Political Economy of Energy Policy: An Introduction Varun Rai Asst Prof. Public Affairs and Mechanical Engg. in Prof. Tom Edgar’s Energy Technology and Policy Course 18 October 2012 [email protected]

Insights Drawn from Courses I Teach at UT • Political Economy of Global Energy (Fall) – Application of major theoretical concepts to analyze outcomes in the energy space

• Innovation and Diffusion of Energy Technologies (Spring) – Interaction between technological change and policies in energy

• UT Energy Symposium (Fall and Spring) – Invited speaker series on international energy issues

• Innovation, Growth, and Conflicting National Interests: Analyzing the Evolution of the Global Solar Industry (Fall’12 and Spring’13) 2

Insights Also Drawn From Presentations and Discussions of Former and Current Colleagues, Teachers, and Students • Stanford – Mark Thurber, David Victor, Jim Sweeney

• UT Austin – Students in my classes; Michael Webber, Carey King, Jay Zarnikau

• Speakers at the UT Energy Symposium

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Theoretical Frameworks: Highlights • Theory of economic regulation (interest groups) – Institutional constraints; Conditions for change • Collective action • Credibility of commitments • Principal-agent problems • Networks, monopoly, and regulation • Risk and uncertainty (Focus on extremes for fat tails) • Political time horizons • Conditions for reform • Price vs quantity instruments for internalizing externalities • Macroeconomic drivers of innovation and technological change

Typical Case Studies • • • • • • • • • • • • • • • •

RPS California electricity crisis Emissions trading schemes Solar PV Nuclear/INPO BP oil spill Electricity reforms/deregulation in Brazil and UK CCS Demand side management Energy innovation in China and US Rural electrification National oil companies Fossil fuel subsidies & Ethanol subsidies Climate change policy Land use change issues/Forest management Shale gas

Principal-Agent Theory

Suggested readings: Gary Miller (2005). “The Political Evolution of Principal-Agent Models.” Annual Review of Political Science. 6

Principal-Agent Theory

Government

Principal Incentive/monitoring scheme

Oil Company – Private – State-Owned

Agent

• Different preferences from principal (e.g. most pay for least work) • Knows more about its performance (“information asymmetry”) • Common knowledge of (rational) preferences • Other assumptions involved as well

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World Oil Supply

Source: World Energy Outlook (2010) 8

Role of NOCs in Oil Oil Reserves* as of Oct 2009 (top 1460 petroleum companies)

2008 Oil Production (top 1460 petroleum companies)

Total = 1.5 trillion barrels

Total = 77 million barrels/day (94% of world total)

*Wood Mackenzie commercial + technical reserves

(All reserves and production figures on working interest basis)

NOCs control 73% of world oil reserves and 61% of world oil production Data Source: Wood Mackenzie Corporate Analysis Tool9

Largest Reserves Holders are NOCs

NOC (PESD sample) NOC (Other) IOC (Major) IOC (Other)

*Wood Mackenzie commercial + technical reserves as of Oct 2009

(Reserves figures on working interest basis)

Data Source: Wood Mackenzie 10

World Oil Supply

Source: World Energy Outlook (2010) 11

How NOCs are Different and Why It Matters

Source: PESD, Stanford

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Our Sample of 15 NOCs

Gazprom

KPC

CNPC Sonatrach

PDVSA

ADNOC

NNPC Petrobras

Source: PESD, Stanford

ONGC

Petronas

Sonangol

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Price Responsiveness of Global Oil Supplies % of Global Oil & Gas Reserves P

Petrostates Unable to Use Cash

40%

Q P

“Resource Curse” 45%

Q P 15%

IOCs, Globalized NOCs Source: PESD, Stanford

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Electrification of Transportation A Long-Term Shift?

Source: US Department of Energy 15

Ethanol Production Has Been Actively Encouraged. WHY?

Source: Michael Webber 16

Pledging To Get Off Foreign Oil Is A Bipartisan Tradition. WHY?

Source: Michael Webber 17

Theory of Economic Regulation

Suggested readings: George J. Stigler. (1971). “The Theory of Economic Regulation,” The Bell Journal of Economics and Management Science, Vol. 2 (1), pp. 3-21. Bruce Yandle. (1983). "Bootleggers and Baptists - The Education of a Regulatory Economist," AIE Journal on Government and Policy, May/June 1983, pp. 12-16. 18

Bootleggers and Baptists • Demand for regulation – Organized groups with concentrated benefits heavily influence policy/regulation formation – Concentrated benefits; Diffuse costs – Costs of organization (Collective action/Free-riding)

• Supply for regulation – Politicians need resources to stay in office – Constant balancing act of political costs and benefits

• Bootleggers and Baptists – Ideal case when benefits of certain policies/regulations are concentrated, yet those same measures have general popular/social appeal – Examples? 19

Peltzman Model of Optimal Regulatory Policy

Source: Economics of Regulation and Antitrust, W. Kip Viscusi, Joseph E. Harrington, John M. Vernon (2005) .

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Bureaucratic Structure

Suggested readings: Terry M. Moe (1989), “The Politics of Bureaucratic Structure,” in Can the Government Govern?, eds. John E. Chubb and Paul E. Peterson, The Brookings Institution, Washington, D.C. 21

Main Message • Structural politics is interest group politics – Agencies are born out of political considerations and interest • National interest is not critical to agency formation • Voter indifference and lack of knowledge; and Interest groups’ activism

– Need to understand the choice preferences of groups and actors

• Creation/building of organization/agencies are CRITICAL – Winners and losers try to anticipate future scenarios, and force shape the agency to guard their own interests in the face of political uncertainty – Once created, it’s very hard to change legislation or to make major changes to bureaucratic structure of affecting the agency • Need special circumstances: BP Oil spill?

