Editor note: August 30th marks the 4th anniversary of Milton Friedman’s death. This exchange with Robert Bradley–when Dr. Friedman was 91 years old–is testament to the mental powers of one of the greatest social thinkers of modern time.

Friedman had not met Bradley but was in the habit of actively communicating with scholars until his final illness.

I had heard that the great economist and social thinker Milton Friedman (1912–2006) was a prolific communicator with those who posed worthy questions to him. So when I got involved into mineral resource theory, which would culminate with my 2007 essay, Resourceship: An Austrian Theory of Mineral Resources, I asked Dr. Friedman in August 2003 about his views on the late Julian Simon (1932–98), specifically whether Simon’s work on resources, and his conception of the ultimate resource, merited a Nobel Prize in economics.

The discussion continued from there as I tried to flesh out his views of whether “depletable” minerals such as oil were somehow different from “nondepletable” resources. I believe Friedman agreed with Simon that there is no difference from a social science/business perspective. But Friedman disagreed with Simon’s assessment of the contribution of Harold Hotelling, who mathematically proved that the cost and thus price of a fixed resource in a world of perfect knowledge was ‘good’ economics. Read on….

FRIEDMAN TO BRADLEY, 9-4-03
—– Original Message —–
From: “Milton Friedman” <friedman@hoover.stanford.edu>
To: “Rob Bradley” <iertx@swbell.net>
Sent: Thursday, September 04, 2003 10:59 AM
Subject: Re: Questions for Milton Friedman

Dear Rob Bradley:

1. I doubt very much that Julian Simon would have been considered for a Nobel Prize in Economics if he had lived longer.

2. I think he probably should have been considered for a Nobel Prize.  He took a very independent position with little backing, dug deep and provided very good evidence for his predictions and expectations.

Sincerely yours,
Milton Friedman

BRADLEY TO FRIEDMAN, 9-6-03
Dear Dr. Friedman:

As a follow-up question relating to the below, I would like to better understand your view of natural resources and whether you think there is a separate economics of natural resources compared to general economic theory.

But first some background.

I have just completed writing a history of natural resource thought.  I summarize depletionism by looking at W.S. Jevons’ The Coal Question, Harold Hotelling, and other theories such as the bell curve of M. King Hubbert (a geologist) showing the life cycle of fossil fuel production.  Much of this is known at least peripherally by economists.

More originally, I also traced expansionism–a school of resource thought that has not been appreciated or formalized as such.  My “breakthrough” was discovering the writings of an institutional economist who was at North Carolina and then the University of Texas, Erich Zimmermann.  In his 1933 treatise, World Resources and Industry, he offered a “functional theory” of resources that argued that resource exist in the mind, not the ground.  That resources are dynamic concepts and come from subjective appraisals and changing technologies.  Instead of resources as a noun, think of the verb “resourcing” (my word, not his).  Zimmermann, anticipating Julian Simon by many decades, made the point that the greatest resource is the human mind–human ingenuity.

Thus Zimmermann (theoretically–see below) breaks out of the depletionist trap since resources are not seen as a blob.  If you think of resources as a fixed supply, you are caught in the depletionist trap.

Methodologically, his breakthrough is employing subjectivism rather than objective (fixed or given quantity) analysis–giving credence to a point Hayek once made that major advances in economics have come from new applications of subjectivism.

Thus Zimmermann to me deserves his place in the history of economic thought (very few know about him).  But his problem was going on to worry about overproduction and depletion in later chapters of his book, not understanding discount rates and capital values and that sort of thing.  So Zimmermann began a new paradigm of thought–expansionism–for others (Morry Adelman, Julian Simon, etc.) to independently advance.  I now am grappling with how to “close the loop” on this alternative view of the natural resource world.

Now to my questions.

Back around 1978 you wrote an essay, “The Energy Crisis: A Humane Solution” where you questioned the distinction between “renewable” and “nonrenewable” resources since oil, gas, and coal are “producible … at more or less constant or indeed declining cost because of the improvements in the technology of drilling and exploring and so on.”

This statement, during a time of record high oil and gas prices, was bold. It also predates most of the thinking of Julian Simon.  The person making the point was Morry Adelman of MIT who remained focused on production costs unlike so many Hotelling-inspired economists of the period.

1) How did you come to this view?  Was it because of Adelman, your own reflections given a number of studies that came out from the Paley Commission (1952) and books from Resources for the Future in the 1960s, or both?

2) do you believe there really is a natural resource economics in the sense that “depletable” resources have a fundamental difference from reproducible goods?

3) Do you believe, pending more research, that there might be an opposite “paradigm” (from depletionism) of resource expansionism where, indeed, natural resource prices on average can rise less than the rate of inflation because of the cascading effect of new knowledge and technology and expanding capital for mining?  There is a lot of evidence right now that resource prices from the 19th century to the present have increased less than the general basket of goods, but I am wondering if there is something systemic that can be theoretically anchored in the “nondepletable” and indeed expanding nature of knowledge and capital (in capitalistic settings).

4) Regarding #3, I wonder if there should be a prominent place in the economics Hall of Fame for Zimmermann, Adelman, Simon, and maybe a few others for helping to solve one of the riddles of economics, why “depletable” resources do not deplete, and maybe why “depletable” resources expand–or at least can expand over great periods of time.

I have a presentation at the annual Southern Economic Association meeting in November where I will outline these two “natural resource paradigms” in a history of thought speech, and everyone would be most interested in hearing your thoughts, your time permitting.

Best wishes, and many thanks, Rob Bradley

P.S. I have attached a PowerPoint illustrations of two heuristics–one of the “depletionist” bell curve and “expansionist” resource pyramid as a very simple way to contrast the two schools of thought.  Have you ever seen this heuristic?  Is it useful?

FRIEDMAN TO BRADLEY, 9-8-03
Dear Mr. Bradley:

The basic point I believe in your natural resource discussion is that the economic product in question is not coal or oil or natural gas but energy.

The question is, what is the supply curve of energy? The use of coal or oil is a simply a means of producing energy. The stock of coal, of oil, etc., is certainly in some sense finite, but that doesn’t mean that the potential amount of energy capable of being produced by whatever source is to be considered finite.

Energy will be produced in whatever way is cheapest at the time and as new means of producing energy are discovered the particular mode of producing energy will change from coal to oil to natural gas to atomic sources. That is the view expressed in the statement of mine that you quote.

In answer to your questions about that statement, I have absolutely no idea what led me to think of it except that it is straightforward simple economic analysis.

Re your second question, I do not believe there is a natural resource economics.  I believe there is good economics and bad economics.

Three, I do not believe what is involved is an obvious “paradigm.” The question is a factual one whether the long-run supply curve of energy (or other natural resource output), whether it is upward or downward sloping, is trending down.

I have not seen before the heuristics you attached. I do not find it particularly instructive.

Wish you luck at the November meeting.

Sincerely yours, Milton Friedman

————————————–2004————————————

BRADLEY TO FRIEDMAN, 10-5-04
Dear Dr. Friedman:

….  On a related matter, I must ask another favor and draw your attention to an important history-of-economic-thought matter.  It concerns the “mineral resource problem” (depletion) that has given rise to so much pessimism and alarmism.

Here is a simple four page article I wrote

http://www.energyrealism.org/running_out_oil.pdf

where I present a different way of viewing mineral resources.  I champion an institutional economist who was part of the University of Texas institutional school, Erich Zimmermann, who offers a different view of viewing resources from the Harold Hotelling “fixity” view and the “bell curve” of oil production of the late M. King Hubbert.

Two questions:

1) is the “functional theory of resources” (Zimmermann) a sound way to view the “mineral resource problem” (aka depletion) in your view.  Restated, is it “good economics”?

2) F.A. Hayek once remarked that major advances in economics have come from new applications of subjectivism.  I see the above as a challenge to the seductive objectivist, fixity view of minerals, whereupon each extraction reduces supply for the future.  Do you agree with Hayek’s methodological insight in general or in this instance in particular?

Your opinion will be important to share with other economists, and with your permission I will do so.  I feel there is some work to do in this area, even if it is just using the history of thought to get to a sounder base of thinking to address what is, once again, a major public policy issue.

Thank you so much, Rob Bradley

FRIEDMAN TO BRADLEY, 10-11-04
Dear Rob:

Mr. Zimmerman’s views are perfectly sensible  but I do not see in Mr. Zimmerman’s view an application of subjectivism. Indeed it is an implication of the Harold Hotelling analysis. On the Hotelling analysis a resource that is finite will exhibit increasing relative prices over time. In fact, oil has not done so; its price has been falling.  Hence, the Hotelling analysis implies that oil is not from an economic point of view a finite resource, that it is a producible commodity like most others which has an elastic supply curve, more elastic in the long run than in the short run. This point has been understood for a very long time.

This is good economics. I cannot see that it justifies a new category such as a “functional theory.”

I guess I do not agree with Hayek’s insight. I believe that most advances in economic theory come from attempting to explain phenomena which either were not important before or were not recognized as important before rather than from applications of subjectivism. Indeed, in this case, I do not see that subjectivism plays any special role in the correct analysis of the supply and price of oil. I have long argued that there is good economics and bad economics and that that distinction is basic much more so than distinctions between Austrian economics, classical economics, Chicago economics, etc., and I would add functional economics.

Sincerely yours, Milton Friedman

BRADLEY TO FRIEDMAN, 10-14-04
Dear Dr. Friedman:

The categories “good” and “bad” economics may not go far enough in my view.

I propose to take an additional step to delineate between technically correct (and worthwhile) economics and economics that is superior for real-world understanding and policymaking.  There is a lot of economics that is technically correct but misleading, even diversionary.  Such economics must be handled with great care, particularly with students and policymakers who need to get the big picture.

I believe that at least in an Economics 101 sense, “good economics” as you define it can be at odds.  Here is my example returning to Zimmermann versus Hotelling.

Harold Hotelling in his 1931 article complained that standard economic theory was “plainly inadequate for an industry in which the indefinite maintenance of a steady rate of production is a physical impossibility, and which is therefore bound to decline.”  He did not qualify this statement elsewhere in the article and even brought in the real world relevance of his demonstration.

Hotelling was wed to the fixity notion of resources, and not surprisingly, a whole literature developed in the 1970s looking for the depletion signal.

The collateral damage went further.  Some economists at Resources for the Future, previously a bastion of expansive-resource thought, fell into the depletionist trap of predicting that oil and gas prices had to rise.  And you know what James Schlesinger and others in government were saying.  This came out of the seductive demonstration of Hotelling in part, maybe large part.

Zimmermann’s “good economics”–which would have interpreted the 1970s price behavior in institutional terms–was completely lost in the debate, although M. A. Adelman and others brought in some of his ideas through the back door.

Thus as we return to a 1970s-type mentality, I am trying to resurrect Zimmermann’s approach as “better economics” to Hotelling’s “good economics.”

I am trying to get the profession to not look for a “depletion signal” and focus on property rights and other institutional factors to explain the change in petroleum scarcity.

I believe that you see the approaches of Hotelling and Zimmermann both as good economics.  Forgetting labels such as Zimmermann’s “functional theory” and Hotelling’s “fixity theory,” would you go so far as to say that Zimmermann’s approach is “superior” economics to Hotelling’s “good economics.”  Perhaps there are two answers: one as a theoretical economist and one as a historian of economic thought.

