What Put California at the Top of Residential Solar?

California leads the nation in residential solar photovoltaic installations.  In fact, nearly half of all systems installed have been in the Golden State.

So why is California the leader?  Sure, California has plenty of sunshine, but there are many other states that can compete on that dimension, including Florida, the Sunshine State.  It’s not the federal tax benefits, which are available to all US residents.  It’s not California’s Renewables Portfolio Standard, which effectively excludes residential solar.  Some point to the California Solar Initiative that gave rebates for new systems from 2007 to 2013, and that is surely part of it.

But another factor is the “solar friendly” residential electricity prices.  Not only do California’s two largest utilities have some of the country’s highest average residential electricity prices, the rates are also tiered, meaning that they increase for additional kilowatt-hours as the household consumes more over the month.  As a result, large users face rates for much of their power that can be three times higher than rates in many other states, including the Sunshine State.

SolarPVIncentives-Tiers

Have the level and structure of retail rates been a major factor in California’s residential PV boom?  I’ve been wondering that for a while, so in the last few months I’ve been sizing up the various solar incentives for customers of Pacific Gas & Electric, the state’s largest utility, which has by far the most residential rooftop solar capacity in the country.  The result of this work is being released today in a new Energy Institute working paper, “The Private Net Benefits of Residential Solar PV: And Who Gets Them”.

Using data on PG&E households that installed solar from 2007 to 2013 (and for some data, into early 2014), I examine the collection of incentives that were available, whether the system was bought by the homeowner or owned by a solar company, known as third-party owners (TPOs).  TPOs can lease the panels to the homeowner or agree to sell the electricity the panels generate under a power purchase agreement that specifies the price per kilowatt-hour (kWh), usually for 20 years.   I then put all these incentives together with reported prices of the systems to calculate the net benefits.

The incentives include direct rebates and tax credits, as well as indirect incentives from the structure of retail tariffs and the credit for electricity grid injections from the panels under “net metering” policies, as I’ve discussed in an earlier blog.

To start with the easiest ones, the California Solar Initiative was offering $2.50 per watt rebates back at the beginning of this period – when the full systems cost around $10 per watt on average.  The CSI rebate stepped down over time, eventually hitting $0.20/watt in 2013 just before it disappeared.  In the first half of 2014, the average full system price was down to around $4.50/watt.

SolarPVIncentives-CSI

If you bought the system, you got the CSI rebate.  With a TPO, the company that owns the system got the rebate and — I hope — you got a lower price reflecting at least part of that savings. In either type of transaction, how much the price adjusted to pass through the savings to the homeowner, or how much the installer captured, is a point of strong dispute.  Different analyses have estimated 17%, 45% and 99% passthrough rates to homeowners.  Unfortunately, my study can’t unpack that even in the simple case of system purchases, let alone with much more complex lease or power purchase agreements.  I estimate the incentive the homeowner and seller jointly received, not how they divided it up.

At the same time as California had the CSI, the federal government was giving a 30% tax credit for solar, but only up to $2000 for the entire system if a homeowner bought it in 2007 or 2008.  TPOs got the full credit from the start.  Since 2009, homeowners have also had no cap on the tax credit.

If you think figuring out federal tax credits could get a bit tedious, imagine the thrill of analyzing the economics of accelerated depreciation.  I’ll spare you the details here (a phrase that may have been more welcome a couple paragraphs earlier), but the bottom line is that accelerated depreciation — which only TPOs can utilize — amounted to an additional 12%-15% incentive, about half the size of the 30% federal tax credit, and larger than the CSI since 2010.  The figure below shows my estimates of the size of these incentives, all per kW of installed capacity, from 2007-2013.

SolarPVIncentives-Estimates

That brings us to the incentive from residential rates.  During the period I studied, the 5 tiers of PG&E’s rate structure averaged $0.13, $0.15, $0.28, $0.37, and $0.40 per kilowatt-hour (kWh).  The solar PV on your rooftop crowds out the most expensive kWh first by reducing the total kWh for which you get billed.    Over these years, the systems installed were on average displacing kWhs that would have cost the customer an average of about 26 cents.  Importantly, that is much higher than the 19 cents per kWh they would have saved if PG&E charged a single flat rate for electricity (that raised the same revenue).  If PV adopters expected the tiered prices to stay at those levels (adjusted for inflation), I show that PG&E’s tiering of rates created nearly as much additional incentive to install solar as did the 30% federal tax credit.

The savings are so large in part because of net energy metering (NEM), which means the household only pays for the net consumption — that is, total consumption minus the electricity the panels produce — even if some of the panel production gets injected into the grid (which happens any time that the household consumption is lower than production).  An alternative approach, used in other parts of the world, is to pay the household a lower price for grid injections than the retail price the household pays for receiving electricity.  Surprisingly — at least to me — moving from NEM to that alternative approach, but keeping the same tiered rates, would reduce the incentive for solar by only about half as much as moving from tiered to a flat electricity rate.  The steep tiers create a much larger incentive than NEM, though the combination creates a still larger incentive.

Important note: those steep tiers created strong incentives only if they were expected to last.  Maybe they were, but they didn’t.  Already, in 2015, the lowest tier prices have risen and the highest have fallen so much that the highest tier price is now about twice the lowest rather than three times.  Proposals now before the California Public Utilities Commission would change the spread to just 20% or 66% depending on which proposal is adopted.  This will further lower the average price of electricity that the solar panels replace, and lower the incentive for large users to install PV.

Beyond the size of these incentives, I also wondered who was going solar, particularly how much the recipients of incentives tilt towards high-income households.  Using very granular census data, I estimated household incomes for each PG&E customer who installed solar.  Not surprisingly, they are heavily skewed to the wealthy with 35%-40% of systems going to households in the top 20% of earners.  But that has been changing since 2011, with the measure of inequality among adopters declining by nearly one-fifth from 2010 to 2014.  In the first few months of 2014, households in the highest of the five income brackets were still 82% more likely to adopt solar than households in the middle bracket, but that’s down from 116% in 2010.

Estimating incomes of solar adopters also give some insight into how the private benefits vary among those who do install PV systems.  As you would expect, the lower income adopters tend to consume less electricity and put in smaller systems, but they actually put in larger systems relative to their consumption.  That means they start lower down on the tiered rate structure and they crowd out a larger share of kWh, which are kWh that wouldn’t have cost that much anyway.  Systems on the roofs of the highest income bracket households crowded out electricity that would have cost them 27 cents per kWh on average, while the systems on middle income households displaced 25 cent power, and the households in the lowest bracket displaced 21 cent electricity on average.  Among those who installed solar in 2007-14, the wealthiest customers were likely to get the largest savings.

