Congress has historically used tax incentives as a proxy for a national energy policy. Twenty years ago, two separate but similar programs targeted new domestic energy sources: wind and “unconventional” natural gas.
Tax incentives for energy production reduced the investor’s financial risk, effectively subsidizing research and development in these new areas. How has it worked out? What can the experience tell us about the merits and long term viability of each energy source?
In the case of natural gas, the unconventional sources of supply that were targeted for assistance today comprise almost 50% of domestic supply. The tax credits are ancient history, having expired in 2002.
The economics of wind energy, on the other hand, prove to be utterly dependent on ongoing assistance in the form of tax credits. But even government cash in the form of the tax credit is not sufficient to keep wind energy competitive. Wind energy industry groups constantly lobby Congress and the states to mandate the use of wind energy in the electrical generating supply mix.
Let’s take a closer look.
In the late ’70s, the U.S. had a natural gas supply problem. Prices of natural gas had long been kept low by federal price controls. M. King Hubbert, who correctly forecast domestic “Peak Oil” in 1970, foresaw a similar peak for natural gas, to occur around 1980. But Hubbert was wrong.
Hubbert’s pessimistic outlook alarmed Congress. Some geologists suspected that the nation’s natural gas supply picture could be improved by looking beyond conventional sources in the Gulf of Mexico and Mid-Continent to the low permeability “tight” reservoirs that blanket much of the Mountain West. Everyone knew the tight rocks contained gas; the challenge lay in coaxing the gas out in sufficient quantities to justify the considerable drilling cost. Even more speculative unconventional sources included gas from coal seams and ultra-tight shale formations.
The 1980 Windfall Profits Tax contained a little-known provision called the “Section 29 Tax Credit”. To provide an incentive for developing supply from unconventional sources, Congress cut the producer’s income tax liability by up to $1.00 per thousand cubic feet (MCF) of gas produced. (At the time, the wellhead price of gas averaged well under $2.00 per MCF, much less in the Mountain West.) Only wells drilled before 1992 qualified for the credit.
Fast forward to 2010: Gas never “peaked.” As wells were drilled and technology improved, the resource base grew. By 2009, the U.S. had produced more gas than Hubbert’s entire resource base estimate from 1977. In fact, based on the 2009 estimate, we may ultimately discover and produce three times more gas than was thought possible in Hubbert’s day.
The tax credit was the key that unlocked the potential of unconventional gas. Later advances in hydraulic fracturing, horizontal drilling and other technologies, coupled with higher wellhead prices, grew the resource potential tremendously. By 2007, unconventional gas made up 42% of the nation’s total production; the share is expected to increase to 64% by 2020.
Congress has also graced the wind industry with favorable tax policy. The Energy Policy Act of 1992 established a Production Tax Credit (PTC) of $0.022 per kilowatt-hour (kwh) of wind-generated electricity. According to Robert Bryce of the Energy Tribune, the cost of that energy equates to $6.44 per million BTU (or roughly $6.44 per MCF of natural gas).
Big picture, that means that the federal subsidy for wind energy is about equal to the current delivered cost of natural gas ($4.00 per MCF at the wellhead, plus processing and transportation to the burner tip). Boone Pickens has estimated that wind energy is viably competitive with natural gas only when the wellhead price is $9.00 per MCF or more.
What would happen to wind energy investment absent the production tax credit? We tried removing the credit in 1999, 2001 and 2003. As a result, the installation of new wind generating capacity fell by 75% or more in 2000, 2002, and 2004.
The current PTC for wind has been extended for two years, through 2012.
Beyond PTCs, wind interests have a goal of federally mandated usage of renewables in the supply mix. The Democratic congressional leadership is reportedly planning to bring renewable mandate legislation up for consideration during this fall’s lame duck session. Not a bad deal if you can get it: a product with a government-mandated market share, coupled with a government-backed floor price.
The bottom line: Natural gas, even unconventional natural gas, is viable without the constant infusion of government funds and market interference. Wind energy is not. Despite the propaganda war against it, natural gas remains a clean, efficient and nearly 100% American energy choice.