My answer is the same: I see better theory as real-world oriented and then can look back to see examples like the above (and like Schumpeter’s attack on equilibrium competition theory) as bad in practice as far as education and policymaking go.

Perhaps from the above there could be three rather than two categories: bad economics, correct economics, and good economics.

I appreciate this exchange and believe it will be a contribution to the history of economic thought.

Sincerely, Rob Bradley Jr.

FRIEDMAN TO BRADLEY, 10-15-04
Dear Rob:

If you use a tool that is designed well for one purpose for a purpose for which it is not suited, that does not detract from the goodness of the tool for its purpose. The same thing goes with economics.  Hotelling’s analysis is good economics. If it is applied properly to the case of oil it produces the right result, namely that oil is not as an economic matter an exhaustible resource. That result follows from the Hotelling demonstration that an exhaustible resource will have a price that is rising over time.

Since the price of oil was not declining over time, it is not economically an exhaustible resource.

Zimmerman’s using Hotelling properly and drawing the right conclusion rather than the wrong conclusion is good economics and to be applauded, but it is not a different kind of economics and it does not mean that his economics is superior to Hotelling’s economics.

I must confess that I tend to stay away from this kind of methodenstriet. I have always said that I would prefer to do economics to talking about how economics should be done or was done or is done.

As a matter of full disclosure, I should note that Harold Hotelling was my teacher. I took both mathematical statistics and mathematical economics from him. He was a great teacher and had a good deal of influence on me. I have no doubt that if he himself had applied his study of exhaustible resources and looked at the data, he would have come to the right conclusion from it.

Sincerely yours,

Milton Friedman
Senior Research Fellow
Hoover Institution
434 Galvez Mall
Stanford, CA 94305-6010

A Look Back

What can I say about the opportunity to exchange such as scholar. And not the depth of his knowledge at such an advanced age. Milton Friedman died with his spurs on, as they say in Texas.

Friedman helped me in another way by endorsing a primer written by Richard Fulmer and myself, Energy: The Master Resource (Kendall-Hunt, 2004). He provided a quotation that was too late for the printed copy, but in the brochure we had his following words:

This splendid book effectively debunks the widespread predictions of energy doom. Its factual base is comprehensive, its exposition clear and straightforward, and its economic reasoning sound.

I think of these words on my rainy days. My what a scholar said them, and what a scholar I want to be having received them!

Long live Milton Friedman who would be 98 this July 31.

The anticipated rate shock gets worse for New Mexicans: a nearly 50% rate hike in five years. While PNM claims New Mexico still has some of the lowest rates in the country, the citizens are not taking the preventable increase lying down. David King, chairman of the New Mexico Public Regulation Commission (PRC), for example, calls the rate increase a “hot potato” saying that he’s received “a flood of calls from ratepayers.”

Public Outcry

During the month of July, PNM has been holding Public Forums through out their service area regarding their Integrated Resource Plan (IRP). The flyer promoting the event invited the “public” to join in on the discussion on topics such as “To what degree are consumers willing to pay more for a different combination of power sources?” The news about the proposed rate increase came out at the same time as the forums were scheduled. While PNM had a set program they’d planned to deliver, the attendees had little interest in the PNM’s dog-and-pony show.

I attended the forum in Santa Fe—the second they held in the state. The anger in the room was palpable. The woman leading the meeting for PNM admirably accepted being pelted with questions about the rate increase.

One questioner asked, “To what is this rate increase going?”

“Environmental improvements,” was the answer.

The questioner asked about  the $330 million PNM spent as a result of a lawsuit filed against them by the Sierra Club. There was acknowledgment that this was accurate. The questioner continued, “I understand that PNM did not fight the lawsuit?” Again, affirmed. “He commented, “You could have hired the best lawyers in the country for $330 million.”

So, the Sierra Club is one contributor to the increase. The current rate increases do not include much of the additional costs for renewables–but they are coming. The Santa Fe Reporter asked about the rate increase, “Does that mean there could be another rate increase in the future to pay for the costs of complying with renewable energy requirements?” The PNM representative, replied, “The answer is ‘yes.’”

Finally, a marketing executive from PNM had to come and quiet the crowd. He told us that they need to “get through the program.” Clearly the program was more important than customer feedback.

Once the PowerPoint presentation was over, another PNM representative attempted to guide us through an “exercise.” There were audible moans at the implication that we were now going to play a “game.”

We had to choose whether we’d prefer option #1, “Maintain reliable energy access and keep the lights on,” or option #2, “Minimize customer rates for energy.” The distributed solar group was angry that their choice was not even presented on the five point/30 minute exercise. Those who were there to express their frustration over the rate increase didn’t like the exercise—which some called “insulting.” One woman stood up in disgust and exclaimed, “this is ridiculous.” With that she stomped out.

The meeting went downhill from there and the exercise was abandoned. The man who earlier attempted to calm the crowd, called me out specifically, “Marita, this is the wrong place for you and your group. You need to be at the PRC [New Mexico Public Regulation Commision] Hearing.”

I assured him we’d be there too (it is scheduled for December when anger over the rate request will presumably have died down). People dribbled out of the meeting room while the facilitator let people vent their frustrations–but the damage had been done. Instead of building coalitions or making allies, PNM antagonized most of the “public” who had attended the forum.

I received similar reports from CARE (Citizens’ Alliance for Responsible Energy) friends from both the Albuquerque and Los Lunas forums—though after the raucous time in Santa Fe, they did seem to stick to the agenda more tightly.

Time to Undo New Mexico’s RPS?

PNM was the focus of the public’s wrath. But the fault goes to New Mexico’s Public Regulation Commission and other elected representatives who voted for renewable portfolio standards and other measures that increase energy costs.

In 2009 and the New Mexico State Legislature unanimously passed a bill that upped the percentage of electricity generated by renewables by 2011 from the current mandate of 6% to 10%, then to 15% by 2015, and 20% by 2020—and renewables cost more.

On my current PNM bill I am paying between $0.07 and $0.10 a kwh. Yet, if I have solar panels on my roof and produce more solar than I can use, PNM will pay me $.13–.15. So if PNM is paying more for solar power than they are charging me for electricity—they are in trouble. (For the worse-than-bad economics of solar, see David Bergeron’s MasterResource post on Arizona’s solar program.)

The PRC is also considering a plan from PNM that would add 80 megawatts of solar to their system to help them meet state-mandated renewable energy standards—for which PNM says they will “defer the costs associated with the renewable resources as regulatory assets on its balance sheet.” So, according to PNM that rate hike will an additional increase!

New Mexico’s Bad Energy Actors

What’s the national lesson—especially for our lawmakers? Renewable energy mandates mean higher costs and rates without any meaningful environmental improvement. And as the truth gets out, ratepayers do not like it. It is as if they have been mislead and lied to by those in authority.

Elected officials, such as New Mexico’s Ben Ray Lujan and Maritn Hienrich clearly haven’t gotten the word about their constituents attitudes and anger. They each just voted for the CLEAR Act (HR 3534) in the House Natural Resources Committee, which will raise energy costs and increase reliance on foreign energy sources.

On the Senate side, Senator Bingaman has been quietly working behind the scenes to make energy still more expensive. He has a bill that has already passed the Natural Resources Committee markup that would increase renewable electricity and is now writing a power-plant-only carbon cap bill. His legislation aims to limit emissions from the electric power sector.

Wake up and learn a lesson from New Mexico. We are not happy with a 50% increase in energy costs and you won’t be either! Do not let our congressmen and senators raise your energy bills!

There is never a good time to intentionally raise the cost of energy—a resource central to all economic activity—but now, with an economy in critical condition, is the worst possible time. And for what purpose? To reduce global temperatures in 2100 by an amount too small to measure? Renewable energy is not green. Even if the climate needed to be “saved” (a questionable point), it cannot be saved with unreliable power sources that may well require more energy to construct than they will ever produce.

Let’s go ahead and say it: Any Senator, any Congressman, any state legislator, who votes to raise energy costs doesn’t deserve our vote.

Marita Noon is the Executive Director at CARE (Citizens’ Alliance for Responsible Energy), the New Mexico nonprofit organization advocating for citizens’ right to energy that is abundant, available, and affordable. CARE works on energy issues state, region, and nation wide. Find out more at www.responsiblenergy.org.

[Editor note: The summary and analysis below is reprinted with the permission of the Institute for Energy Research. The sections past the summary are authored by Dr. Andrew Chamberlin. Cap-and-trade remains alive unless the U.S. Senate fails to pass legislation to go to conference with HR 2454, The American Clean Energy and Security Act of 2009.)

To better understand the broad consequences of the proposed Kerry-Lieberman American Power Act on the U.S. economy, the Institute for Energy Research commissioned Chamberlain Economics, L.L.C to perform an economic and distributional analysis of cap-and-trade portion of the proposal.

The report examines the impacts that the American Power Act would have on the U.S. economy, the method by which emission allowances are distributed to corporations and the distributional cost of the bill on households by income, age group, region and family type.

The study’s key findings of the American Power Act follow:

•   U.S. employment would be reduced by roughly 522,000 in 2015, rising to over 5.1 million jobs by 2050.
• Households would face a gross annual burden of $125.9 billion per year or $1,042 per household, with costs disproportionately borne by low-income households.
• On a net basis, the top income quintile will benefit financially, redistributing to these households roughly $12.3 billion per year from the bottom 80 percent of earners.
• Households over age 75 bear the largest burden at 2.3 percent of income, followed by households aged 65-74 and under age 25 at 2.1 percent. By contrast, the nation’s highest-earning households between age 45 and 54 years would bear the smallest percentage burden of just 1.5 percent.
• Contrary to the legislation’s stated goal of reducing price volatility by excluding petroleum refiners from quarterly auctions, the Kerry-Lieberman bill is likely to significantly increase allowance price volatility from quarter to quarter, compared to an ordinary auction in which all covered industries bid for allowances.

The authors also explored two specific propositions: the first, the potential for shareholders, and not consumers, to benefit from the distribution of free emission allowances; and, second, the expected consequences of the bill’s creation of a separate pool of allowances for petroleum refiners, thus adding to the price volatility of those allowances.  Both conclusions are contrary to Kerry and Lieberman’s stated intent of the legislation.

Michael Levi Challenge

Michael Levi at the Council on Foreign Relations challenges the study with a naive view of state and local utility regulation. He argues for a world in which municipal regulators have the ability to force utility managers to act against their own economic interests, passing forward the full benefit of free emission allowances to consumers rather than their own shareholders.

Levi argues,

The regulator knows the value of the free allowances: it is equal to the number of allowances given out for free multiplied by the value of the allowances at auction. If the LDCs cannot account for having spent that money on public purposes, the regulator will know… [I]t’s actually pretty simple.

If only regulating public utilities were simple! Even in the absence of climate policy, there exists today a vast and complex network of utility regulatory boards, governed by millions of pages of regulatory guidelines, all designed to simply govern the ordinary business of utilities. The American Power Act would overlay a complex federal climate policy atop this arrangement. Saying anything about the behavior of regulated firms under climate policy is “simple” belies the complex reality of public utility regulation in the U.S.