As I wrote a few weeks ago, we need a careful analysis of the societal costs and benefits of deploying renewable power at grid scale versus distributed generation.  At the same time, we also need a careful analysis of the incentives that have been created for generating energy from all sources.  Regardless of one’s views on solar, distributed generation, or renewables generally, understanding the size of the financial incentives from direct and indirect factors is critical to evaluating which programs are likely to have the greatest effect on adoption and which customers are likely to get the greatest benefits.

Posted in Uncategorized | Tagged , , | 7 Comments

Is Clean Coal Too Expensive?

Policies that subsidize the demonstration of large-scale technologies make economists queasy. Severin explored this topic in a recent blog.

In retrospect it’s easy to point to failures, including the United States Synthetic Liquids Fuels Program that died in the 1980s and Solyndra’s bankruptcy in 2011. But there are a few clear winners too. Take the government-supported technologies that enabled the US shale oil and gas boom.

Of course in retrospect, it’s easy to identify the failures and the successes. It’s much harder to do it in real time. Still, policymakers presented with many options and limited resources need to make decisions.

One important set of technologies that deserves a critical review right now is the use of coal to produce electricity but keep the carbon dioxide from entering the atmosphere and contributing to climate change.

The Tavan Tolgoi coal mine in Mongolia. Mongolia exports most of its coal to China.

The Tavan Tolgoi coal mine in Mongolia. Mongolia exports most of its coal to China. SOURCE: http://en.wikipedia.org/wiki/Mining_in_Mongolia

Many of the world’s fastest growing economies are relying on coal to lift their populations out of poverty. In 2013, 70 percent of global coal consumption occurred in rapidly growing Asian countries. Remaining coal reserves are enormous too. According to BP’s latest statistical survey, world coal reserves in 2013 were sufficient to meet 113 years of global production.

If clean coal technologies do not become cost effective, developing countries will continue burning coal in an uncontrolled way to meet societal needs.

In the US, clean coal technologies have received hundreds of millions of dollars in subsidies since the mid-2000s, but the federal government is starting to yank its support.

In February, the US Department of Energy pulled the plug on the high profile FutureGen 2.0 project in Illinois. The project’s blue chip sponsors, including major coal producers like Peabody Energy and BHP Billiton, as well as foreign utilities E.ON of Germany and China Huaneng Group of China, needed continued government subsidies to build this first-of-its-kind project. The project had already gone through more than $200 million in federal money, and the DOE decided that was enough. Now FutureGen 2.0 has joined the dozens of other cancelled carbon capture and storage (CCS) projects.

While news from the Prairie State (Illinois) is grim, there has been some progress in the Hoosier State (Indiana), Magnolia State (Mississippi), and the Land of Living Skies (Saskatchewan!). Three plants have been completed or are approaching completion:

  • Duke Energy’s 595 megawatt Edwardsport Integrated Gasification Combined Cycle (IGCC) plant in Indiana. The world’s first large scale IGCC plant. The carbon capture and storage component of the project was dropped part way through construction, although the plant could be upgraded with carbon capture and storage in the future.
    Online date: June 2013. Forecast cost: $1.985 billion. Actual cost: $3.55 billion. Cost per unit of capacity: $6,000 per kilowatt.
  • The Southern Company’s 582 megawatt Kemper plant in Mississippi. The world’s first large scale IGCC plant with CCS. The carbon dioxide will be injected underground in a nearby oil field. Online date: first half of 2016. Initial forecast cost: $2.4 billion. Revised forecast: $6.2 billion. Cost per unit of capacity: over $10,000 per kilowatt.
  • SaskPower’s 110 megawatt Boundary Dam Project in Saskatchewan. The world’s first post-combustion coal-fired CCS project. The plant takes the flue gas from a pre-existing coal power plant and strips out the carbon dioxide. The carbon dioxide will be injected in a nearby oil field. Online date: late 2014. Actual cost: C$1.467 billion. Cost per unit of capacity: over US$12,000 per kilowatt (at today’s exchange rate).

The three plants received either direct government subsidies, or have been authorized by the government to recover costs from their captive customers—a sort of off-the-government’s books subsidy.

To put the plants’ costs in perspective, the graph below compares the capital cost per kilowatt of these plants with the capital costs of other technologies as estimated by the US Energy Information Administration:

Data from US Energy Information Administration (http://www.eia.gov/forecasts/capitalcost/)

The capital cost does not tell the whole story of how power generation technologies compare. Plants also vary in terms of fuel cost, percentage of time they operate, operations and maintenance costs, expected life and pollution they generate. Capital costs are, however, one of the most important components of the comparison between technologies.

The graph shows that these three plants were more expensive than the estimates for similar plants of the same technology, and were much more expensive than many alternatives.

However, it is also important to note that substantial knowledge and experience have been produced as a result of those government investments. Valuing that knowledge and experience is difficult.

Now it is time to ask—should the government subsidize additional coal projects like these? Should these first-of-their-kind projects be the last-of-their-kind?

Does this guy deserve more subsidies? Maybe so. SOURCE: http://www.gutenberg.org/files/36141/36141-h/36141-h.htm

Does this guy deserve more subsidies? Maybe.
SOURCE: Punch, Vol. 105, August 19, 1893 at http://www.gutenberg.org/files/36141/36141-h/36141-h.htm

To make this decision, policymakers should be exploring a number of things: Why did the projects cost so much? What caused the budget over-runs? How can costs be reduced and output increased for future plants? Is there a plausible path to make the technology cost competitive? How can clean coal avoid the increasing cost trends experienced by nuclear energy, highlighted by Lucas in a prior blog?

Policymakers need to carefully consider subsidizing second, and even third, versions of each promising clean coal plant. That may be a hard case to make in the US given expectations of large natural gas supplies and low natural gas prices, but European and Asian countries may be able to justify further government investments in coal.

The opportunity is too big to ignore coal.

Posted in Uncategorized | Tagged , , , | 14 Comments

Subsidizing renewables for the damage not done

In this divided age, few topics beyond motherhood, apple pie, and the iPhone 6 enjoy widespread public approval. So it is notable that, in a recent Gallup Poll, two out of three Americans support an increased reliance on solar and wind energy sources.

solarSource: http://www.americasupportssolar.org/

While (almost) all of us seem to agree that more is better when it comes to renewable energy, things get more complicated when it comes to determining what form that more should take.  In other words, how do we get the biggest bang for our green energy buck?

In last week’s blog post, Severin argued convincingly that the answer lies in the creation of policy and market incentives that accurately reflect the real benefits and costs of different renewable technology options. A great idea!  But messy and controversial to implement.  To design these incentives, we need to measure and monetize the various costs and benefits that alternative energy technologies incur and afford.

