsidy would decrease in proportion to the narrowing of the gap and disappear completely in 1985 or whenever the gap disappeared. Similar arguments could be made concerning the necessity of regional variability of solar subsidies, to reflect regional differences in the gap. However, the administrative costs of such variable amount subsidies can be substantial, thus the NEA decision for a “one-step” decline from the full amount to zero in 1985.
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F. T. SPARROW
REFERENCES 1. R. Bezdek and F. T. Sparrow, “Are Subsidies for Solar Energy Development Justified on the Basis of Economic Efficiency’?”Submitted for publication, April 1980. 2. F. T. Sparrow, “Critique of an Analysis of Federal Incentives Used to Stimulate Energy Production”, Proc. Federal Incentives Used to Stimulate Energy Production, Battelle Northwest Laboratories, Battelle Memorial Institute, Richland, Washington (June 1978). 3. B. Mason et al., “Solar Energy Commercialization and the Labor Market”, SERI/TP-53-123 (Dec. 1978). 4. M. Schachter, “The Job Creation Potential of Solar and Conservation: A Critical Evaluation”, DOE Internal Rep. (Nov. 1978). 5. C. Peterson, “Sector Specific Output and Employment Impacts of a Solar Space and Water Heating Industry”, National Science Foundation/Research Applied to National Needs Report (Dec. 1977). 6. “Macroeconomic and Sector Impacts of Installing 2.2 Million Residential Solar Units”, EZA Analysis Memorandum, Draft (1978). 7. M. D. Yolkell, Untitled SERI Draft Report on social benefits and costs of solar energy (Jan. 1979). 8. H. Inhaber, “Risk with Energy from Conventional and Non-Conventional Sources”, Science (23 Feb. 1979), pp. 718-723. 9. RUPI, Inc., “Federal Incentives for Solar Homes”, Final Report to the U.S. Department of Housing and Urban Development (July 1977). BIBLIOGRAPHY 1. Bennington G., et al., “An Economic Analysis of Solar Water and Space Heating”, Rep. M76-79, MITRE Corporation, Metrek Division, McLean, Virginia (Nov. 1976). 2. Bezdek, R., A. Hirshberg, and W. Babcock, “Economic Feasibility of Solar Water and Space Heating”, Science (23 Mar. 1979),pp. 1214-1220. 3. Bright R. and H. Davitian, “The Marginal Cost of Electricity Used as Backup for Solar Hot Water Systems: A Case Study”, Energy in press. 4. Cone B. W. and R. Bezdek, Energy 5,389 (1980). 5. Sparrow F. T., “Solar Energy Economics in the United States”, Proc. Znt.Symp., Non-Technical Obstacles to the Use of Solar Energy, Brussels (May 1980). 6. Yokel1M. D., “Economic Measurement of Energy Related Environmental Damages: A Workshop Summary”, SERZ/TP 52-058(Dec. 1978).