Rebuttal to Levi

There are several problems with Levi’s criticism. The most obvious is, why not distribute allowance values directly to electricity and natural gas consumers, rather than first granting them to utilities? As we have seen in recent financial and environmental disasters, regulators can, and often do, fail to fulfill their role as industry watchdogs. Other provisions of the bill, such as the “consumer relief” program, auction allowances and distribute cash payments directly to households. This could easily be done for electricity and natural gas consumers.

Using a simple database of addresses for existing ratepayers, IRS administrators could distribute rebate checks to households, piggybacking on the infrastructure of the Earned Income Tax Credit with no danger of moral hazard, and no need for additional costly, complex regulations on LDCs. Why not make the system as simple as possible, rather than leaving it open to the possibility of regulatory failure? As we make clear in our study, lawmakers did not follow this approach. That suggests there exists instead a political dynamic at work that has more to do with compensating industries for losses from cap-and-trade than actually compensating consumers, as claimed by advocates of the bill.

Levi’s argument that shareholders will not economically benefit from free allowances is simply inconsistent with the fact that LDCs and their parent companies themselves have lobbied heavily for these provisions. U.S. Senate records show electricity LDCs have spent millions lobbying for provisions in cap-and-trade bills in recent years. Atlanta-based Southern Company, which covers 4.4 million residential customers with local utilities in four states, spent $9.8 million alone in 2008 on climate change lobbying.

American Electric Power, which operates electricity LDCs in 11 states serving more than 5 million customers, spent $8.4 million. Other large electricity firms such as Duke Energy, FPL Group and Ameren spent similar amounts lobbying during the period in which both the Waxman-Markey and Kerry-Lieberman bills were being crafted on Capitol Hill. If shareholders are expected to receive zero benefit from free allowances, what explains these tremendous lobbying expenditures? Such behavior is simply not consistent with a naive view the American Power Act that simply assumes, with no microeconomic foundation, that utility consumers stand to benefit from free LDC allowances.

In fact, distributing funds directly to households rather than indirectly through free allowances to LDCs would have been a much more efficient way to provide consumer relief. If households are given cash rebates, these may be used for other purposes than electricity and natural gas, such as home weatherization, more efficient vehicles or other household expenditures. Instead, the American Power Act leaves open the possibility that utilities could simply be forced to offer households a credit on a utility bill. That is, rather than allowing consumers to choose how best to spend these benefits, LDCs would have the ability to restrict it for use on utility bills only—guaranteeing LDCs additional revenue they wouldn’t otherwise enjoy. Thus, even in the unrealistic scenario in which regulators are able to perfectly force LDCs to pass benefits on to consumers, the bill does this in a highly inefficient way that favors utilities over consumers.

Chamberlin argues that lawmakers cannot control the economic incidence of regulatory policy any more than revenue officials can control the economic incidence of business taxes. Levi argues this analogy is inaccurate since “those firms aren’t regulated.” But from the standpoint of revenue officials, they are very much regulated. Revenue officials are charged explicitly with enforcing the legal incidence of business taxes specified by lawmakers.

This is a different form of regulation than cost-of-service price regulation, but it remains an explicit legal control over the behavior of firms backed by the force of law. The fact that this regulatory regime is unable to control tax incidence is highly relevant to understanding the behavior of regulated utilities under cap-and-trade.

Levi argues that since regulators will know the dollar value of the subsidy granted to each LDC, they can simply verify that an identical amount has been spent on “public purposes.” But this view is highly unrealistic. Anyone who has worked in a municipal regulatory rate-setting environment—which I have at the Seattle Department of Transportation—will tell you that accounting costs are not unique. Labor comprises the vast majority of costs within regulated utilities. Accounting costs for projects within LDCs are built from time-card data on employees’ allocated of time, along with various indirect and other allocated costs—all of which are subject to wide discretion by both employees and utility managers, little of which is observable by outside regulatory bodies.

Consider a simple example. Suppose that an electric utility receiving $12 million of free allowances is required by regulators to increase expenditures on “public purposes” by $12 million, as Levi argues. Suppose further that prior to cap-and-trade, this utility operated a $15 million energy conservation program, distributing energy-efficient light bulbs to households and conducting public education campaigns.

What in the language of the American Power Act prevents utility managers from simply shifting funds internally, scaling back the energy conservation program to $3 million, freeing up $12 million of existing budget authority for “public purposes?” Because internal funds are fungible, managers can easily reduce ancillary services to households—effectively increasing electricity rates to consumers on a quality-adjusted basis—while leaving shareholders unaffected, thus shifting the full burden of climate policy onto consumers. Such behavior is common in the regulatory literature in economics, which is vast and brimming with examples of regulatory failure of exactly this type assumed away by Levi and the authors of the Kerry-Lieberman bill.

Levi argues utilities can be forced to spend the value of free allowances for “public purposes.” But what qualifies as a “public purpose”? The text of the American Power Act provides only vague guidelines, and does not require that utilities actually provide rebates to consumers as has been widely assumed by advocates of the bill. Does investing in clean energy sources qualify as a “public” purpose? What if doing so leads to somewhat higher profit margins for utilities?

What if the value of free allowances is instead used to establish a “rate stabilization fund” to shield consumers from rate volatility? What if consumers are granted only a partial rebate check, with the remainder used to upgrade capital equipment that lowers costs and thus increases profits for the firm?

Levi assumes a clear distinction between “public” and “private” purposes for utility expenditures. In reality, the language of the American Power Act leaves the concept of “for the benefit of” ratepayers open to wide discretion—something utilities themselves are surely aware of, judging from their extensive lobbying efforts to secure those provisions.

Criticism of Employment Effects Estimates

Another criticism made by Levi is that the estimated employment impacts in our study are invalid because more capital-intensive industries will be more heavily affected than labor-intensive industries by climate policy.

As made clear in the Chamberlin study, estimated potential job losses are only order-of-magnitude estimates designed to give a general idea of the size of the employment effects we can expect from a policy that reduces GDP by the amounts predicted by EPA in various years. We don’t model the entire American Power Act bill. Instead, we show about how many jobs can reasonably be expected to disappear if GDP falls by a given amount, holding all else constant.

The study assumes that the overall GDP reductions will be felt by industries in proportion to the fossil-fuel carbon intensity of their products. Levi is right that if industries are affected in different proportions than what we assumed, the pattern of employment losses — and potentially the overall total job losses — will differ from our estimates. But it’s easy to see that they won’t differ by much. In fact, it turns out our estimates are robust across a wide variety of assumptions about the distribution of GDP impacts among industries.

To see why, suppose Levi is correct that capital-intensive industries will be most heavily affected by Kerry-Lieberman. Rather than dividing the overall GDP impacts among industries by carbon intensity as we’ve done, we can instead divide it by an estimate of capital intensity by industry. A back-of-the-envelope way of doing this is to use data on the relative share of labor income as a percentage of value added for industries. In capital-intensive industries, labor income will be small relative to total value added. We can then weight these “capital intensity factors” by total industry output to arrive at a reasonable proxy for capital intensity by industry. These figures can then be used to distribute overall GDP impacts to industries, consistent with Levi’s argument above.

Are Estimated Job Losses Too Conservative?

Re-running the Chamberlin model using this method, the employment effects of Kerry-Lieberman would be significantly larger than our estimates—not smaller as Levi assumes. Here are the figures for total job losses in various years under the assumption that capital-intensive firms are more heavily affected:

2015 : -653,783

2020 : -895,924

2030 : -3,511,055

2040 : -4,915,477

2050 : -6,440,970

Overall, these figures are broadly comparable to our original estimates. However, they are higher by roughly 25 percent. It is simply not the case that our study has over-stated employment effects from the bill as Levi claims. To the contrary, if Levi’s argument above is correct, our estimates may in fact may err on the conservative side. This should not come as a surprise—our estimates of job losses should be considered order-of-magnitude estimates, which are unlikely to vary dramatically to changes in the assumption of how overall GDP declines are distributed among industries.

While the U. S. Environmental Protection Agency would surely love to use the findings of the Independent Climate Change Email Inquiry (aka the Muir Russell report) to brush aside the many challenges mounted, in response to the Climategate email scandal, to the EPA’s finding that greenhouse gases endanger the public’s health and welfare (a finding which enables the EPA to regulate greenhouse gas emissions), they’ll find little in the Muir Russell report to help in their defense.

Well, I should qualify that. They’ll find little scientifically to help their defense. Politics is another matter.

Since the EPA has largely based its Endangerment Finding on an appeal to authority—the primary authority being the IPCC—rather than its own investigations, the Muir Russell report plays right into the EPA’s hands when concluding (emphasis in original):

[W]e do not find that their [influential scientists from the Climate Research Unit of the U.K.’s University of East Anglia] behaviour has prejudiced the balance of advice given to policy makers. In particular, we did not find any evidence of behaviour that might undermine the conclusions of the IPCC assessments.

At face value, it seems as if the EPA could take this as the only proof needed to dismiss all of the post-Climategate calls for it to reconsider it pre-Climategate Endangerment Finding.

But, as with just about everything else about the EPA’s Endangerment Finding, such action would be a gross oversimplification, a side-step around the deeper complexities, and an incomplete address of the issues raised against it.

Background

The Muir Russell panel was hired by the University of East Anglia (of which the Climate Research Unit, or CRU, is a part) to look into many of the allegations levied against CRU scientists as a result of the contents of the leaked Climategate emails. The Muir Russell panel found that while generally some of the CRU scientists did not play well with others whom they didn’t like, that their poor social skills did not result in any gross perversion of the scientific process—or at the very least, they didn’t subvert things enough to “undermine the conclusions of the IPCC.”

Of course they didn’t—their subversion was integral in establishing the conclusions of the IPCC!

It is the scientific truth (or our uncertainty thereof) which undermines the conclusions of the IPCC, not the contributions of the CRU scientists that erected it.

And establishing scientific truth was not a focal point of the Muir Russell panel.

IPCC “Assessments”

What the Climategate emails expose is how the CRU scientists, with the help of many others (whose behavior was not investigated by the Muir Russell panel), went about constructing the IPCC foundation—by selectively and purposefully portraying the science of climate change the way that they did.

As I have said repeatedly, the IPCC produced “assessment” reports—that is, selective presentations of climate science. Pick a different group of assessors, and you get a different “assessment.” Case and point, the NIPCC assessment report which has a fundamentally different take on things than the IPCC does.

Apparently, there is some debate as to whether or not the IPCC was supposed to operate in this manner. The Muir Russell panel claimed that is was (emphasis added):

The IPCC produces assessments of the current state of understanding of climate change, its causes and implications. Its approach is to produce the most probable account of these issues; together with their uncertainties, and to identify where there is insufficient evidence to discriminate between different interpretations of a phenomenon. Its purpose is to produce a “best estimate” of what is currently understood, through the work of a group of scientists chosen for their expertise and experience to make reasoned assessments on the balance of evidence. It is not to produce a review of the scientific literature.

While Roger Pielke Jr. claims that they were not:

The idea that the IPCC presents a “best estimate” understanding based on the views of a selected group of scientists is completely contrary to how the IPCC characterizes its own work. To suggest that the IPCC is “not to produce a review of the scientific literature” is just plain wrong.

However, since the title of the latest IPCC report is “The Fourth Assessment Report of the Intergovernmental Panel on Climate Change,” and not something like “The Fourth Comprehensive Review of the Science of Climate Change by the IPCC,” I side with Muir Russell rather than Roger Pielke Jr. on this one. Whether or not that is how the IPCC was supposed to function, that is how it did function. And as such, the CRU scientists involved in the IPCC process helped develop and flavor the IPCC conclusions, as revealed in Climategate emails in their full glory.