Some co-authors, Duncan Callaway and Gavin McCormick (who was featured in an earlier post), and I have been trying to tackle one corner of this larger valuation exercise. In some ongoing research which will be released soon as an Energy Institute working paper, we estimate the greenhouse gas emissions impacts associated with incremental increases in renewable energy generation in different parts of the country.

The basic idea is as follows: when a wind turbine or solar PV system is connected to the electricity grid, the clean energy produced will displace electricity generation at other sources. We estimate the associated emissions impacts which largely depend on the emissions intensity of the marginal production that gets crowded out.

At this point, you might be wondering why we should be so concerned with measuring the emissions damages not done. If our objective is to design policy incentives to accurately reflect emissions costs, why not penalize emissions damages directly with an emissions price?

“Tax carbon” is a hallowed refrain on this blog (and on a vanity license plate of an economist we know and love). But when it comes to designing policies to encourage renewable energy, production-based subsidies and credits (such as the production tax credit and renewable portfolio standards) are a politically preferred policy instrument in the U.S. This is true now, and as states look to leverage existing renewable energy policies to comply with the proposed Clean Power Plan, this could hold true for the forseeable future.  So long as we are in the business of subsidizing renewables for avoided emissions damages, it’s worth thinking about how to design these second-best incentives.

Measuring damages avoided

To estimate the emissions impacts of marginal changes in electricity generated by existing sources, we use hourly data from six major independent system operators (ISOs) in the United States over the years 2010-2012. We then match these estimates with simulated renewable energy production across thousands of wind and solar sites to estimate the average quantity of emissions displaced per MWh of renewable energy generated across different regions and technologies. We also consider the emissions impacts of some common energy efficiency improvements.

The figure below summarizes our estimates of avoided emissions on a per MWh basis over the 2010-2012 period. The colors denote the different technologies we consider. Technology-specific estimates are grouped by region. The bars of each box plot denote the range of/variation in our estimates due to the day-to-day variability in power system operations.

plot1

Pounds  of Carbon Dioxide displaced per MWh of renewable energy generated (or energy saved)

The graph shows lots of variation across regions in the average quantity of emissions displaced per MWh generated or saved[1]. This is not surprising given the large differences in the generating portfolios across regions. Displacing a MWh of conventional electricity production had a relatively small impact on emissions in California where the generating mix is not very carbon intensive. The largest emissions reductions are found in the Midwest (MISO) and Mid-Atlantic (PJM). In these regions, the generating units that would be crowded out when renewables kick in are often coal-fired.

There is much less variation in avoided emissions across different resources – for example solar PV versus wind – within a region. Intuitively, this is because marginal emissions rates are fairly constant within regions across hours and across seasons. One exception is New York (NYISO), where the marginal emissions rates are significantly lower on average during high-demand hours. Solar PV resources and commercial lighting retrofits, which generate electricity/savings disproportionately during daylight hours, displace fewer emissions per MWh than wind energy or residential lighting improvements.

What does this mean for subsidizing green?

If we want to design production-based credits or subsidies to accurately reflect emissions damages avoided, these results suggest that subsides should vary significantly across regions. Variation in avoided damages across technologies within a region appears less important.

To put these estimates into some kind of perspective, we assign a dollar value to each ton of CO2 displaced, $38/ton, and compare these monetized avoided damage benefits to the average wholesale electricity market value of the renewable electricity generated. The graph below summarizes our estimates for solar and wind energy for two extreme cases: California (relatively less carbon intensive on the margin) and the Mid-Atlantic (relatively more carbon intensive generation).

 blog_figure

Marginal value per MWh of Solar and Wind Energy Generated

The blue bars show the average wholesale market value of the electricity produced by wind and solar resources, respectively, in these two regions over this period. These values reflect the fuel and operating costs avoided at marginal sources. Electricity generated by solar PV is somewhat more valuable because solar resources are disproportionately available during high demand hours when marginal operating costs are higher.

Our estimates of avoided emissions damages, measured in terms of dollars per MWh, are shown in green. In California, these avoided emissions benefits are approximately a third as large as the wholesale market value. In PJM, monetized emissions benefits and the wholesale market value are of similar magnitude.

Smart subsidies for renewable energy

Our punch line is that the marginal value of emissions displaced per MWh of renewable energy generated has been economically significant in recent years. And these values vary significantly across regions with different generation portfolios. Of course, the quantity of emissions damages truly avoided will also depend on what other policies and programs are in play. For example, if a region imposes a binding emissions cap, an incremental increase in renewable energy will not reduce overall emissions in any meaningful sense.

These estimates of avoided emissions damages capture only one dimension of the potential benefits generated by incremental increases in renewable electricity generation. But it’s an important dimension, particularly when it comes to policies that are designed to reduce the carbon intensity of the electricity sector. From an economic perspective, these policies would ideally impose a tax on emissions calibrated to the damage caused. If instead these policies take the form of renewable energy credits, these incentives should reflect the level of – and variation in- the damages avoided.

[1] Note that if a region has imposed a binding cap on emissions, increasing renewable electricity generation may affect the way the emissions target is met, but not the level of aggregate emissions. Emissions in California were not capped during our study period.

Posted in Uncategorized | Tagged , , , | 22 Comments

Is the Future of Electricity Generation Really Distributed?

Renewable energy technologies have made outstanding progress in the last decade.  The cost of solar panels has plummeted.  Wind turbines have become massively more efficient.  In many places some forms of renewable energy are cost competitive.  And yet…just as these exciting changes are taking place, the renewables movement seems to be shifting its focus to something that has little or no connection to the fundamental environmental goals: distributed generation, particularly at the residential level.  In practice, this means rooftop solar PV.

Instead of seeking the most affordable way to scale up renewables, the loudest voices (though possibly not most of the voices) in the renewables movement are talking about “personal power”, “home energy independence”, “empowering the consumer”, and rejecting “government-created monopolies”.  In the not so distant future, residential PV may be augmented with onsite storage (as suggested by Tesla’s announcement this week of its Powerwall home battery system).

SolarInstallCapacity

Residential is now a growing share of U.S. PV installations. Source: GTM research

The new emphasis on distributed generation has created a very unusual coalition between some traditional environmentalists and some anti-government crusaders.  Parts of the tea party movement have joined the Sierra Club in advocating for “DG-friendly” residential electricity tariffs, which mean high volumetric electricity charges in order to make rooftop solar economic.

I’m sorry, but count me among the people who get no special thrill from making our own shoes, roasting our own coffee, or generating our own electricity.  I don’t think my house should be energy independent any more than it should be food independent or clothing independent.   Advanced economies around the world have gotten to be advanced economies by taking advantage of economies of scale, not by encouraging every household to be self-sufficient.

