This article originally appeared March 13 on the blog of the Harvard Business Review. Daniel C. Esty is the commissioner of the Connecticut Department of Energy and Environmental Protection and is on leave from Yale University, where he is the Hillhouse Professor of Environmental Law and Policy.
U.S. energy industries, from oil and gas to ethanol, wind, and solar, have long enjoyed lavish government subsidies and other support. But those days are coming to an end. President Obama in his 2012 State of the Union address called for an end to the "taxpayer giveaways" the oil and gas industry has long enjoyed; this year, Congress let the 30-year, multibillion dollar ethanol tax credit expire; and after years of over-promising and under-delivering in the clean-tech space (think Solyndra) the days of freewheeling government support in that arena are clearly over as well.
It's not a moment too soon. Subsidies, while they have their place, can create disincentives for becoming lean and competitive. One reason that clean energy tends to be more expensive than fossil fuel is that it can be. As long as it's subsidized, there is little pressure to compete on price. To be competitive and sustainable, alternative energy sources must ultimately match—or outperform—fossil fuels on price and performance. It's not sufficient for the world's new energy sources to be clean; ultimately, they have to be cleaner, cheaper, and more reliable than fossil fuels. This same principle applies more broadly to clean technology; to compete, it must outperform incumbent technologies on these dimensions.
Politically, this means the focus must shift from simply supporting clean energy (as, for example, the ethanol subsidies did) to creating a fair competitive environment that levels the playing field and rewards innovators who create the cleaner, cheaper, more reliable alternative energy sources and technologies.
The first critical step already under way toward this fair competition is to strip away the subsidies that have distorted both the clean and conventional energy markets. Ending ethanol subsidies is a step in the right direction, as is president Obama's call to end the $4 billion annual tax breaks and subsidies unfairly benefiting the oil and gas industry. Parallel supports of the coal industry must be eliminated as well. At the same time, the U.S. government must work to ensure fair competition globally. That means using trade strategy to apply existing laws, principles, and policy mechanisms to attack subsidies that are distorting the competitive environment outside of the U.S., particularly in China. It would only undermine the long-term goal of creating an innovative, sustainable, and competitive clean energy and technology marketplace if the U.S. tried to match Chinese subsidies.
Next, in a further leveling of the field, incumbent energy technologies must be required to pay for the externalities they create. That means putting a price on carbon emissions, as Steve Charnovitz and I argued recently in HBR and otherwise factoring the full environmental impact into any energy cost equation. Incorporating environmental impact into the pricing of fossil fuels and nuclear power would raise their costs appropriately and create a fairer competitive environment for cleaner alternative energy.
Finally, we need to leverage private capital to identify and invest in breakout opportunities, with the government playing a supporting role. Whatever limited government money is available would be devoted not to sustaining existing clean energy sources or technologies but supporting start-up projects that might otherwise not get off the ground. It's critical that the government not try to pick winners, but rather to foster a clean energy race among all of the options—wind, solar, geothermal, second-generation biofuels, and new entries that haven't yet been imagined. The goal would be to support new entrants just long enough to see if they can achieve commercial scale and compete in the marketplace. This approach would produce innovation and ensure that the market (not government) picked winners.
One model is the Connecticut "Green Bank," the Clean Energy Finance and Investment Authority that uses private capital and other monies to offer low-interest loans to clean-energy and energy efficiency projects. The Green Bank recently ran a reverse auction that invited zero-emissions power projects to compete for a power-purchase agreement. Winners got a 20-year commitment for the purchase of power at a competitive, agreed upon rate. This brought the cost of power from the two winning Connecticut solar producers down to 19 cents per kilowatt hour in one case and 21 cents in the other—virtually the same price as that from competing incumbent electricity providers.
We used a clever government strategy to harvest competitive market dynamic to bring both cleaner and cheaper electricity to Connecticut. It's a model that could be applied at a national scale to stimulate innovation, create new businesses, and produce more clean and inexpensive power.