The Climategate, the EPA, and Muir Russell

What the EPA has been asked to do by its reconsideration petitioners (in light of the Climategate emails and its fallout), is to consider just how much influence the actions of the CRU scientists and the many other leading climate scientists not investigated by Muir Russell had in shaping the assessment in a particular manner in lieu of other valid and in many cases more compelling evidence pointing to different conclusions.

The petitions to the EPA asked many more questions, and presented far more evidence—both from the body of the Climategate emails and from the scientific literature produced subsequent to the latest IPCC report—than the Muir Russell panel answered or even investigated.

Here are a few examples of questions from one particular EPA petition, the Peabody Petition, that the Muir Russell panel did not adequately address (because it was beyond their scope, they glossed over the issue, or both).

“Divergence”

On the influence of the issue of “divergence” (i.e. in the past couple of decades some tree ring records fail to respond as expected to rising temperatures which calls into question the reliability of using them as temperature proxies in the pre-instrument era—for which they have been used), the Muir Russell panel has this to say (emphasis in original):

We do not find that the way that data derived from tree rings is described and presented in IPCC AR4 and shown in its Figure 6.10 is misleading. In particular, on the question of the composition of temperature reconstructions, we found no evidence of exclusion of other published temperature reconstructions that would show a very different picture. The general discussion of sources of uncertainty in the text is extensive, including reference to divergence. In this respect it represented a significant advance on the IPCC Third Assessment Report (TAR).

OK, so the IPCC included a discussion of uncertainty and a brief mention of divergence in its text. But the IPCC grossly downplayed how significant an issue divergence may be in interpreting the temperature reconstructions. In fact, as pointed out in the Peabody Petition (which acknowledges how the IPCC dealt with the topic), there have been at least three papers published in the peer-reviewed scientific literature since the IPCC Fourth Assessment Report (AR4) was released that concluded that divergence eviscerates the reliability of temperature reconstructions. According to the Peabody Petition:

More importantly, after AR4 was issued, at least three studies have been published reanalyzing the data used in the proxy reconstructions cited in AR4, including two by authors whose reconstructions were used in AR4. These studies concluded that, in fact, the divergence problem makes the reconstructions unreliable. According to one study, the divergence problem “serve(s) to impede a robust comparison of recent warming during the anthropogenic period with past natural climate episodes such as the Medieval Warm Period or MWP.”⁵⁷ Another study found that the divergence problem makes it “impossible to make any statements about how warm recent decades are compared to historical periods.”⁵⁸ Another concluded that the divergence problem “is of importance, as it limits the suitability of tree-ring data to reconstruct long-term climate fluctuations, particularly during periods that might have been as warm or even warmer than the late twentieth century.”⁵⁹

It would seem, therefore, that the IPCC should have been more cautious in dismissing the divergence problem. It would also seem that the IPCC may have understood that there was something to hide after all.

⁵⁷ Rosanne D’Arrigo, et al., On the ‘divergence problem’ in northern forests: a review of the tree-ring evidence and possible causes, 60 GLOB. PLANET. CHNG. 289 (2008).
⁵⁸ Craig Loehle, A mathematical analysis of the divergence problem in dendroclimatology, 94 CLIM. CHNG. 233 (2009).
⁵⁹ Jan Esper and David Frank, Divergence pitfalls in tree-ring research, 94 CLIM. CHNG. 261, 262 (2009).

Clearly, Muir Russell in no way provides any scientific help for the EPA on the topic of divergence.

Transparency and Openness

Nor does it provide much assistance to the EPA on other topics raised in the Peabody Petition, including the (mis)match between recent temperature trends and climate model projections, demonstrable (and in some cases, admitted) errors in the IPCC reports, or the lack of openness and transparency in the preparation of the IPCC reports or the underlying literature upon which they rely. In fact, as to the latter, the Muir Russell finds (emphasis in original):

But we do find that there has been a consistent pattern of failing to display the proper degree of openness, both on the part of the CRU scientists and on the part of the UEA, who failed to recognise not only the significance of statutory requirements but also the risk to the reputation of the University and, indeed, to the credibility of UK climate science

This is a huge blow to the EPA’s claims of a rigorous, transparent and neutral scientific process.

Subversion of Peer-Review

Further, the exposed infractions run far beyond “failing to display the proper degree of openness” and in fact spill over into perverting the peer-review process—one of the most fundamental elements of modern science.

Astonishingly, the Muir Russell panel gives the CRU scientists a free pass when it comes to their actions regarding peer-review (emphasis in original):

In addition, we do not find that their behaviour has prejudiced the balance of advice given to policy makers. In particular, we did not find any evidence of behaviour that might undermine the conclusions of the IPCC assessments.

But the Muir Russell panel only focused on a few cases of peer-review meddling involving only a few CRU scientists. As a whole, Climategate reveals a much larger number of instances involving a much larger number of people. So the Muir Russell panel’s results are woefully inadequate for the EPA’s purposes.

And even in the cases that they did review, Muir Russell’s allegations that the way the Climategate scientists acted to wield their influence on the peer-review process was “ordinary,” is simply absurd.

For instance, it is not “ordinary” for a group of scientists to organize a boycott of a particular journal—in this case Climate Research.

Amusingly, in its submission to the Muir Russell panel (located here in its gory detail), the CRU maintains that the “CRU staff have not ‘boycotted’ the journal Climate Research.” An admission which indicates to me that they think “boycotting” a journal is not ordinary practice. Yet, back in the 2003/2004 time period, I specifically heard the term “boycott” being used to describe what was being organized against Climate Research for publishing papers that were not liked by some folks—and the Climategate emails confirm that such organization was taking place.

So what to make of CRU’s claim that they did not “boycott” Climate Research?

On the CRU web site there is a listing of publications by CRU scientists. On that list, I count 16 papers published by CRU scientists in the journal Climate Research during the 7 years prior to 2003/04 (by the likes of scientists like Phil Jones, Mike Hulme, Tim Osborn, Claire Goodess—all folks who make an appearance in the Climategate emails)—so obviously Climate Research was a journal frequented by CRU. In the years since 2003/04, CRU scientists published 2 papers in Climate Research (both papers by a pair of scientists, neither of whom was caught up in the Climategate scandal). Sounds like something changed in the 2003/04 timeframe.

And just in case you were wondering whether the (non)boycott had any impact on the types of papers accepted by the Climate Research editors, I was a co-author on 7 papers published in Climate Research from 1996-2004 and none since. In fact, the editors at Climate Research haven’t considered my last two submissions worthy of even being sent out for review, a fate that I would guess happens to less than 5% of all papers submitted to Climate Research, and one most commonly reserved for submissions that aren’t written in readable English. I may not be the world’s greatest writer, but I do write in English.

So, once again, it sounds like something changed at that journal in the 2003/2004 timeframe.

If you think the stink raised by CRU et al. didn’t have something to do with it, then you must sit on the Muir Russell panel.

And the Climate Research affair is just one of the instances of strong-arming peer-review that is evident in the Climategate emails. There are plenty of others—all well-documented in, for example, the Peabody Petition.

Bottom Line

While the Muir Russell panel may look the other way on most of these issues (after all they only had to answer to the University of East Anglia, the very folks they were investigating), the EPA does not have that luxury—because the EPA serves the American public, and the American public deserves, and hopefully will insist, that EPA does a more in-depth and open-minded job in responding the points well-raised in the various petitions to reconsider its Endangerment Finding.

A diligent EPA will find little of substance in the Muir Russell report and instead will conduct a thorough investigation of its own into the points raised by the petitions brought against it.

We’ll find out what course the EPA decided to take pretty soon, as the EPA is supposedly scheduled to release its Response to the Reconsideration petitions sometime in the next few weeks.

And now that the Senate seems unlikely to take up the issue of greenhouse gas emissions control anytime soon, all eyes will be on the EPA. Hopefully it will conduct itself in a scientifically responsible manner.

The Muir Russell panel—hired by the University of East Anglia (UEA)—concluded (some add, predictably) that the scientists from for the Climate Research Unit (CRU, which is part of the UEA) had not really done anything wrong aside from not being particularly cooperative with folks that they didn’t like.

The CRU scientists and their close colleagues who were caught up in the Climategate affair claim vindication (see RealClimate), alarmists love it (see ClimateProgress, Newsweek), those in the middle were a bit displeased (see The Atlantic, New Scientist) or wishy-washy (see DotEarth), and those feel that the Climategate emails revealed glaring problems with how climate change research is being conducted and brought to the public were crying “whitewash” (see Wall Street Journal, Watts Up with That).

It makes me wonder why Muir Russell bothered in the first place.

I find my reaction somewhere between the last two categories, which I guess would make me wishy-whitewashy. I don’t think Climategate revealed any great fractures in the general concept that human greenhouse gas emissions are leading to a warmer world, but it most definitely did confirm what I felt had been the case all along—that the Climategaters were not playing fair. And not playing fair has a lot more consequences than the Muir Russell panel cared to admit—this is where the “whitewash” comes in for me.

The lead editorial in the July 19th Wall Street Journal—which was largely reflects the op-ed by Patrick Michaels published a week prior by the WSJ—touches on some of the most glaring shortcomings of the Muir Russell panel and its findings—from non-independence, to circular logic, to evading the hard questions.

But anyone who has spent anytime with the Climategate emails, or read any of the myriad of blogs detailing their contents and adding behind the scenes insight from the folks who were actually involved in what was going on (myself included) hardly needs Muir Russell, or any of the other “independent” reviews to tell them what to think.

Aside from posing some questions directly to the CRU folks caught up in the whole Climategate affair (from scientists to administrators), there was little that Muir Russell’s group had available to them that all the rest of us didn’t already have. And just because Muir Russell queried CRU scientists Phil Jones, Keith Briffa, et al. directly about some of the allegations/implications of their emails doesn’t really give Muir Russell any special insight. I think that pretty much everyone could already anticipate the CRU response—duck, dodge, and parry. And CRU didn’t disappoint.

So Muir Russell’s “findings” shouldn’t be given any more credence than anybody else’s “findings.” It really doesn’t take any special talent to read through the Climategate emails and see that something was amiss—either in the layfolks’ opinions as to how scientists conduct themselves or as to how the scientists actually conducted themselves.

The shenanigans on display in the Climategate emails are just not right, no matter how you look at them.

The (mis)behavior revealed in the Climategate emails not only negatively impacted the work of those who it was directed towards, but also the general scientific community as well—which in turn effects each and every one of us, as the topic of anthropogenic climate change and what and whether to do anything to try to mitigate it is among the burning topics of the day. Gaming of the science has huge implications—look no further than the EPA to see this. Since the EPA relied largely on appeal to authority (largely the IPCC) to base its groundwork for regulating greenhouse gas emissions, if the “authority” has been tainted by a misapplication of basic scientific principles, then the EPA’s foundation is built on an unsure footing.

The Muir Russell findings underplays this danger in its three main conclusions, reproduced below (emphasis in original, British spelling retained).

• Climate science is a matter of such global importance, that the highest standards of honesty, rigour and openness are needed in its conduct. On the specific allegations made against the behaviour of CRU scientists, we find that their rigour and honesty as scientists are not in doubt.