That’s not to say that distributed generation couldn’t be the best way for some people at some locations to adopt renewables, but simply that DG should not be the goal in itself.  We desperately need to reduce greenhouse gases from the electricity sector, not just in the U.S., but around the world, including some very poor countries where affordability is a real barrier and electricity access is life-changing.  If DG is the least costly way to get that done, I’m in, but the choice should be driven by real cost-benefit analysis, not slogans about energy freedom.  TopazSolarFarm The 550 MW Topaz Solar Farm in San Luis Obispo County, California

The Pros and Cons

Compared to grid-scale renewables, DG solar has many advantages.  Generating and consuming power onsite means no line losses, which typically dissipate 7%-9% of grid-generated electricity before the power gets to your house. In addition, DG solar occupies your rooftop, a space that doesn’t have a lot of alternative uses, so the real estate cost is essentially zero.[1]  And as an extra bonus those solar panels also shade part of your roof, reducing the heat gain on hot sunny days.

In certain cases, distributed generation delays distribution system upgrades as demand on a circuit grows, because less power has to be shipped into the circuit on sunny days.  It also can reduce the need to build new transmission lines to carry power from distant grid-scale generation.

Having many small DG solar installations also spreads them around – spatial diversification – reducing the overall volatility of generation when clouds roll through.  Plus, spatial diversification and onsite generation can make the system more resilient to natural or man-made disasters, such as storms or sabotage.

Solar_panels_on_house_roof_winter_view

The obligatory residential PV photo  (Source:http://256.com/solar/images/)

But distributed generation also has some serious drawbacks.  The first and foremost is that design, installation and maintenance of solar PV small rooftop by small rooftop costs a lot more per kilowatt-hour generated than grid-scale solar, probably about twice as much these days.  The scale economies that are lost with small systems on roofs of different size, shape, and orientation is a big disadvantage compared to grid-scale solar plants that are 10,000 to 100,000 times larger than a typical residential installation.  The size of grid-scale plants also makes tracking devices practical, which allows the panels to move throughout the day to continually face the sun and generate more electricity.

While small scale spatially-diversified generation could in theory reduce distribution upgrades and improve resiliency if the location and types of installations were optimized for those benefits, that’s not how DG solar is actually getting installed.  Systems are put in where homeowners choose to install for their private benefits regardless of the impact on the grid, and they can actually destabilize distribution circuits when they pump too much power back into the grid.  In Hawai’i, where 12% of houses now have rooftop solar, that’s already a serious concern.

Though it’s great that DG solar can contribute energy to the grid when the household doesn’t consume it all onsite, exporting power from the house reduces the DG advantage in line losses and distribution capacity upgrades.  For a typical residential system, at least one-third of the electricity generated is injected into the grid, though that may change with cheaper small-scale storage, one of the many technological factors in flux.

The technology installed with DG solar also is not optimized for the grid, so current systems aren’t contributing to resilience.  Solar PV installed today doesn’t have the smart inverters or the onsite storage that would be necessary for the systems to remain operational when the grid goes down.  Closely related, DG solar systems aren’t communicating with – or controllable by — the grid operator, so the system operator has to just guess when they might start and stop pumping power into the grid.

How do these pros and cons sort out?  Right now, I believe that residential solar loses to grid scale.  But I’m not convinced that will always be true.  And I don’t think that means households should be impeded from adopting DG solar today, just that we shouldn’t be giving it special incentives.   We need to recognize that DG’s role in the electricity future is uncertain and locking in on this (or any other) technology is unwise.  

An economically resilient system for renewables adoption

Well, then, how should we decided whether to go with DG renewables or grid-scale technologies?  We shouldn’t decide.  Instead we should design incentives that reflect the real benefits and costs of each type of system and then let them battle it out.  This has two big advantages.  First, it reduces the political fighting that comes with policymakers choosing one technology over another, or even the share that each technology should get.  Second, it pushes all alternative technologies to keep innovating and lowering their costs.

Designing such science-based incentives isn’t easy.  It requires detailed examination of each of the costs and benefits I’ve listed (and probably others that commenters will suggest).  It will not be possible to nail down each of these factors exactly, but we can’t make good electricity policy if we don’t carefully study what benefits and costs each technology brings to the table.  Tying renewables incentives to the best engineering and economic analyses of their net benefits will involve some heated debates about those analyses, but at least we will then be arguing about the right issues.

Then we should craft incentives that accurately reflect the net benefits each alternative technology offers.  I’m not sure exactly how those incentives should be structured.  But I can tell you that they don’t involve paying households retail rates for power injected into the system, as net metering policies currently do.  And they don’t involve maintaining retail rates that are many times higher than avoided costs — even including pollution costs — in order to create artificially high savings for PV adopters, as the current tiered electricity rates do in many states, especially in California.

They do include much greater use of time-varying pricing and, probably, location-varying pricing to reflect the real value of power on the grid.

Smart incentives based on careful analyses can reflect the dynamic value of distributed solar and distributed storage.  Curtailing net metering would boost the value of battery storage.  A lower cost of storage would smooth out prices over time and location, which would reduce the production timing advantage solar has, but would also reduce the problems of load balancing on individual circuits as DG solar ramps up.  Lowering volumetric residential rates would make end-user storage less valuable by closing the gap between retail and wholesale prices.

If DG solar with incentives that reflect its true benefits wins, that will be great, because we will know we’ve got the least-cost approach to reducing the externalities of electricity generation.  If it sputters, that will be fine too, because it will indicate that there are other less-expensive ways to achieve our environmental goals.  Either way, it’s time for incentives that are truly calibrated to costs and benefits, not to achieving penetration of one low-carbon technology over another.

[1] Though many people don’t have a roof for solar, either because they live in multi-family housing or, in the developing world, because the roof can’t hold the weight of solar panels.

To join the Energy Institute email list and receive notices of new blogs, working papers and events (one or two per week), click here

Posted in Uncategorized | Tagged , | 37 Comments

Air Conditioning and Global Energy Demand

Sales of air conditioners have exploded worldwide over the last few years, driven by middle-income countries where households and businesses are buying air conditioners at startling rates. My colleagues Max and Catherine have written about China, for example, where sales of air conditioners have nearly doubled over the last 5 years. In 2013 alone there were 64 million air conditioners sold in China, more than eight times as many as were sold in the United States.

china

In a new paper coming out this week in PNAS, Paul Gertler and I examine the enormous global potential for air conditioning. The paper is available here. Household incomes are rising around the world and global temperatures are increasing. Both factors will drive increased adoption of air conditioners.

This is mostly good news. Air conditioning will bring relief to the more than three billion people who live in the tropics and subtropics. However, meeting the increased demand for electricity will also be an enormous challenge requiring trillions of dollars of infrastructure investments and potentially resulting in billions of tons of increased carbon dioxide emissions.

