Over the next 5+ years, oil prices will likely keep going up. In a blinding flash of the obvious, the Boston Globe (free registration required) argues higher oil prices will attract, guess what, more oil. That shouldn’t be a surprise to any economists out there. But most people assume that higher oil prices will open the door for solar/wind/hydrogen economy.
First, where is the oil going to come from? Alberta, Canada for one. Alberta is a Saudi Arabia right in the States’ backyard. The only trick is that the oil is in the form of oil sands. Getting the oil out of the oil sands requires “from 40 percent more to five times the emissions” of the traditional oil business.
So, if we want to move away from oil what can be done about it? There has been a lot of debate between a cap-and-trade system vs. a carbon tax. I won’t get into that here, except to say that either would be better than what we have now (which is nothing).
But I want to go a step further and argue for alternative energy subsidies and that such subsidies would move the energy market closer to a perfect competition. I’ll use solar as an example, but the same could be applied to wind, passive heat pumps, and any other environmentally benign energy.
The energy industry, by its nature, is a regulated monopoly. So, the starting point is already far from a perfect competition. How can we bring it closer to that ideal? There are many, but I will focus on one. Solar panels are still expensive. A subsidy would lower this cost, and with it the barriers to entry. More suppliers of electricity (individual homeowners) would then enter the market, something economists call “Atomicity.”
If the carbon tax is in effect, these homeowners can also enjoy further savings on their electricity from not having to pay as much of this tax. But this is not a type of savings humans are particularly good at enjoying. If I give you a dollar, you get more enjoyment than out of the abstract notion of having just saved a dollar. Cutting homeowners a subsidy check will be more motivating than their passive savings. I love getting my tax refund, even though I know it’s my money to begin with.
How big of a subsidy is needed? A good metric should be to provide a subsidy large enough to make solar competitive to other types of investments. Say the yield on Treasure Bills is 4.65%. A solar panel is not liquid since it’s difficult to sell it off your roof. It is also risky since it may get damaged or you may have a run of cloudy days. These factors introduce a premium of, for example, 1%. The subsidy should make the “yield” of installing a solar panel 5.65%.
Poke holes in my argument in the comments.
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