• In addition, we do not find that their behaviour has prejudiced the balance of advice given to policy makers. In particular, we did not find any evidence of behaviour that might undermine the conclusions of the IPCC assessments.

• But we do find that there has been a consistent pattern of failing to display the proper degree of openness, both on the part of the CRU scientists and on the part of the UEA, who failed to recognise not only the significance of statutory requirements but also the risk to the reputation of the University and, indeed, to the credibility of UK climate science.

Their second point is the one which rubs me completely the wrong way. It is a pretty broad statement considering that Muir Russell took a pretty narrow look at the potential abuses. Muir Russell focused specifically on the actions of only CRU scientists (the Climategate emails involved a lot of scientists other that those directly employed by the CRU) and involved only a few cases of the potential for abusing power. And even in those cases, they did not look very deeply and gave out free passes.

For instance, in shrugging off the potential influence on science by the man-handling of the peer-review process evident in the Climategate emails, the Muir Russell panel defers to the opinions of editor of the medical journal The Lancet, Dr. Richard Horton. Somehow, Horton dismisses the behavior on display as “ordinary.”

Regardless of what the Horton claims about the behind-the-scenes behavior of scientists regarding peer-review, organizing a boycott of specific journals is NOT “ordinary” behavior nor should it be condoned.

And if all of the other activities that Horton claims are “ordinary”—then no one ever told me.

For all these years I have been submitting papers to journals, respectfully arguing my case with the reviewers and editors when given the opportunity, and then waiting to see what happens.

Silly me.

I now find out that I should have been pressuring journals to remove editors who were responsible for papers that I didn’t like, organizing everyone I could convince to boycott journals that occasionally published papers that I thought were bad, sending in unsolicited comments to journals and editors about papers which I found out through the grapevine were being considered, coercing editors to fast-track my submissions and delay publication of rival papers, writing nasty emails to people who found results that were a bit different than mine (and copying journal editors on the correspondence), generally creating an intimidating atmosphere, etc.

If not everyone knows that this is how it it done, it is little wonder that the literature—and the assessment reports thereof—is dominated by those who do.

In the closing thoughts of its editorial, the Wall Street Journal presages how the Muir Russell report may be used:

We realize that, for climate change true believers, last week’s report will be waved about as proof that the science of climate change is as “settled” as the case for action. It’s never hard to convince yourself of what you’re already disposed to believe.

In a follow-up to this post, I’ll look at an example of how the Muir Russell report may be “waved around”—in this case by the EPA in defending itself from myriad of challenges to its “Endangerment Finding”—that greenhouse gas (GHG) emissions endanger the public health and welfare—a finding which paves the way for EPA to issue regulations of the GHG emissions. A string of recent petitions have implored the EPA to consider how the Climategate emails cloud the EPA’s vision of the state of climate science and to look into the matter for itself. However, if the past is any indication of the future, the EPA will quite likely “wave around” the findings of the Muir Russell panel—as incomplete, superficial, and uncompelling as they are—and in one fell swoop, dismiss all the challenges. I’ll discuss why this is both inappropriate and unsatisfying.

Enacting the right regulations is somewhat simpler than electing an omni-everything being to run the world, but not much.  As evidence, consider the fact that it was a lot of the wrong regulations that got us into this mess in the first place.  Also consider the oft heard argument that financial regulators needed to “get out ahead of the innovators.”  Clearly, a job for the omniscient.  There is, after all, a reason why the Wright Brother’s flight at Kitty Hawk preceded the establishment of the Federal Aviation Administration.

Any time government regulators try to do much more than lay out the basic rules of the game, unintended consequences and moral hazards rear their ugly heads.  The following list of pitfalls, adapted from our book Energy: The Master Resource, is offered as a caution to regulatory enthusiasts. 

Pitfalls and Pratfalls

1.  Laws and regulations may institutionalize the tragedy of the commons. The rule of capture (which stated that oil belonged to whomever pumped it out of the ground) and related regulations led petroleum companies to drill as many wells as possible in order to get the oil before their competitors could. By encouraging companies to drill otherwise unnecessary wells, the rule led to wasted resources and sometimes to reservoir damage.

Groundwater in the United States is still a common property resource and, because no one owns it, no one has an incentive to conserve it.  Farmers in California, enjoying subsidized water prices, have been growing water-intensive crops such as rice and cotton in desert areas despite endemic water shortages.

2.  Special interests lobby the government to get their products or services mandated by regulation. The mandated use of ethanol in automotive fuel is an example.  In the United States, most ethanol is made from corn. Farmers who grow corn and companies that make ethanol from it have heavily pressured Congress to require its use.  As a further subsidy, the government has banned imported ethanol even though it can be purchased from other countries for less than it costs to make it here.  One unintended consequence has been an increase in food prices.  As the price of corn has risen, so has corn-based animal feed and with it the price of beef, milk, chicken, and eggs. 

3.  Regulations can create (or destroy) entire industries overnight. The use of such power adds uncertainty and risk to the market. If risk reaches unacceptable levels, investors put their money elsewhere. The concentration of political power in Washington forces companies to lobby Congress and the White House for protection against its arbitrary use. Corporate lobbying, in turn, increases people’s distrust of the system.

4.  Regulations are often the result of compromise. After concessions have been made to this powerful congressman or that influential senator, the resulting law or regulation may be very different from the original proposal and have very different consequences. Politics may be “the art of the possible,” but what is politically possible may be neither practical nor environmentally friendly.

Compromise can also result in laws so vaguely worded that they can be interpreted in any number of ways. In the end, it is left up to regulatory agencies and the courts to decide what a bill actually means. Their interpretations may be very different from the original intentions of the bill’s proponents.

The Clean Air Act amendments of 1977, for example, stated that only new factories and power plants would have to meet the tighter emissions standards imposed by the Act. Existing plants would continue to be regulated under the pre-existing standards unless the old plants were “substantially modified.” Unfortunately, Congress did not precisely specify what “substantially modified” meant.

In 1998, the EPA sued the owners of a number of old plants, charging that the upgrades done over the years to these plants had cumulatively added up to “substantial modifications.” The owners responded, with some justification, that the EPA had originally approved their changes, and that altering the rules after-the-fact amounted to the passage of a retroactive law, something explicitly forbidden by the U.S. Constitution (section 9, article 3).

5.  Lobbyists may support regulations as a way of hurting their competition. Utility companies with “old source” power plants, for example, welcomed the Clean Air Act’s 1977 amendments, because it put potential competitors at a disadvantage by raising the cost of market entry.

Other amendments to the Clean Air Act required power companies to reduce sulfur dioxide emissions by installing scrubbers. A less expensive way to lower emissions would have been to switch to low-sulfur coal, but eastern labor unions and coal mining companies (which produce high-sulfur coal) successfully lobbied to get the requirement for scrubbers enacted into law. This resulted in a waste of resources as (otherwise unnecessary) scrubbers had to be built, installed, and powered.

In the United States during the twentieth century, government intervention in the energy market has commonly been industry-driven. Firms often organized lobbying groups to obtain favorable regulation or special subsidies. Free-market economist Milton Friedman complained, “Time and again, I have castigated the oil companies for . . . seeking and getting governmental privilege.”

6.  Regulations can eliminate or alter feedback. Feedback is an essential component of any activity. Imagine how dangerous the world would be for a person who had lost the ability to feel pain (as happens with certain forms of leprosy). Such a person could do serious damage to himself by continuing to walk on a badly sprained ankle, or putting his hand on a hot stove without knowing it.

Government action can create a sort of institutional leprosy by weakening or even destroying the feedback loops that make it possible for companies to know whether their activities are of any value. For instance, by taxing productive companies in order to subsidize unproductive ones, governments perpetuate the waste of resources.

7.  “Hard cases make bad law.” All too often, regulations are hastily written in response to the public’s demands that the government “do something” in the face of a crisis. Petroleum price controls during the 1970s are a case in point. Under the provisions of the rules, refiners could charge more for higher-octane fuels, so they were encouraged to increase the lead content to artificially boost octane ratings.

At the same time that crises lead to demands for action, they tend to increase the cost of any action. For instance, in response to the power shortage of 2000–2001, the state of California negotiated long-term contracts for the purchase of electricity. Within a few months market electricity prices had dropped well below what, in the midst of the crisis, had appeared to be justified. This multi-billion dollar mistake was borne by California taxpayers.

8.  Regulations often have unintended side effects. New laws or regulations may change the incentives people face and encourage them to act in ways that the lawmakers had not foreseen.

Recall the 1977 Clean Air Act amendments that placed strict emissions regulations on new power plants, while leaving existing facilities under the older standards (a practice known as “grandfathering”). Those rules increased the costs of new plants relative to existing ones, encouraging power companies to keep older plants in service longer than they otherwise would have. Old plants are less efficient than new ones and the result was more fuel used and more pollution created.

Fears of oil spills have led lawmakers to prohibit offshore drilling in many of America’s coastal areas. As a result, the nation must import more oil than would otherwise be the case. However, imported oil is delivered via tanker. Notwithstanding the recent tragedy in the Gulf of Mexico, tankers pose a greater oil spill danger than does offshore oil production.  Similarly, forbidding drilling in onshore and near shore locations forces oil companies to drill in more hostile areas making accidents more likely.  American coastlines are, therefore, actually less safe thanks to such legislative “protection.” 

The Community Reinvestment Act and the American Dream Down Payment Act were supposed to increase homeownership.  Instead, they helped drive up home prices and fueled the housing bubble.

9.  Regulators do not bear the costs of their regulations and have little incentive to ensure that the benefits outweigh those costs.  The United States Forest Service does not pay the cost of building timber roads in the nation’s forests; the money is paid right out of the treasury.  However, the Forest Service is allowed to keep some of the proceeds from timber sales in its own budget.  This practice provides an incentive for the Service to build logging roads into remote areas of the nation’s parks to allow timber companies access to trees that would otherwise be uneconomical to harvest. 

The result, according to Tom Bethell (The Nobelest Triumph: Property and Prosperity Through the Ages) is that “[b]y 1991, the service had constructed 360,000 miles of roads – eight times the length of the U.S. Interstate Highway System.”  Because the cost of many of these roads exceeded the value of the timber harvested, resources were wasted.  Because the link between costs and rewards was eliminated, damage is being done to thousands of acres of park land through deforestation, loss of habitat, and soil erosion for no net gain.  

10.  Public officials are self-interested, and their self-interest may not always be in the public interest, as James Buchanan and Gordon Tullock (the main developers of Public Choice Theory) pointed out.

For instance, managers with the federal government are often paid in proportion to the number of people who report to them. Their incentive, therefore, is to increase the size of their departments. All too often, they act in accordance with this incentive regardless of the cost to taxpayers.

More familiar are the politicians who purchase votes by using tax dollars to pay for projects of questionable value, or city officials who get kickbacks in return for construction contracts.

11.  Once in place, regulations are difficult to eliminate— Friedman’s “tyranny of the status quo.” For example, even though the problems with ethanol have been known for years, the regulations requiring its use have yet to be repealed.