Our evidence comes from analyzing rich microdata from Mexico, a country with an unusually varied climate ranging from hot and humid tropical to arid deserts to high-altitude plateaus. As the figure below illustrates, we find little air conditioning in cool areas of the country, at all income levels. Even at high income levels saturation never exceeds 10%. In warm areas the pattern is very different. Saturation begins low but then increases steadily with income to near 80%. In gray is the distribution of annual household income.

Fig 4a

Fig 4bFig  4 LabelSource: Davis and Gertler, PNAS, 2015.

We combine our estimates with economic and temperature change forecasts to predict future air conditioning adoption in Mexico. Under conservative assumptions about income growth, our model predicts near universal saturation of air conditioning in all warm areas within just a few decades. Temperature increases contribute to this surge in adoption, but income growth by itself explains most of the increase.

To get some sense of the global implications, the table below lists the top 12 countries in terms of air conditioning potential, defined as the product of population and cooling degree days (CDDs). Excluding the United States, the list is dominated by middle- and low-income countries with warm climates. A total of almost 4 billion people live in these 11 countries, subject to an average of 2,700 annual CDDs.

Table 2Source: Davis and Gertler, PNAS, 2015.

Take India, for example. Compared with the United States, India has four times the population, but also more than three times as many CDDs per person. Thus, India’s total potential demand for cooling is 12+ times that of the United States. India already experiences frequent brownouts and blackouts, as Catherine blogged about here, which would be exacerbated by increased air conditioning if infrastructure does not keep apace of demand.

What air conditioning will mean for electricity consumption and carbon dioxide emissions depends on the pace of technological change. Continued advances in energy-efficiency or the development of new cooling technologies could reduce the energy consumption impacts substantially. Similarly, growth in low-carbon electricity generation could mitigate the increases in carbon dioxide emissions.

The future pattern of air conditioning adoption will also reflect what happens to prices. Equipment prices are likely to continue to decrease, which would further accelerate adoption. What will happen to electricity prices is less clear. A substantial increase in electricity prices, for example, resulting from carbon legislation, would slow both adoption and use.

Finally, there are broader adaptations that over a long time period could substantially reduce the need for air conditioning. Previous studies have found that people move away from regions affected by extreme temperature, so migration could mitigate the need for air conditioning. Demand for cooling also depends on how we build our homes and businesses, norms that can evolve over time in response to changes in climate as well as the availability and cost of cooling technologies.

The continual increase in global incomes means people are living more comfortably. This should be celebrated. But at the same time, it also means real challenges for electricity infrastructure and the global environment. We need an “all-hands-on-deck” approach including aggressive funding for innovation, efficient pricing of energy, and evidence-based environmental policies. We need efficient markets if we are going to stay cool without heating up the planet.

Posted in Uncategorized | Tagged , , | 7 Comments

Building Codes That Work

If I got a dollar each time someone says that California’s energy efficiency codes have led to significant decreases in electricity consumption, I could buy a Tesla to help reverse that trend. In the halls of power, climate regulators discuss this source of energy savings potential with a level of excitement rivaling that surrounding the appearance of Harrison Ford as Han Solo in the new Star Wars trailer. New building codes are a significant part of projected emissions reduction goals in the US, Europe, Japan and elsewhere. The question of course is, whether building codes actually cause such decreases in energy consumption.

Figuring out the realized magnitude of energy savings from building codes is tricky. You cannot just compare the energy consumption of buildings built today (post building code) to those built prior to the imposition of building codes for at least three reasons:

  • Today’s homes are much bigger and we are increasingly building new homes in hotter parts of the state/country.
  • People who use a lot of energy consuming services (e.g., cooling) might self select into more efficient newer homes.
  • The imposition of a building code is not random, but a policy choice. Areas with extreme seasons and a greener populace are more likely to adopt such regulations.

There are a number of papers that have tried to overcome some of these barriers. Yours truly tried to overcome the problem of policy endogeneity (problem 3 above) in a cross-state and -time comparison and found savings of about 2-5%. Kotchen and Jacobsen in a nice experiment compare new buildings pre and post a building code in Gainesville, Florida and find savings of a similar magnitude. These savings are significantly smaller that ex ante engineering estimates, yet still economically and statistically significant.

A recent NBER working paper by Arik Levinson, who recently worked for the White House Council of Economic Advisors, argues that there is no evidence that California’s building codes have led to a reduction in electricity consumption after you address the three issues above. This paper struck a nerve with my friends in Sacramento and was featured on the Freakonomics podcast. So what does it do?

Using data from two rounds of California’s Residential Appliance Saturation Survey for about 16,000 homes matched to detailed electricity billing data, he estimates regressions, which account for detailed characteristics of the homes and occupants and the climate zones they are in. The key variables of interest are indicators of year built for each housing unit. He finds no statistically significant evidence that buildings of younger vintages use less electricity than older buildings – with the exception of the most recently constructed buildings.

Levinson then questions this finding for the most recent years. What if buildings become leaky after just a few years? Or maybe new homeowners have no money to spend on electricity and conserve energy right after purchasing a new home. As time goes by and budgets become less tight, they just might turn on the AC more frequently. Figure 3 in the paper makes exactly this point.

arik

What you see here is electricity consumption against building age by construction decade. The fact that the leftmost line segments slope upward most steeply suggests that newly built houses within a construction cohort do consume less electricity. Levinson argues that this is in fact evidence in favor of the point that buildings deteriorate quickly after being built and/or residents turn up the heat/AC once they have more cash.

The paper also shows convincing evidence that buildings built under different building code regimes do not have statistically different temperature response profiles. He digs into national survey data and shows further evidence in support of his findings based on California data.

If you stop reading and thinking here, you might walk away with the idea that building codes are useless and we should spend our money on more worthwhile causes like desalinization (don’t get me started on that bright idea). Don’t walk. One more paragraph. You can do it.

The paper recognizes up front that owners of older homes might spend money on insulation, new windows and better sealing to make their homes more efficient. This would of course make the older pre-code homes more like post-code homes and increase the likelihood of a no effect finding. Does this happen? A three thousand dollar rebate check on its way in the mail to me from Sacramento for my newly sealed 1947 built home is evidence that this happens. Even my politically conservative neighbors have been spotted with the insulation truck outside their 1948 home.

Second, we will never observe the true counterfactual home that would have been built instead of the building code compliant home that was eventually built. Even the most careful econometrician does not observe all relevant characteristics that change over time.

Third, building codes provide many benefits that are not measured in kilowatt-hours, but in comfort. Visit your strange friends living in a house with single pane glass and sit near the window on a cool night.

Finally, much of the benefit from building codes comes from lower natural gas consumption for heating. The paper does not study this dimension in great depth.

