Cutting Carbon Emissions: The False Dilemma

Much of the debate over fossil fuel emission reduction focuses on whether the economy can absorb the costs of a shift to more climate-friendly forms of energy consumption.  The discourse takes a cost-benefit analysis to the change and attempts to rationalize whether the the risks justify the rewards, or simply whether the ends justify the means.  As an idealist who enjoys outdoor activities, I can easily come to the conclusion that the ends justify the means myself—to me, a cleaner environment is worth a significant cost–not everyone sees eye to eye on the issue.  Political constituents with exposure to the energy and manufacturing sector in particular do not see it this way.

The false dilemma is that our choices are not mutually exclusive.  We do not have to choose between a cleaner environment or a more robust GDP.  The real choice is whether we want a robust and profitable energy sector, or whether we want to increase the size of our alternative energy industry.  What we are debating is a massive shift in wealth from the owners of our resources to the owners of innovative technologies.

I think that in a purely rational marketplace with no inefficiencies the economically efficient outcome would be the end result; however, with regard to energy in particular, there are significant implications for global wealth AND POWER (never underestimate the role that power plays in decision-making).  Power politics cannot be equated for in economic models.  People who have a vested interest in protecting the status-quo do not do so in order to promote growth in aggregate demand; they do so to protect their personal claim to wealth.  In the end, our government pursues policies that favor a small subset of our society because those with the means control the process.

Just yesterday, I saw a commercial form the American Petroleum Institute that attempted to ride the coattails of the anti-tax movement.  The commercial insinuated that the government was trying to tax the energy industry into a precarious position.  Of particular note is the fact that many Americans are unaware as to how robust the government subsidizes fossil fuels, particularly in contrast to the alternative energy industry.  Nowhere are these subsidies mentioned in the API commercial, yet in isolation, that commercial would have you believe that “government” seriously handicaps oil companies in the US, when in fact, the government generously subsidizes the industry.  This infographic from a few months back highlights the point:

Our government is far more friendly to oil than clean energy.

In essence, the costs of fossil fuel dependency are felt more heavily by those sectors of our economy that expropriate and consume carbon-based energy.  Those who own the resources used for energy spend a lot of money ensuring that more energy-efficient solutions are not pursued in the long run.  They fear such a shift because they know that it will not necessarily place a significant burden on society at large, but rather, it would shift a substantial portion of their revenues to different sectors–mainly those that are involved in alternative energy pursuits.  Some of these companies are now investing more money in lobbying against these measures than in pursuing alternatives because they know that their risk/reward is far greater in protecting what they have than in finding something new (the following chart from Public Integrity shows just how much is being spent on “climate change” lobbying by sector):

The combined weight of manufacturing, power companies, oil and gas, and mining and coal far exceed all other lobbying industries combined as of 2008.  These industries pay handsomely for the political protection that helps pursue the preservation of their assets’ values (assets being their energy resources).

Energy efficiency is a capital intensive endeavor with substantial short-term costs in some sectors of the econony.  However, in pursuing a reduction in greenhouse gases, expenditures on alternative energy will increase, as will investments on technologies that improve efficiencies.  Furthermore, setting targets for consumption reductions can lead to increased investment in technology, just at a time when many are still left licking their wounds from the aftermath of both the tech bubble popping in the late 1990s/early 2000s and the financial crisis of 2007-present.

The Time Costs of Delay:

The longer we continue to rely on carbon-based energy, the higher the costs will be in the long-run.  As time moves on and the world continues to consume fossil fuels at an increasing rate, scarcity will ultimately drive prices higher.  While we do not know the maximum quantity of consumable fossil fuels available on Earth, we do know that the accessible quantity and ease with which we can expropriate the supply will continue to diminish.  Furthermore, as developing economies (just take a quick look at China or India) continue to grow at an impressive rate, there will be increased consumption of fossil fuels from the developing world, in addition to the developed.

Not too long ago, the International Energy Agency (IEA) released a report declaring that this year, despite the lingering effects of the global economic crisis, world oil demand will reach a RECORD high.  This is happening despite the fact that global consumption levels (global GDP) remains below 2007 level.  In both the long and short run there will be substantial upward pressure on the price of fossil fuels and this cost risk is far greater than that associated with a shift into alternative forms of energy.

Some assert that the cost will be borne more heavily by the manufacturing sector than any other, and that ultimately this will lead to the continued conversion of the U.S. economy from one which produces to one which services (i.e. the shift from a manufacturing to a service-based economy).   While it is true that the manufacturing sector will pay some of the cost, there are ways to mitigate the expense and yet further ways to ensure that there will not be continued flight away from the U.S. by manufacturers seeking a lower cost structure.

This is just one reason why a global consensus and united effort on carbon emissions is particularly important.  If you have all countries working in concert pursuing a goal, there would be no incentive for a company to move from one locale to another in order to arbitrage the regulatory structure.  Yet our country, the one who stands to benefit most from a global consensus on alternative energy, is the single biggest impediment to building a global consensus on the transition away from fossil fuels.

One factor that is largely ignored by such cost-centric critics is that for a manufacturing-based company to move from the U.S. to another country is also a very capital intensive venture that comes with large short-term costs, just like energy efficiency does.  Building a new factory and establishing the transportation infrastructure necessary to bring the goods to market are huge short-term fixed costs, and the transportation costs are variable costs that will add up for such a company over time.

What Next

Following the BP Gulf Oil Spill, the tide is certainly changing towards alternative energy.  This latest round of earnings from the solar companies made clear that the United States, while a laggard in solar adoption for the past half decade, is now the major engine for future growth in the sector.  That is one reason why we at the Wall Street Cheat Sheet believe that the solar stocks right now represent a great risk/reward long-term investment opportunity.  Check out “Your Cheat Sheet to Investing in the Sun” for our in-depth coverage of the solar sector and our proprietary research of the industry’s leaders.

Disclosure: Long FSLR and SPWRA