No matter how detrimental a regulation is, or how outdated it has become, there is usually someone who benefits by it. The beneficiaries of the regulation generally have a stronger interest in keeping the regulation in place than anyone else has in getting rid of it. As a result, they are willing to spend time and money lobbying the government to support their position. While the benefits of a regulation may be enjoyed by a relative few, the costs are often spread out among many. If the per person cost of a regulation is only a dollar or two, no one has a financial incentive to travel to Washington to lobby against it. Economists call this the concentrated benefits and diffuse costs problem.

Moreover, the benefits of any particular government action are usually quite visible while the costs are often hidden. For example, if the recycling industry receives a subsidy, the impact on that industry is very apparent in terms of new facilities and jobs. However, these gains may be more than offset by loss of facilities and jobs in other industries. Due to the taxes that must be raised in order to subsidize the recycling industry, consumers have fewer dollars with which to purchase goods and services from other companies. These losses, however, are diffuse and invisible.

Perhaps most importantly, people just do not like to admit when they have made a mistake, and politicians are no exception. If the “Smith Act” causes problems, Senator Smith is unlikely to apologize and propose that his Act be repealed. Instead, the senator will probably argue that his legislation was not properly funded or enforced. In the end, the law is more likely to be expanded than repealed.

For example, the laws and regulations encouraging lenders to give home mortgages to people who cannot afford to pay them back are still in effect.  Rather than admit their mistake, legislators create straw men (e.g., Wall Street “greed”), and then pass regulations to battle them.

12.  Industries exert enormous influence over the government agencies created to regulate them. Reformers, believing this problem is due to an imbalance of power, often seek to remedy the situation by increasing the authority of the regulatory agency. Such measures will likely serve only to solidify the positions of those companies that already dominate the regulated business.

Industry sway over government agencies is a natural result of the incentives inherent in the regulatory process. As has already been pointed out, no one has more incentive to lobby regulatory agencies than do the companies they regulate. And regulators’ self-interest gives them a powerful incentive to listen.

There is also the “revolving door” phenomenon whereby personnel leave industry for jobs with government agencies and vice versa. Some see this as proof of corruption, but there is a simpler, less sinister, explanation. When an agency is created to oversee a business, one of its first needs is employees with knowledge of that business. Where can it go for such people but to the industry itself? Similarly, when government employees retire and wish to begin second careers, where can they go other than to the business about which they have spent their professional lives learning?

13.  Laws and regulations stifle innovation. Once a particular solution is written into law, there is little incentive for companies to try and develop a better one. Laws are notoriously difficult to change and are particularly so when lobbyists’ businesses depend upon the mandated solution. Even if the mandated solution was cutting-edge technology at the time the law was signed, technology becomes outdated very quickly in a free market system.

14.  National regulations can create nationwide problems. In 1978, the Carter Administration, mistakenly convinced that the country was running out of oil and natural gas, passed the Powerplant and Industrial Fuel Use Act. Under the Act, existing power plants were prohibited from increasing their use of natural gas, and new plants were prohibited from using either natural gas or fuel oil. This restriction pointed the industry towards coal despite the fact that this fuel emits more air pollutants and CO₂ than does natural gas.  (While nuclear power was also an alternative, the Three Mile Island incident, which occurred the following year, made the option politically impossible.) President Reagan lifted the restrictions on existing plants in 1981 and on new plants in 1987.

15.  The existence of regulations and of regulatory bodies, give people a false sense of security. Consumers, believing that government watchdog and licensing agencies weed out incompetent and fraudulent service providers, may be less vigilant than they would otherwise be.  Bernie Madoff’s victims were reportedly as mad at the Securities and Exchange Commission (SEC) as at Madoff himself because of the false sense of security that SEC oversight created.

Conclusion

Many of the pitfalls listed above can be avoided if regulators specify goals rather than means. For example, suppose that instead of requiring power plants to use scrubbers to reduce emissions, the law stated that the plants can emit no more than X tons of pollutant a year and did not specify how this was to be accomplished.  Such goal setting would eliminate or reduce regulatory failures: 2 (special interests lobbying the government to get their products or services mandated by regulation), 5 (lobbyists supporting regulations to hurt their competitors), and 13 (laws and regulations stifling innovation).

People are amazingly creative.  Given clear and reasonable goals, they will find ways to achieve them.  And, with hundreds or thousands of people working towards a goal – trying different solutions, failing, then trying again, sharing information about what works and what does not – it is almost certain that their solutions will be far better than anything a regulator could devise.

Note: This post originally appeared on TheFreemanOnline.org as Fifteen Things to Despise about Government Regulation

In 1998, the BPA’s wind generation was roughly 25 megawatts (MW). Today, it totals 2,780 MW and, with the Oregon Renewable Portfolio Standards passed in 2007, over 6,000 MW of wind power is expected to be on-line by 2013. Often overlooked are the impacts of increasing wind generation on the reliability and affordability of electricity that might very well outweigh any of the environmental benefits that are proclaimed to exist.

The negative aspects of wind are quite apparent. Obviously, wind is unpredictable and inconsistent, creating a significant problem for BPA and electric utilities. To prevent brownouts or overloads on the grid, BPA has to schedule energy production in advance and the ability to predict when and how hard the wind will blow is extremely limited (usually a two or three day window) and is often inaccurate.

Because wind power is so unpredictable, every MW must be backed up by an equal amount from reliable, reserve energy sources to replace the energy lost when the wind dies down. This means BPA must have a “balancing” reserve equal to or greater than the wind power capacity utilized at any given time. In the Pacific Northwest the backup source has traditionally been federally owned hydroelectric dams, which are shut on and off to respond to fluctuations in wind energy.

Hydro Backup?

According to BPA, the ability of the federal hydro system to serve as a balancing reserve is between 3,000 – 3,500 MW of installed wind generation. This means that BPA can only back-up roughly half of the projected increase in wind power. In the near future, BPA will be forced to consider other options to establish a satisfactory reserve for integrating the large influx of unreliable energy.

Some efforts to rectify the integration problem include evaluating the feasibility of dynamic scheduling, which means breaking down the periods of time wind generation is scheduled (e.g. from hour-to-hour to 30 minute increments). Additionally, BPA is analyzing better ways to forecast wind speed and is researching storage technologies (such as compressed air or flywheel technology).

Such advances are generally decades-off, and better forecasting can hardly be said to alleviate the problems inherent to ramping wind-balancing generation; therefore BPA will eventually be forced to either buy additional dispatchable generation capacity from third-party suppliers or to build additional back up capacity. This leads to increased costs for BPA, the utilities which purchase power from BPA, and ultimately Oregon ratepayers.

Where this additional back-up power comes from is a critical question. PGE has begun the permitting process for a natural-gas fired plant in North-Central Oregon, and plans for the completion of a second natural gas plant in 2015 are underway. These facilities will become even more necessary as the ability to use hydroelectric dams as back up is strained and wind generation capacity keeps expanding due to legislative mandates

Building new natural gas facilities to serve as a balancing reserve for additional wind sources has several related problems. First, natural gas is subject to price volatility, similar to buying gasoline at the pump. Uncertainty in production and delivery lead to significant fluctuations in natural gas costs.

Further, natural gas facilities produce greenhouse gas emissions, which at least partly negates the purpose of the renewable energy mandates. When asked if wind power was reducing carbon emissions, Deb Malin, a BPA representative, answered, “No. They are, in fact, creating emissions.” This is because when a natural gas facility is ramped up and down to respond to fluctuations in wind power output, it can see its efficiency drop to between 35-50 percent.

Thus not only are electricity rates increasing because of additional wind generation, but the subsequent increase of natural gas reliance further exacerbates the problem by introducing volatility and greenhouse gas emissions.

Wind = Higher Rates

In 2009, BPA requested the Oregon Public Utility Commission to allow an electricity rate increase to reflect the costs of integrating wind. BPA proposed an increase of $2.79 per kilowatt-month, and the OPUC set the final rate increase at $1.29.

Likewise, Pacific Power customers most likely will see a significant increase in their electricity rates, starting January 2011. The second-largest investor-owned utility in Oregon filed a 20% rate increase with the OPUC. 13% of the rate increase is designed to cover costs associated with two new transmission lines and finalized construction of two new wind farms in Wyoming. Seven percent of the increase is to cover “the expiration of long-term contracts for low-priced hydropower, the expiration of a fixed-price gas contract, and costs associated with integrating intermittent wind power”.

So not only will consumers have to pay more money to build additional wind farms (mandated by the state Renewable Portfolio Standard) but also to integrate the intermittent production of these wind power facilities. According to the article, a monthly bill of $80.96 in 2011 will increase to $96.78.

This increase is “a whopper,” said Bob Jenks, executive director of Citizens Utility Board of Oregon, a ratepayer advocacy group. “In the economy we’re in today, where many of their [Pacific Power's] customers are struggling to pay their bills, this is going to be really difficult for folks.”

Interestingly enough, Oregon already has a 100% voluntary system to allow ratepayers to purchase renewable energy if they wish to do so. Green power programs available through all the major utilities give ratepayers the option of paying the above market costs associated with renewable energy. PGE boasted the highest participation rates in the nation during the past few years at a rate of approximately 9%.

Conclusion: Bad Deal for Consumers

It does not seem wise to force Oregonians to purchase an energy source that has so many associated costs. At best, wind power simply replaces a clean reliable and affordable energy source of power: hydroelectricity. At worst, it invites increased price volatility and the prospect of more greenhouse gas emitting facilities. Ultimately increasing wind generation leads to financial burdens on businesses and individuals across the state that ought to be considered further. Legislators should not attempt to choose winners in emerging energy technologies nor force costly energy sources upon ratepayers. Instead utilities should allow ratepayers to pay for the full cost of renewable energy voluntarily and expand renewable energy according to ratepayer demand.

———————

Eric Lowe, formerly a research associate at the Cascade Policy Institute (CPI) in Portland, Oregon, is a master’s degree candidate at the University of Maryland School of Public Policy. He thanks Todd Wynn of CPI for his help. The full-length version of this report was originally published by the Cascade Policy Institute, and can be found at: Think Twice: Why Windpower Mandates are Wrong for the Pacific Northwest.

I submit that this claim reveals an ideological bias, as well as a degree of energy illiteracy.  

Such illiteracy is not new and is often battled by economists.  For example, when I was at MIT, one class was taught by an engineer who believed that oil was underpriced because it cost less than mineral water.  I didn’t have the heart to tell him that this is a common misconception:  the prices of the two are completely unrelated.  

Now there is a new litmus test for energy illiteracy, namely the claim that America is ‘addicted to oil.’ Those stating this are either being less than honest (politicians and special interests) or have failed to comprehend either addiction or economics.  For example, why say Americans are addicted to oil, but not food, housing and clothing?  Or cement or steel?  It is easy to compare the traditional types of addiction with the reliance on these substances to see where oil falls on the spectrum.

What is ‘Addiction’? 

Addictive substances typically cause changes in brain behavior, create a sense of euphoria but also reduce productive activity, making citizens less capable and/or less interested in being productive.  They serve primarily to stimulate pleasure and often distort mental processes, creating biochemical dependencies to the point where those consuming the substances sacrifice their careers, livelihoods, families and everything they hold dear to acquire it on a continual basis.  While there are many functioning addicts, there are also huge numbers whose lives have been ruined by their addictions.  (Just watch “Behind the Music” on VH1.)