Arik, who is an incredibly careful and thoughtful economist, is careful in discussing all of this in his paper, but he still comes to the conclusion that building codes do not result in savings that should be counted as additional under new climate and energy regulation. The main argument there relates to the fact that if people in older homes voluntarily improve the efficiency in their homes, then building codes simply build this into the up front cost of a new home. This makes the new building code essentially a choice that people would make in the absence of the policy eventually and is hence not additional. There is some economic truth to this argument.

In order to settle this, I am afraid, we would need to run one really expensive RCT, where some identical homes are built according to building codes and others are not. We would then have to have random people assigned across these homes and live their very real lives in these homes. If you are a developer, give me a call. I am standing by having a hot cup of tea in my now comfortable, no-longer-leaky California home.

Posted in Uncategorized | Tagged , , , , | 11 Comments

Energy Tourism: The Tesla Taxi in Oslo

2014-04-13 16.08.51 HDRI suspect a fair number of you know what I mean by energy tourism – sure, you’re up for sight-seeing and museums, but you also note the local gas prices, gawk as you fly over wind turbines and grill anyone who will answer about the local energy policy issues of the day.

My husband and I are both in the energy industry, so our kids have gotten used to flipping through vacation photos of solar farms or gasoline in Absolut bottles for sale in Indonesia.

On the first day of a recent trip to Norway, my daughter and I saw two Teslas on a street corner in Oslo – a rare coincidence even at home in Northern California. Over the next couple days in Oslo though, Tesla sightings became so commonplace that we stopped noting them, until we saw the Tesla taxi, pictured below.

tesla taxi

Photo credit: Sylvia Barmack

As we learned, Norway is Tesla’s second largest market after California, and with one-tenth the population of California, this is an amazing penetration of Teslas per capita. Teslas outsold ALL other models in Norway in March 2014.

One of our hosts, who drove us around in her Nissan Leaf, explained all the reasons consumers are drawn to electric vehicles (EVs) in Norway. (Tesla also lists them on their website.)

The big one is that you don’t have to pay the heavy import taxes, so it can be cheaper to buy a Tesla than a regular sedan. It looks like a typical car has to pay a 25% import tax. The exemption from import taxes is set to expire as soon as 50,000 EVs are sold, which may be soon. Anticipating the end of the subsidy, buyers scrambled to buy Teslas and other EVs in March 2015. EV owners also get a break on the annual vehicle tax, paying about $50 while non-electric vehicles pay a couple hundred dollars.

Norwegians also have relatively high gasoline prices – I saw $7/gallon – and low electricity prices, so the operating costs favor EVs more than in the US.

Another benefit of owning an EV is that you get to use the carpool lane. So many people in the well-to-do western Oslo suburb have bought Teslas that they occasionally clog the favored lanes. EV owners are also exempt from parking fees at municipal lots, can ride the ferry for free, can charge for free at certain municipal charging stations – the list goes on.

1006811-14276465406487439-Paulo-Santos

Source: Seeking Alpha.com

If I were a benevolent world planner, and if I believed that we needed a bunch of electric vehicles on the road somewhere, I would definitely drop a bunch of them in Norway. I’d probably even put more there than in California.

First, Norwegians are rich and better able to afford EVs, which, absent subsidies are still more expensive than comparable cars. The World Bank lists Norway as the second richest country in per capita terms, and it has famously flat income distribution, so the wealth is spread across more Norwegians.

There are also important differences in the environmental benefits of electric vehicles depending on where they are located. A recent working paper by Holland, Mansur, Muller and Yates (HMMY) goes through detailed calculations for the United States. As the authors point out, driving and charging a Tesla/Leaf/etc. in Ohio can lead to more CO2 emissions and more damaging local pollutant emissions than driving a comparable car running on gasoline. Ohioans get a lot of their electricity from coal, so there are a lot of GHGs, NOx, etc., emitted when they charge a Tesla.

Here’s where the Norwegians come in: their electricity system runs on over 95 percent hydro, which does not emit GHGs or local pollutants. As HMMY and others have pointed out, though, we want to think about the marginal emissions when an EV owner charges the battery, not the average emissions on a system. In other words, we want to identify which power plants would produce slightly less in a world without that particular EV.

HMMY go through careful calculations to estimate state-by-state marginal emissions from charging EVs. They then use an atmospheric model to figure out how many people the power plant emissions will impact. They use the same model to figure out who is impacted by emissions from gasoline vehicles and summarize the relative benefit of EVs in the map below. Red areas indicate that EVs are more polluting than gasoline cars in much of the Eastern US.

Screen Shot 2015-04-11 at 7.21.14 PM

Source: Figure 1 from Holland, Mansur, Muller and Yates, 2015

An HMMY-style calculation is a bit tricky on a hydro system like Norway’s. Roughly, you can think of charging an EV as draining a reservoir more quickly, so you really want to know whether the reservoir is likely to run dry – in which case, the EV might lead to emissions from a fossil fuel or nuclear plant. Norway is interconnected with Sweden, Denmark and the Netherlands, which have cleaner systems than most of the US, but more polluting than Norway. On the other hand, if new rain or snow will fill the reservoir, the EV charging is pretty much emissions free.

The thing about looking at marginal emissions is that this assumes the main benefits and costs to the EV are abating pollution now. I suspect that, to a large degree, US and Norwegian subsidies for EVs are motivated by policymakers’ desire to jump start EVs.

Those benefits are more uncertain and harder to put a number on, but they include the benefits of helping companies like Tesla down learning curves, incentivizing companies to locate more charging stations (see Max’s recent post), incentivizing more research on lightweight batteries, and making consumers feel more comfortable with EVs.

We do not yet know whether EVs will be an important part of a low-carbon future – biofuels may have a resurgence, or someone may come up with a completely new way to power personal transportation. On the other hand, EVs may be the only game in town in a matter of decades. In the meantime, Norway is the perfect place to be running the EV experiment to help us sort everything out.

Posted in Uncategorized | Tagged , , , , , | 11 Comments

For energy (and water) conservation, moral suasion is no substitute for getting the prices right

My office light switch recently acquired a little sticker that politely reminds me to turn it off when I leave:

switch

Over the past year, an edgy Lawn dude  and an amicable  Bear  have been urging Californians to cut back on water use in order to meet our drought-stricken state’s water restrictions (which have to date relied on public spiritedness versus serious enforcement):

dude

The use of moral suasion to encourage conservation is not unique to California. Public appeals for reductions in energy and water use are ubiquitous. And it is easy to see why. For political and jurisdictional reasons, it is often easier to mount a conservation campaign than raise energy or water prices in times of scarcity. But what impact do these interventions actually have on energy and water consumption?

