Bohanon: ‘Dr. Evil and Energy Subsidies’

June 10, 2013

by Cecil Bohanon, Ph.D.

All energy sources generate what economists call “external costs,” a concept Hoosiers will have to master to make sense of the current energy debate.

It also ends up that most energy sources have benefited from federal government subsidies. There is a great deal of controversy about how much the federal government actually subsidizes various energy sources. Ideological and industry advocates generally insist that the subsidy to their preferred method of energy generation is small and appropriate while the subsidy to other types of energy generation are large and unwarranted.

Windmills are not the biggest game-changer in today’s energy market — rather, it is fracking technology. By injecting large amounts of water mixed with other chemicals into existing oil and gas wells, old wells can yield more oil and gas. More important, previously unexploited deposits become economically feasible because of this technology.

There is nothing really new about fracking; continual technological improvements have allowed us to unlock lots of natural gas that was otherwise unavailable. Fracking has expanded drilling throughout the Midwest, including Indiana — and its future potential is enormous.

Just as all energy sources generate external costs, so does fracking. The process can contaminate ground water, and some suggest there is a link with increased seismic activity. And just as all energy sources have been subsidized by government policy, so has fracking.

A recent newspaper article draws an interesting distinction between two ways that fracking has been subsidized. I think it is of interest for energy subsidies in general.

According to Kevin Begos, fracking technology has received  “. . . about $137 million in gas research over three decades, and . . . federal tax credit for drillers amounted to $10 billion between 1980 and 2002.”

The interesting point is that the research subsidy for fracking is in the millions, while the drilling subsidy is in the billions. The story of government subsidies for wind-generation is similar: Research support is in the millions  but support for construction is in the billions.

The hit movie “Austin Powers” puts this in playful perspective. The arch-villain Dr. Evil comes back from the 1960s and devises a diabolical plot to destroy the world. He proposes to hold the world at ransom for a grand total of, get this, one million dollars. One of his partners in crime comments, “Don’t you think we should ask for more . . . a million dollars isn’t exactly a lot of money these days.” Convinced, Dr. Evil quickly ups the ante to $100 billion.

Millions or billions, leave-it-to-the-market folks like me are suspicious of state subsidies. Even market purists, however, can see a role for government support of basic research. Here is the distinction:

General knowledge (think the Pythagorean theorem) is difficult to discover, but, once discovered, it is both impractical and inadvisable to keep it hidden from general view. No one party has an incentive to discover such general knowledge because everyone gets the benefits from it. State-sponsored research can overcome this problem.

Specific knowledge (think which areas in Indiana are best suited for new energy production) can be obtained by interested commercial parties and can be enormously profitable to those parties; there is little justification for government to support this kind of endeavor.

So, if we must have federal subsidies for energy, it seems advisable to keep them to basic research, and avoid trying to support specific types of energy generation through direct or tax subsidies. And it is probably better to pay off Dr. Evil in 1963 terms rather than 2013 terms — with millions rather than billions.

Cecil Bohanon, Ph.D., an adjunct scholar with the Indiana Policy Review Foundation, is a professor of economics at Ball State University.



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