Steel, on the other hand, is an input for other products, such as machinery and buildings, which are useful and valuable.  No direct pleasure is provided, though many are enamored of structures and machinery (I like trains myself), and people buy it or not as needed and depending on prices.  No one drives into a bad neighborhood late at night to use their last dollar buy steel from strangers.  Yet, it seems that we cannot do without it, and import whatever we cannot produce ourselves. 

So, on the spectrum of goods—psychoactive substances to economic inputs, heroin to steel—where does petroleum fall?  Do we see homeless citizens begging for coins on street corners to fill their SUVs?   Lying to their families about their purchase of premium gasoline?  Losing their jobs because they can’t give up ‘the juice’? 

On the contrary, petroleum is used to transport goods and services, and to move people to work so that they can be economically productive.  It also provides mobility, increasing the freedom of the citizenry significantly over the days of horses and steam railroads, thereby improving their quality of life. 

Many use the charge of addiction to explain consumers’ failure to behave as “experts” believe they should; witness, for example, James Howard Kunstler’s hatred of suburbia and its many aspects, which he blames on cheap oil.  His distain for individual preferences is obvious, and one can imagine him leading a 21st Century Khmer-Rouge-in-reverse, forcing the peasants back to the cities.  

Electric Cars Are No AA Program 

Similarly, the devotees of electric cars—most of whom are unwilling to pay for them without massive taxpayer assistance—seem to feel that gasoline engines were forced on consumers by car makers or “Big Oil.” Daniel Weiss has gone so far as to say:  “one of the reasons why electric cars were abandoned 100 years ago is because the auto companies made a deal with the oil companies and decided to go ahead and pursue that, rather than do batteries.”  It means nothing that, even after a century of development, batteries still cannot compete with the internal combustion engine in economics, range, power, or performance.

The electric car is in fact a Potemkin village on wheels—a high-tech façade that disguises the heavy, dirty industry behind it, both in the manufacture of the vehicles and batteries and the electricity generated to power them.  Given that only the rich will be able to afford them (expensive toys for rich boys), even with substantial tax breaks, the expenditure of government money ($200 million a year in California) to subsidize them is nearly criminal in this time of constrained budget resources.  

Foreign Policy Rationale 

Of course, many also decry oil imports as causing us to pursue an immoral foreign policy, specifically importing oil from disreputable characters or (it is claimed) invading Iraq to secure access to their oil.  Our reliance on imports, the implication runs, makes us vulnerable to political pressure from oil exporters and drives us into foolish wars.  But again, this reflects more an ideological bias than our actual foreign policy history.  

Yes, petroleum is sometimes an issue, but it hardly seems to have an overriding influence.  Recall Nixon’s staunch support of Israel during the 1973 October War (and oil embargo) and the fact that George W. Bush, a Texas oil man with family ties to the Saudi royal family, embraced Ariel Sharon.  Note also American antipathy for Hugo Chavez, even though his country provides us with 10% of our oil imports. 

Alternatively, some analysts argue that the importing more than half of our oil is economically damaging, ignoring the fact that trade is not a zero sum game.  Indeed, oil importers have traditionally outperformed oil exporters economically, partly because they rely on cheap raw material (such as oil) to create manufactured goods.  S. Korea has hardly suffered from relying on oil imports to fuel its economy, nor has Japan, while the countries that rely heavily on oil exports have often failed to prosper.  Should we bemoan the fact that we import cheap oil rather than rely on expensive substitutes, or that we produce manufactured goods instead of raw materials? 

The Oil Lobby Canard 

Both Barack Obama and Daniel Schorr have blamed our lack of an energy policy on lobbyists from the oil industry, a rationalization similar to claiming consumers buy products not because they want them but as a result of advertisers brainwashing them That is, it presumes that “my choice is objective,”and that anyone making a different choice must be brainwashed, rather than simply exercising their own personal preferences.  

No doubt the oil lobby has power, but ask what they have achieved in, say, the last decade?  Did they get the government, under President Bush, to open offshore areas or ANWR for drilling?  Even with Republican governors like Jeb Bush and Arnold Schwarzenegger in power in Florida and California, they did not succeed.  

Conclusion 

What, then, can we conclude about our ‘addiction’ to oil?  It is a totally fallacious concept, promoted by those who have an inherent bias against oil and the oil industry and are seeking to explain the failure of the American public to choose to pay extremely high electricity prices and buy expensive cars incapable of traveling one hundred miles on a single, multi-hour, charge.  The truth is that American consumers have ample choices and have chosen wisely. 

“The BP incident highlights big differences in how socially responsible funds prioritize various causes. Some of these managers considered BP’s stance on climate change a strong positive. ‘BP was the first to break the logjam on climate change policy’ and had been a leader on alternative energy, says Mark Regier, director of stewardship investing for MMA Praxis.”

- Quoted in Eleanor Laise, “Oops: ‘Socially Responsible’ Funds Hold Big Stakes of BP,” Wall Street Journal, July 17–18, 2010.

The greenwashing strategy of BP and Enron has been the subject of three recent posts at MasterResource:

They Loved BP and Enron: Climate Alarmism as the Great Environmental Distraction (Part I: Worldwatch Institute quotations)

BP’s ‘Beyond Petroleum’: Climate Alarmism as the Great Environmental Distraction (Part II: Why the ‘greenwashing’?)

Harvard Business Review Article: BP as Environmental Role Model (Part III on global warming as the great environmental distraction)

Don’t believe that “Beyond Petroleum” BP fooled the politically correct after Enron and even all the way up to the Deepwater  Horizon explosion/Gulf spill of May 2010? Then consider the Wall Street Journal’s “Oops: ‘Socially Responsible’ Funds Hold Big Stakes of BP” (reprinted below as Appendix A).

Enron Fooled the “Socially Conscious” Too

Enron also fooled the same “socially responsible” crowd. As I recounted in Capitalism at Work: Business, Government, and Energy (p. 8):

Enron had been a favorite of the intelligentsia. The New York Times and just about every other media outlet sang its praises. Ken Lay’s company was a champion of all things politically correct. Enron was progressive, practicing “social corporate responsibility” and “stakeholder theory” ….

On the environmental front, Enron practiced “sustainable development” by aggressively investing in politically favored renewable energy and sounding the alarm over man-made greenhouse-gas emissions.

Whether supporting Clinton/Gore’s proposal for a Btu tax; or lobbying the Bush/Cheney administration to regulate CO₂ emissions, receiving a “climate protection award” from the EPA, or a “corporate conscience award” from the Council on Economic Priorities; advancing the interventionist agenda of the President’s Council on Sustainable Development, Business Council for Sustainable Energy, Pew Center on Global Climate Change, and Heinz Center for Science, Economics, and the Environment; or sponsoring Earth Day events in Texas, California, and Oregon, Ken Lay’s Enron was pointing the way to a sustainable energy future—or so it was thought.

Energy “Social Responsibility”: Two Major Fallacies

Two stubborn premises of ’socially responsible’ energy investing should be revisited at this late date.

The first concerns the green greenhouse gas, carbon dioxide (CO2), and the second the non-green intermittent resources: wind and solar power.

Carbon Dioxide. The first fallacy is that CO2 is a known, major, reversible negative externality. On the contrary, a balance-of-evidence case can be made that CO2 is the green greenhouse gas as explained by Chip Knappenberger at MasterResource.

To this point, consider the happy intersection between mainstream climate scientist Gerald North of Texas A&M and mainstream economist Robert Mendelsohn of Yale. Realistic anthropogenic warming estimates such as held by Dr. North have strong positives–and even a net benefit after considering costs–for the environment and for the economy as explained by Mendelsohn. This is a strong argument for rejecting a case for ‘market failure’ and government correction, as if there were not government failure and analytic failure also.

There are real pollutants and there are speculative ones. CO2 is a speculative, politicized one. It is time for ’socially conscious’ investors to focus on real environmental issues.

“Green” Renewables. Windpower is the green energy that is not green. Wind environmentalism is an oxymoron; the triumph of image and inertia over reality.

The fatal attraction of environmentalists toward industrial wind turbines (industrial wind parks) has peculiar roots. Left environmentalists like wind not because it is back to nature and benign–it is neitehr of these things. They like wind because it is about the only thing they can offer after (rejected) nuclear or hydro as a ’supply side’ energy source. And the very problems of wind energy–high costs and unreliability–morphs into their demand-side  strategy of conservationism. So the Left environmentalists supply-side strategy is really their demand-side strategy–but at the expense of the environment!

Socially conscious investors should turn against wind power and on-grid solar power in particular for the simple fact that the wrong environmental standard has been used. Kent Hawkins has explained the dirty secret of intermittent generation as a backdoor pollution source (see Appendix B). And in a more general sense, Peter Huber explains why renewables have severe environmental tradeoffs:

“The greenest fuels are the ones that contain the most energy per pound of material than must be mined, trucked, pumped, piped, and burnt. [In contrast], extracting comparable amounts of energy from the surface would entail truly monstrous environmental disruption…. The greenest possible strategy is to mine and to bury, to fly and to tunnel, to search high and low, where the life mostly isn’t, and so to leave the edge, the space in the middle, living and green.”

- Peter Huber, Hard Green: Saving the Environment from the Environmentalists (New York: Basic Books, 1999), pp. 105, 108.

Conclusion

The case studies of BP today and Enron yesterday demonstrate the fallacy of using climate alarmism and renewables-based energy transformation as litmus tests for socially responsible energy investing. But will substance overtake form in this area? It is high time for an open, honest debate where the best arguments from both sides are aired for both fund managers and investors to decide.

Appendix A: Eleanor Laise, “Oops: ‘Socially Responsible’ Funds Hold Big Stakes of BP,” Wall Street Journal, July 17–18, 2010.

The oil that spewed into the Gulf of Mexico has stained some “socially responsible” mutual funds.

These portfolios aim to invest based on environmental, human rights, corporate governance and other criteria. Yet a number of major socially responsible funds and indexes

Workers in Waveland, Miss., clean up oil that washed ashore from the Deepwater Horizon spill in the Gulf of Mexico.

The BP case shows just how different socially responsible portfolios can be. While BP had clear safety issues that alienated some of these funds even before the Gulf spill, others favored the company because of its stance on climate change and alternative energy.

The upshot on socially responsible investing: “Investors need to do more legwork than they might have originally thought when choosing an SRI fund,” says Kathryn Young, mutual fund analyst at investment-research firm Morningstar Inc.

Though still a small corner of the mutual-fund industry, socially responsible funds have attracted steady investor interest in recent years. Shareholders added about $1.4 billion to these funds in the first six months of this year, bringing total assets to more than $50 billion, according to Morningstar.

While the term socially responsible implies major investing restrictions, funds employ a wide range of strategies both to pick stocks and to decide when to sell. Domini Social Investments, which runs Domini Social Equity and other funds, has avoided BP completely. Pax World Funds had flagged BP over safety concerns last year but still held the stock on April 20; it sold a few days later. MMA Praxis Mutual Funds held BP in its International Fund as of June 30, and in a review last month decided not to exclude the stock from its investment universe. (It isn’t clear how many socially responsible funds held BP as of April 20, since mutual funds are required to disclose holdings only on a quarterly basis.)

