The Future of Regulation and Free Markets for Energy

By Melissa Reardon, M.S. Class of 2017, Environmental Fluid Mechanics & Hydrology

Regulation and free markets have both been suggested as ways to encourage decreasing energy consumption and resulting pollution, particularly with regard to greenhouse gases. Regulation comes in a variety of forms, including subsidies, mandates, and cap-and-trade markets, each resulting in different prices for conventional and renewable energy. In free markets, prices are decided solely by competition between privately owned businesses.

Proponents of free markets for energy argue that free markets are more efficient and lead to clearer price signals to consumers (Morgan, 2016; Murphy, n.d.). While a free market certainly sounds appealing, it is not a very realistic end goal. First, the large-scale energy market has never been completely “free”; oil and gas, the main conventional sources of energy, have received subsidies since 1918 (Pfund & Healey, 2011). Second, many of the major technologies in the energy sector required subsidies from the government to become as large-scale as they have (Pfund & Healey, 2011).

Instead, it is more realistic to plan for regulation as the main tool to encourage decreases in consumption in the future. Not only has regulation been a part of the energy market from its beginnings, but it has also led to improvements in efficiencies and technologies. For example, regulation on sulfur dioxide pollution in the form of amendments to the Clean Air Act, new source performance standards, and other mandates led to innovation in sulfur dioxide control mechanisms for power plants (Taylor, Rubin, & Hounshell, 2005).

The Corporate Average Fuel Economy (CAFE) standards are another example of successful regulation. The CAFE standards were created in 1975 to make car manufacturers “increase […] the fuel economy of the passenger car and light-duty truck fleets sold in the United States” (Committee on the Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards, Board on Energy Environmental and Energy Systems, Transportation Research Board, National Research Council, 2002, p. 1). These standards directly contributed to increasing gas mileage efficiencies in cars throughout the United States (Fig. 1) and, as a consequence, led to a decrease in greenhouse gas emissions for drivers across the country (Committee on the Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards, Board on Energy Environmental and Energy Systems, Transportation Research Board, National Research Council, 2002).

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Fig. 1. Fuel economy of new and on-road cars and light trucks, respectively, from 1965 to 2001 resulting from the CAFE standards. Source: Committee on the Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards, Board on Energy Environmental and Energy Systems, Transportation Research Board, National Research Council, 2002, p. 16.

However, regulation also comes with its own set of problems that will need to be addressed for it to be used effectively. The first problem is rebound effects. Increased efficiency does not necessarily lead to decreased consumption; instead, consumers tend to buy more energy efficient items, resulting in the same amount of consumption (Herring & Roy, 2007). This could be addressed with changes to the price of energy that better encapsulate the negative externalities or “true cost” of energy sources.

The price of energy raises a second problem with the current regulation: subsidies. Worldwide, oil and gas companies today receive subsidies of over $500 billion. By comparison, wind and solar companies receive subsidies totaling $66 billion (Barlag & Bruner, 2014). From a historical perspective, renewable energies have also received significantly smaller subsidies in the United States than oil and gas companies have received over their respective tenures. From 1918 to 2009, the average annual subsidy for oil and gas companies was $4.86 billion 2010 dollars. Renewable energies, by contrast, received an average of $0.37 billion 2010 dollars per year from 1994 to 2009 (Fig. 2, Pfund & Healey, 2011). By equalizing the subsidies, the price of different energy sources could be more accurate and act as a better signal for consumers to switch to renewables.

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Fig. 2. Historical average annual energy subsidies from the United States federal government for oil and gas (O&G), nuclear energy (nuclear), biofuels, and renewables over their respective tenures. Source: Pfund & Healey, 2011, p. 29.

Regulation has always been involved in the energy markets in the United States and will likely continue to be so. It has been an effective tool in reducing greenhouse gas emissions and sulfur dioxide pollution through, respectively, CAFE standards and changes in legislation, standards, and mandates. However, in the energy market, regulation may need to take on characteristics of free markets, specifically clearer price signals. These price signals may be improved through prices that incorporate negative environmental externalities or through equal subsidies for conventional and alternative energies. With these changes, regulators and legislators should be able to more effectively guide consumer behavior toward energy sources with fewer greenhouse gas emissions.

References:

Barlag, P. A., & Bruner, P. (2014). No Free Market for Energy. MIT Sloan Management Review. Retrieved from http://sloanreview.mit.edu/article/no-free-market-for-energy/

Committee on the Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards, Board on Energy Environmental and Energy Systems, Transportation Research Board, National Research Council. (2002). Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards. Washington, D.C.: National Academies Press.

Herring, H., & Roy, R. (2007). Technological innovation, energy efficient design and the rebound effect. Technovation, 27(4), 194–203. http://doi.org/10.1016/j.technovation.2006.11.004

Morgan, T. (2016). The Case For Free-Market Energy: Removing Energy Subsidies And Price Controls Improves Market. Retrieved from http://www.forbes.com/sites/drillinginfo/2016/03/28/the-case-for-free-market-energy-removing-energy-subsidies-and-price-controls-improves-market/#62f288ab2d5a

Murphy, R. P. (n.d.). Why Free Market in Energy? Retrieved from http://instituteforenergyresearch.org/analysis/why-free-market-in-energy/

Pfund, N., & Healey, B. (2011). What Would Jefferson Do?: The Historical Role of Federal Subsidies in Shaping America’s Energy Future.

Taylor, M. R., Rubin, E. S., & Hounshell, D. a. (2005). Regulation as the Mother of Innovation: The Case of SO2 Control. Law & Policy, 27(2), 348–378. http://doi.org/10.1111/j.1467-9930.2005.00203.x