Prices versus moral suasion

A new E2e working paper explores this question in the context of electricity. More than a year after the Fukishima earthquake, several of Japan’s nuclear power plants were still out of commission and electricity supply was tight. Policy makers were looking for ways to reduce electricity consumption during critical peak times.

Koichiro Ito and his co-authors set out to test the relative effectiveness of an increase in critical peak electricity prices versus “moral suasion”:  a polite request for voluntary reductions in consumption. Customers who volunteered to be part of the study were randomly assigned to one of three groups:

  • A price treatment: Higher electricity prices during critical peak hours. Customers were charged prices ranging from $0.65/kWh – $1/kWh (up from a base rate of approximately $0.25/kWh).
  • A “moral suasion” treatment: Courteous day-ahead and same-day requests for electricity demand reductions during critical peak days.
  • Control group: No notification of/price increases during critical peak events.

The figure below summarizes the average impacts of the two treatments on household electricity consumption during critical peak hours (relative to the control group). Effects are summarized by treatment “cycles”.  Each cycle consists of three non-consecutive critical peak event days, so the graph helps to illustrate how the effect of the treatments persist (or not) across repeated critical peak days throughout the season.

Average effect of treatment on peak electricity consumption

graph

It probably will not shock you to learn that the price treatment had a much larger impact on consumption as compared to moral suasion.  The courteous appeal for voluntary reductions measurably reduced consumption during the initial events, although the effect peters out quickly. In contrast, the response to the price treatment persists throughout the duration of the experiment.

Of course, these quantitative findings may not generalize beyond this set of Japanese electricity customers. But key qualitative findings are consistent with other studies. During the California electricity crisis, for example, researchers similarly found that demand response to public appeals for voluntary conservation was significantly smaller than response to price increases (although the effects of moral suasion were found to be somewhat more persistent).

Can public appeals for conservation hold water in California?

These qualitative results are compelling – and pertinent to a crisis we are currently facing here in California.

140219-california-drought

Source: Bakersfieldnow.com

We are in the midst of the most severe drought on record. Last year, the Governor issued a voluntary reduction order, asking Californians to please cut back on water use by 20 percent. In the latter part of last year, customers in my district cut back a non-trivial 13 percent in monthly year-over-year comparisons. But we are off to a slow start this year, conserving just 4 percent in January and February.

Absent divine intervention (e.g. torrents of rain in the coming dry season), we need more than benign intervention (e.g. public appeals for voluntary conservation). An executive order issued last week signals a move in this direction.  The order  imposes mandatory water restrictions designed to achieve a 25 percent reduction in potable water use by urban residents.

Hitting this conservation target will be difficult – if not impossible – to achieve with only public appeals and hard-to-enforce restrictions. So, to echo arguments that have been made again and again on this blog (we are a persistent bunch), the time is ripe for water prices that reflect the true cost of water use.  This would not only help incentivize sustained conservation, but also help to cover operating and infrastructure costs that currently exceed revenues (see this report for a sobering look at water sector finances).

As far as I can tell, the state does not have the ability to directly control how local water agencies set their rates.  But a perfect storm of rising infrastructure costs and water scarcity could force the issue. We are already seeing water price increases and conservation pricing proposals.

If the current crisis does lead to substantive and widespread water rate reform, there will still be plenty of work for Lawn Dude and friends. In water, like electricity, lack of salience, hassle costs, and other factors can stand in the way of cost- efficient investments in efficiency.  We should put public campaigns in their rightful place: useful complements to – but not substitutes for – efficient price signals.

Posted in Uncategorized | Tagged , | 10 Comments

In Praise of Cleaner-burning Gasoline

Last week was spring break at UC Berkeley, so I took a few days off for a very pleasant vacation, walking by the ocean with friends and enjoying the beauty of California. As a result, I wasn’t able to be at the hearings on gasoline prices in the California State Senate last Tuesday. The state has seen a price spike over the last month that at one point drove pump prices to a dollar above the rest of the country.  We’re used to paying a bit more for gas here — due to higher taxes and the cleaner-burning fuel used only in California — but the difference is usually around 30-40 cents.

Though I missed last week’s hearings, I’ve been at enough legislative sessions on gas price spikes (and read news reports on this one) to have a pretty good guess at what went on.

Some consumer groups and left-leaning politicians confidently accused Big Oil of colluding, manipulating California’s gasoline prices, and gouging drivers.  Then industry representatives and right-leaning politicians responded with equal certainty that recent price spikes are the result of California regulations that since 1996 have required a gasoline blend used nowhere else in the world.

CAGasolinePrice2015Mar

In a blog post a couple years ago, I explained why they are both wrong.  The accusers don’t have evidence that producers are artificially restricting output to drive up prices; real scarcity could completely explain the state’s higher gas prices and occasional spikes.  But the defenders who are claiming that the price fluctuations reflect only competitive market dynamics also have no proof.  In fact, since I wrote that post in 2012, concentration among California gasoline producers has increased further, which has ratcheted up the incentive to create artificial scarcity in the market.

In late 2014, the California Energy Commission appointed a 5-member committee, called the Petroleum Market Advisory Committee, to consider what drives California’s gasoline prices and whether the market is workably competitive.  I’m one of those lucky five.  There will surely be some interesting meetings.

LAsmog

But before diving into the murky world of gasoline price competition, let’s step back and remember the murky air that prompted the California Air Resources Board (CARB) to adopt the world’s strictest gasoline standard (known as CARB gasoline) and effectively separate our gasoline market from the rest of the country.

In the 1990s, California had very poor air quality.  Most of the population lived in counties that were out of compliance with federal standards for ozone, a gas that damages lungs and leads to a variety medical problems, including premature death.  The Los Angeles-San Diego corridor was in “severe nonattainment” for ozone.  Federal standards for reformulated gasoline (RFG) went into effect in the early 1990s, but those standards were critically flawed — as Max Auffhammer and Ryan Kellogg have documented in a 2011 paper published in American Economic Review, which has received far too little attention from the EPA (A nice non-technical summary of the paper is here).  The federal standard has a loophole that allows refiners to meet it by adjusting their gasoline formulation in a way that has little or no ozone-reducing impact.

AuffhammerKelloggOzone

The California standard closes that loophole by requiring a stricter formulation.  Auffhammer and Kellogg show that only California’s standard has had a substantial, and statistically significant, impact on ozone.  Combining their results with medical research on the impact of ozone, they estimate that the California standard saves at least 660 lives per year, which more than justifies the additional cost of our cleaner-burning gasoline.[1]  And their estimates don’t count reduced illnesses (short of death) or other reduced environmental damage that we know are also caused by ozone.  A new study out of USC this month shows that kids in Los Angeles today have substantially healthier lungs than those who grew up there 20 years ago and links the improvement to reduced auto emissions.