In the past, many funds followed a fairly simple methodology, screening out companies focused on areas like alcohol, tobacco or weapons. But in recent years, partly to achieve better diversification, some have taken a more nuanced approach. Instead of ruling out entire industries, they may select companies in each sector that have demonstrated some commitment to social principles. Many are even trying to distance themselves from the “SRI” moniker, which some associate with the negative screening approach, in favor of terms like “sustainable” and “environmental, social and governance,” or ESG, investing.

Pax World, for example, a few years ago dropped strict screens that had ruled out gambling and alcohol-related stocks. Now, “we take a best-in-class approach,” rather than focusing on what not to invest in, says Joe Keefe, Pax World president and chief executive. One of the benefits of that approach, he says, is that “you can get broad diversification and exposure to all industries.”

Similarly, Calvert Asset Management Co. in late 2008 launched a new category of funds that use limited screening but focus more on engaging with company management to push for changes. And that is how it wound up holding BP. While the oil giant didn’t pass the screens employed by Calvert’s traditional socially responsible funds, it was held in the engagement-focused Calvert Large Cap Value Fund. That fund liquidated its BP holdings in late June, says Bennett Freeman, senior vice president for sustainability research and policy. “Engagement often takes a long time to demonstrate tangible results,” Mr. Freeman says.

Why soften the investing parameters? To track the broader market more closely. In the 10 years ending June 30, the average socially responsible fund gained an average of 0.1% annually, versus a 1.59% annualized loss for the Standard & Poor’s 500-stock index. In the first six months of this year, socially responsible funds fell 6.2%, versus a 6.7% decline for the S&P 500.

But the BP incident highlights big differences in how socially responsible funds prioritize various causes. Some of these managers considered BP’s stance on climate change a strong positive. “BP was the first to break the logjam on climate change policy” and had been a leader on alternative energy, says Mark Regier, director of stewardship investing for MMA Praxis.

Other managers focused on safety and already were backing away from the stock before the spill. Pax World, which put BP on a watch list in October 2009 due to safety concerns, launched a full review of the company earlier this year. BP failed, though Pax World still held the stock at the time of the spill. Even so, “our process was working,” Pax World’s Mr. Keefe says.

Even broad socially responsible indexes disagree on how to handle BP. The stock was removed from two KLD Research & Analytics indexes, now owned by MSCI, in 2007 and 2008. The Dow Jones Sustainability Indexes dropped BP after the spill, on May 31. Yet another index lineup, FTSE4Good, still includes BP. Index components are reviewed on a semiannual basis, and the next review will be in September, says Jill Mathers, a spokeswoman for FTSE Group.

Investors with deeply held convictions about a particular social or environmental issue would be wise to delve deeply into a fund’s holdings before taking the plunge. Says Adam Kanzer, managing director and general counsel at Domini: “No two are exactly alike.”

Appendix B: Kent Hawkins on Incremental Emissions from Fossil-Fuel-Firmed Windpower

 Subsidizing CO2 Emissions via Windpower: The Ultimate Irony

Part I: Overview of Wind Integration Studies

  

Part II: Wind Integration: The Netherlands Study

 

Part III: Wind Integration: The Colorado Study

 

Part IV: Wind Integration: The Texas Study

“Bottom line, the program has raised electricity prices, created a slush fund for each of the member states, and has had virtually no impact on emissions or on global climate change.”

Against a backdrop of oil spewing into the Gulf of Mexico, the Obama administration stepped up its campaign to pass national climate change legislation. Senate Majority Leader Harry Reid, D-NV announced last week that he plans to bring a comprehensive energy and climate bill to the Senate floor by the end of the July. The bill, still to be written, is expected to include a cap on carbon emissions produced by the nation’s electricity providers.

But before the U.S. embraces such a program, Congress — and the public — would be wise to examine the early performance of the Regional Greenhouse Gas Initiative (RGGI), the nation’s first mandatory greenhouse gas cap and trade system.

Bottom line, the program has raised electricity prices, created a slush fund for each of the member states, and has had virtually no impact on emissions or on global climate change.

Background

The federal government has been debating national climate legislation since 1992. Over one-hundred heads of state attended the United Nations Conference on Environment and Development, where it was assumed that man-made global warming was a problem and deserved public-policy action.

The Kyoto Conference followed in 1997.  The conference resulted in the proposed Kyoto Protocol, a treaty to reduce greenhouse gas emissions (“GHG”) through either a cap-and-trade or a carbon tax programs in developed nations, and through carbon emission subsidies for underdeveloped nations.

The Protocol established the concepts of Joint Implementation (“JI“) and Clean Development Mechanism (“CDM”) as means to fund GHG reductions in the developing world. With Kyoto, “carbon finance” was born.

Major compromises in Kyoto included setting 1990 as the baseline to get Eastern European buy-in and exempting the underdeveloped world. The 1997 Byrd-Hagel Resolution, which passed the U.S. Senate by 95-0 ensured the U.S. would not sign onto Kyoto. It was the sense of the Senate, as cited in the resolution, that the protocol would “result in serious harm to the economy of the United States.”

RGGI in Action

Ten years later, in 2008, the Regional Greenhouse Gas Initiative (“RGGI”) was launched.

RGGI was the first mandatory system in the country aimed at capping and reducing CO₂ emissions over time. The region consists of ten Northeastern states: New York, New Jersey, Delaware, Maryland, and the six New England states.

Member states agreed to an initial emissions cap of approximately 188 million tons of CO₂, representing the total amount of CO₂ that power plants in the ten states were expected to emit in 2009, the first year RGGI went into effect. This cap is to remain in place until 2015 and then drop by 2.5% per year from 2015 to 2019 – a total drop of 10% by 2019. At the time the RGGI caps were set, stakeholders assumed that business-as-usual emissions from electric generation would grow roughly 1% each year.

Over two-hundred generators are subject to RGGI within the ten states, including all fossil fuel-fired power plants (coal, oil, and gas) with a capacity of at least 25 megawatts.

Each state is allocated a quantity of CO₂ allowances according to previous emission history. New York State, for example, received 64 million allowances while Maryland received 38 million etc. up to the 188 million tons.

One allowance is equivalent to one ton of CO₂. Generators within the respective states are required to purchase, through auction or directly from the state entity managing the program, a single allowance (permit to emit CO₂) for every ton of CO₂[1] they emit. RGGI requires that at least 25% of the allowances be auctioned by the states with the proceeds to be spent for consumer benefit and strategic energy projects.

A minimum price for RGGI allowances, known as the “reserve price,” was set at $1.86 per ton. This floor price prohibits allowance prices from dropping to zero when emission limits are met, thus ensuring minimum revenues for state supported energy programs.

Quarterly, online auctions are conducted by World Energy Solutions which returns the proceeds to the member states. The initial RGGI auction, held September 2008, raised $39 million for the member states. Total proceeds raised to date, including the most recent RGGI auction (June 9, 2010), stand at $662.8 million.

Auction participation is not limited to power generators. Allowance trading can also occur within a secondary market that is expected to lower transaction costs and provide power plants an opportunity to acquire allowances at any time rather than through the quarterly auctions. Unsold allowances are made available for sale in future.

RGGI’s Questionable Benefits

In its annual report on RGGI (October 2009) member State New Hampshire described the program in only positive light:

“… to date RGGI has been an unqualified success, particularly given the obstacles proposed by undertaking cooperative efforts among the ten states to establish and operate a viable carbon emissions trading market with a common currency (budget allowances) recognized by all parties. RGGI has helped establish a new and vibrant market for carbon in the United States with robust trading and strong demand for CO₂ allowances. RGGI auctions have been conducted for a full year, smoothly and professionally. The state has received over $15,000,000 to date in allowance auction revenues…. Total revenues collected for consumer benefit in the ten RGGI states have exceeded $400 million.”

But a closer look at the program should give the public and federal legislators pause.

Superficially, the good news is that RGGI’s initial year saw emissions from participant power plants fall 34% to just above 120 million tons of CO₂.  This figure is well below the 188 million ton cap and even below the program’s 2019 goal of 10% reductions from 2005 levels[2]. However, most objective observers do not credit RGGI for the precipitous drop in overall emissions. Mild weather, the current economic downturn and lower natural gas prices caused a significant drop in electricity consumption.

In fact, RGGI allowances added about 0.9% to retail electricity prices in New England with little tangible benefit for ratepayers beyond another government program.

The distribution of RGGI revenues did little to raise public confidence. In New Hampshire, columnist Fergus Cullen wrote that too many of the twenty-one projects funded so far with RGGI proceeds were tainted by what he called “cronyism and corporate welfare.”

Political/Enviro Cronyism?

A quick look at the grants funded in New Hampshire affirms this point.

Clean Air Cool Planet , the global warming alarmist group whose aggressive political lobbying is credited with the state joining RGGI, received over $1.2 million through two grants, including $813,402 to be shared with the University of New Hampshire to create the Carbon Challenge website. The state’s descriptions of the two grants (“to provide residents and communities with the information, tools and support necessary for households to make substantial reductions in their energy consumption and thus greenhouse gas emissions“) are vague and the money unlikely to translate into measurable results.

A $470,000 grant was funneled to Fraser paper mill in Gorham, NH, to help reduce the mill’s oil consumption. The company declared bankruptcy in 2009, and this month it is expected to divest of all its assets, raising doubt that the money spent will have any long-term public benefit.

New Hampshire is not alone. Maine allocated ten-million dollars in RGGI revenues to form Efficiency Maine Trust, a public entity whose purpose is to help residents save on electricity and use less heating oil. Each of the 10 member states describe their allocations of the money in similarly vague terms.

An Energy Tax for Political Kitties

Actions this year by four member states demonstrate that RGGI is little more than an energy tax to be spent as politicians see fit. In Maryland, legislators voted to take 50% of the RGGI revenues and distribute the money to lower income residents to help pay their power bills. New York’s Governor David Patterson will use $90 million of revenue to address state budget deficits. New Jersey followed suit and grabbed $65 million to cover a shortfall in last year’s budget. New Hampshire closed its budget gap by diverting $3.1 million from RGGI funds.

Conclusion

Under RGGI, the cap was purposely set low and compliance has already been met through 2019 and beyond due to fortuitous circumstances. While the cost per allowance is also low (now selling at the floor price of $1.86 per unit) participant states have managed to amass over half a billion dollars in proceeds since September 2008.

Yet it is very doubtful whether projects receiving RGGI grants have achieved anything except for superficial “feel-good” results. With the decline in the economy, Maryland, New York, New Jersey, and New Hampshire redirected the money to cover budget shortfalls — thus cementing the view of skeptics that cap-and-trade is nothing more than another government program aimed at taxing energy.

Senate negotiators are currently considering an initial carbon price of around $20 dollars a ton, rising as high as $50 per ton by 2050. The Wall Street Journal recently reported that a national cap and trade system could generate between $1.3 trillion and $1.9 trillion during fiscal years 2012 and 2019.

Regional disparities in fuel uses, if not addressed in the law, will unfairly burden residents in coal-powered states like Kentucky, while favoring others in New England (natural gas, nuclear) and the Pacific Northwest (hydro). Although there is some indication from the White House that money would go toward a tax cut for the “middle class,” RGGI proves there will likely be substantial wiggle-room to use the money to promote more government growth. 

RGGI is Exhibit A against a national cap-tax-and-spend program. Americans should understand this program and run in the other direction.

[2] Barring changes in the cap, CO₂ allowances are valued at the $1.86 floor price and will likely remain in surplus through to 2019.