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Separation of Powers: Congress vs. President • Congress/legislators don’t have pre-conceived notion of the bureaucratic structure should be – Ready to be influenced: “Congress, a comfortable place for business” – Not intrinsically motivated by agency efficiency or effectiveness – Ready to build piece-by-piece—“Congressional Bureaucracy”

• Presidents have keen interest in hierarchical control – – – –

Main motivator is how they will be judged in the eyes of history Demand control and efficiency, to their preferences Fearsome presence on the political scene Prefer Executive control, and political appointees

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Example: EPA • • • • • • •

Formed in 1970; Not through legislative action Bureaucratic reorganization Political battles between congress and president Patch work Tight timelines Impact of changing presidential leadership Fragmentation: Federal-state battles

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Credibility of Commitments

Suggested readings: North, Douglass C. and Barry R. Weingast (1989). "Constitutions and Commitment: The Evolution of Institutions Governing Public Choice in Seventeenth-century England." The Journal of Economic History, 49(4): 803-32. 25

Credibility of Commitments • Credible commitments, codified and institutionalized, are key to encourage systematic investments leading to economic growth • The process of macroeconomic reforms and institutional transition can be long and painful for large parts of the society • Role of technology and opportunities to exploit them for profits also impacts these various pressures for institutionalization of commitments and rule of law • Examples? 26

Price Volatility Hurts High Capital Cost Projects

Source: “Investing in Power”, UKERC

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How Much Commitment?

• Timing of commitment – Need a certain level of maturity in the performance and economics of the technology – Nuclear power in the U.S.; Too much risk was taken away too early – Technology push, R&D, first – Is CCS ready?

• Market structure considerations key – Competition to lower costs – Standardization • Needs coordination among the players

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How Much Commitment? Lessons for CCS from Nuclear Power and LNG

Source: Rai, Victor, and Thurber, Energy Policy, 38(8) (2010)

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Learning in Uncertain Environments

Source: McKinsey, CCS: Assessing the Economics (2008)

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How Much Commitment? Lessons for CCS from Nuclear Power and LNG

Millions 2003$/mtpa

600 500 400 300 200 100

Series 1 (Sheperd and Ball) Series 2 (Greaker and Sagen)

0

Average estimated cost of nuclear power

Unit cost of natural gas liquefaction plants

Source: Rai, Victor, and Thurber, Energy Policy, 38(8) (2010) 31

Gasification US Project Realities Typical Project Profile

Sources of Project Uncertainty

•Project Developer Led

•3-4 years; $1.7 Billion – $ 3 Billion to construct

•Time •Market •Interest rates/Credit availability •Energy prices / Availability •New energy developments •EPC Risk • Contractor Skills / Experience • Construction cost •Regulation changes •Permit changes •Changes in policy goals •Changes in client goals and management

•30 years to operate

Uncertainty in Gov. Programs

• • •

Limited resources (OPM) Banks define risk and uncertainty Pre-FC spending tension

•5-7 years in development - $100 Million to get to NTP

•First-come-first-serve allocation process • Can’t take award to a bank •Funds commitment date Source: Doug Heguy, GE

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Collective Action

Suggested readings: “The Logic of Collective Action” by Mancur Olson “Hostages of Each Other” by Joseph V. Rees “Governing the Commons” by Elinor Ostrom 33

Collective Action • Ability of a group to supply common goods (for that group) – Organizations and common interests

• What types of groups are more capable of doing that? – Smaller groups are better – Heterogeneity: Large benefits for a small subset of members

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Institute of Nuclear Power Operations Why INPO?

• TMI accident on 28 March, 1979 in Harrisburg, PA • What is INPO? – Private industry regulatory bureaucracy – Mission: Safety of nuclear power plants; prevent core damage – Personnel drawn from within the industry • Early formation and staff from the Navy nuclear operations • Co-optation; Rotation; All levels of management and staff

• What are the conventional expectations of performance for such and industry group? – Mostly lip service and PR; – Self-regulation will be largely ineffective

• How successful has INPO been in it’s mission? – Quite

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Underlying Tenets of INPO • Extreme interdependence of players in the industry – Highly galvanizing extreme events possible – Raises costs for EVERYONE; Regulatory, Financial, and Political – Hostages of each other

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Contrasts with Other Industries • Chemicals • Oil and Gas – Highly fragmented, very large and diverse set of participants – Competitive environment • Unlike nuclear power, which is regulated rate-of-return business

• What are the collective action issues? – Free-riding – Costs of organization – Many players, so benefits are very high for a small set of players

• Overall, on an average, one would expect much lower provision of public goods in these industries 37

Energy Systems Transformation Group (EST Group) Varun Rai Asst. Prof of Public Affairs and Mech. Engg. Faculty Associate, Energy Institute Faculty Fellow, CIEEP Director, EST Group University of Texas at Austin 38

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EST Group Research Projects

180.00

Million Tonnes CO2 Captured / yr

160.00

• Climate change policy – Engagement with developing countries – Technology transfer

Gas, EOR, ECBM,

140.00

No Addi onal Hydrocarbons Produc on

120.00

Mixed/Unknown

100.00 80.00 60.00 40.00 20.00 0.00 05 20

07 20

09 20

11 20

13 20

15 20

17 20

19 20

21 20

23 20

25 20

350.00

– Low-carbon growth – Electricity reforms – Low-income households

Million tonnes/yr

• Energy and development

300.00 250.00

5% growth rate 7% growth rate

200.00 150.00 100.00 50.00 0.00 2012

2017

• Technological change and energy – Rates and direction of changes • Carbon capture and storage (CCS) • Electric Vehicles • Solar PV 40