The results in California have been tangible.  Ozone concentrations have steadily declined over the last 20 years.  The haze in the LA basin continues to dissipate.  Our air is cleaner and as a result we are healthier.

So, what has the California gasoline standard actually cost consumers?

The most direct measure is retail prices, but they are confounded by taxes, which vary month to month because California and some other states collect both a per-gallon excise tax and a percentage sales tax.  Still, from 2009 to 2013, California taxes averaged about 20 cents per gallon above the national average and our retail prices averaged about 34 cents above national average.[2]  Much of the 14 cent difference is likely attributable to CARB formulation, but it’s difficult to know how much.

CARBGasPriceDiff

A cleaner measure is refinery-level wholesale prices, which do not include taxes and are easier to compare over a long time span.  In the 13 years prior to adoption of CARB gasoline 1983-1995 (as far back as the available data go), California wholesale prices averaged 6 cents above national average (in 2014 dollars).  From 1996 through 2014, they have averaged 16 cents above national average (in 2014 dollars), an increase of 10 cents per gallon.

The average Californian uses about a gallon of gasoline per day, both directly in their car and indirectly in the fuels that are used by businesses that serve them.  So, we are each paying, on average, somewhere in the range of $37-$51 per year.  That’s saving hundreds of lives and preventing lung damage in thousands of other people each year.  And these health benefits go disproportionately to the poorest residents, because they suffer the greatest share of the impact from ozone.

Yes, our occasional price spikes are annoying.  And, yes, they raise real concerns about the competitiveness of the market, which the state should continue to investigate.  But averaged over the years, the cost of our cleaner-burning gasoline is actually pretty modest.  Californians love to gripe about the high cost of living here, but we stay in large part because of the natural beauty and our enjoyment of being outdoors.  Paying a bit more for gasoline — along with the state’s program to check tailpipe emissions at the time of vehicle registration — makes an important contribution towards maintaining that beauty and the ability to enjoy it.

[1] In doing their calculations, Auffhammer and Kellogg use the EPA’s value of a statistical life and assumed that the California formulation raises costs by 8-11 cents per gallon.  Their argument stands up, however, even if the CARB formulation cost more than 30 cents per gallon.

[2] The difference in state levies increased on January 1 with the inclusion of transportation fuels in the state’s cap-and-trade program.  As I discussed last summer, and has since been confirmed by the industry and the Air Resources Board, this is expected to raise California gas prices by about $0.10 per gallon.

I’m still tweeting energy news articles and new research papers @BorensteinS 

Posted in Uncategorized | Tagged , , | 8 Comments

How Should We Design Government Policies to Stimulate Innovation?

Last Friday was our 20th Annual POWER Conference. Thanks to all who attended and an especially large thanks to the conference sponsors who made the event possible. For those of you who couldn’t attend, the program is available here with links to several of the research papers that were presented.

One of the highlights was a new paper called, “Financing Constraints as Barriers to Innovation: Evidence from R&D Grants to Energy Startups”, by Sabrina Howell, a PhD Candidate at Harvard who does fascinating work on energy and innovation finance.

The paper focuses on the U.S. Department of Energy’s Small Business Innovation Research grant program. The SBIR program has been around since 1983, and provides more than $2 billion annually in grants to small, high-tech firms. DOE’s program funds technologies across the energy spectrum — previous recipients include Sunpower, First Solar, Evergreen Solar, Oscilla Power, and A123.

sunpowerfirstsolarevergreensolaroscillaa123-logo-white-background

The results in the paper are striking. Howell finds that receiving an early-stage “Phase 1” grant of just $150,000 approximately doubles the probability that a firm will subsequently receive venture capital (VC) funding. Recipients of Phase 1 grants produce more patents, are more likely to commercialize their technologies, and are more likely to exit via IPO or acquisition.

In order to perform the analysis, Howell obtained internal data on successful and unsuccessful applications from 400+ SBIR competitions over a 20-year period. She exploits the fact that SBIR applications are ranked by DOE reviewers, but that only applications above a certain cutoff receive funding and reviewers don’t know what the cutoff will be until after all the applications have been ranked. These rankings allow her to implement a compelling quasi-experimental research design.

 Probability of Venture Capital Financing After Grant Decision Fig1

This figure from her paper illustrates the main idea. The red vertical line indicates the cutoff for a Phase 1 SBIR grant.  Applications to the right of the cutoff were funded, while applications to the left were not. The figure shows for each rank the fraction of firms that subsequently received VC financing. Grants increase this probability from about 10% to 20%, and the difference is strongly statistically significant as indicated by the 95th percentile confidence intervals.

This “rankings” based approach is a significant advance because it allows Howell to make causal statements about SBIR grants. How successful would SunPower, First Solar, and Oscilla Power have been without winning an SBIR grant? This is a very hard question. But what these rankings allow Howell to do is to compare applications that just barely won a grant with those that barely missed the cutoff.  Near the cutoff her approach is akin to a randomized experiment, comparing firms that DOE reviewers deemed similar.

Firms who receive one of these $150,000 Phase 1 grants can then apply for a second round. Phase 2 grants are $1 million and intended to fund later stage demonstrations. Though Phase 1 grants have large positive effects on subsequent VC financing and other outcomes, Phase 2 grants are much less successful, with tiny or negative effects on VC financing and small positive effects on patents. This may reflect selection. For example, Howell finds that the more successful Phase 1 recipients tend not to apply for Phase 2, so the composition of applicants in Phase 2 tends to be lower quality on average.

These results have important policy implications. The DOE spends much more on Phase 2 than Phase 1, but Howell’s results suggest that it probably would be better to allocate more to Phase 1. This is consistent with general economic intuition. For later-stage projects, private sector funding is likely to work better because more information is available and the investments are larger scale.

Some critics of government R&D programs argue that programs like SBIR just crowd out private investment. But if this were the case, you would not expect to see any impact of these grants on subsequent VC funding. Or, more starkly, you would expect to see more private financing received by unsuccessful applicants. Howell’s paper doesn’t tell us exactly what the right level of government funding is, but the paper’s results provide clear evidence against this crowd out argument.

Howell’s website (here) includes a link to the paper and, if you are really interested, to all eight appendices! We need much more research like this aimed at understanding how to best stimulate innovation. It is hard to think of any more important topic, particularly in the energy sector given the enormous scope for spillovers and positive externalities.

Innovation needs to take center stage not only in Washington DC, but also here in California. As Severin pointed out in a blog post here, California produces only 1% of the world’s greenhouse gas emissions. So the success or failure of California’s climate policies hinges on stimulating innovation that can be exported to the rest of the world. We need more emphasis in all of our programs on knowledge creation and we need to rigorously evaluate all of our policies along this dimension.

Posted in Uncategorized | Tagged , , | 7 Comments