The following is a contributed article by Kenneth W. Costello, a regulatory economist and independent consultant who has worked for the National Regulatory Research Institute, the Illinois Commerce Commission and Argonne National Laboratory.
With deepening concerns over climate change, policymakers, electric utilities and environmentalists are championing the idea of "electrification," notably for the replacement of fossil fuels with electricity for direct end uses like transportation, and water and space heating.
Electric vehicles and heat pumps are the "electrification" technologies that have received the most attention up to now. Other than power plants, the two largest sources of carbon emissions are cars and light trucks, and buildings. For buildings, the two largest emitting sources of carbon are for space heating and water heating.
Environmental groups and others warn that stringent climate goals are out of reach as long as widespread use of fossil fuels continues in home appliances and vehicles: The numbers just don’t add up for deep decarbonization if fossil fuels remain a major source of energy for transportation and buildings.
The electric industry sees electrification as an opportunity for revitalizing sales and revenues. A growing number of utilities now consider electrification as an integral part of their future business plan. With smart dispatching, utilities realize the added benefit of optimizing their load shape from electrification of transportation and water heating.
Supporters contend that electrification should occur sooner than later — preferably over the next two or three decades — and accelerated by subsidies and other governmental inducements. Some even advocate for mandated electrification to avoid climate catastrophe. Others point to the less lofty goal of revitalizing the electric industry. Another group argues that electrification is already economical for end uses, like water and space heating.
The core question for policymakers
Before endorsing electrification, policymakers should stop to ask the following question: Have markets or regulatory barriers prevented or discouraged socially beneficial electrification? These barriers can include inadequate information to energy consumers, myopic decision-making by consumers, and distorted regulatory prices.
Energy decisions fundamentally involve consumers choosing among different energy sources for fulfilling their heating, transportation, cooling and other energy-service needs. Policymakers should first determine whether undue market problems exist, what effect they would have on consumer behavior and whether "outside" actions could rectify them cost-effectively. If policymakers conclude that end use markets for electricity and other energy sources are functioning well, then little reason exists for them to take any action. Any such action would likely cause more harm than good.
In almost all U.S. sectors, whether energy or non-energy, the market is the primary mechanism for consumer decision-making. An energy consumer’s major consideration is the required capital and energy costs for providing, for example, the level of heating comfort and other benefits that the consumer desires. Non-price factors such as comfort, reliability and the carbon footprint also enter into consumers’ decisions. Another factor is the high cost of conversion from natural gas to electricity for space and water heating.
Overall, whether energy consumers rely on fossil fuels or electricity for their transportation or home energy needs comes down to a rational choice of what source of energy would best satisfy those needs. In most instances consumers express their choices and make the best decisions for themselves, given the market conditions they face. But for various reasons, markets occasionally fall short of operating the way they should and consumers err in maximizing their well-being, justifying at least consideration of outside intervention.
Conditions for outside intervention
With high surety, in the future, clean energy will be the primary source of electricity production and the argument for electrification becomes more defensible. The question then becomes: Should we hurry electrification through governmental actions with incentives and subsidies, or instead, allow the market by itself to determine the speed and magnitude of electrification?
The latter course of action is more tenable with a carbon tax or an equivalent cap-and-trade program that attempts to convey proper price signals to consumers in making energy choices. A well-designed tax (admittedly, easier said than done) would include the societal cost of carbon emissions in the prices of competing energy sources. It would mitigate, but not necessarily eliminate, the role of out-of-market policies over electrification. Policymakers could still justify outside intervention as long as nontrivial market problems prevail.
Without a carbon tax, however, policymakers must depend more on inferior policies to place clean electricity on a level playing field with fossil fuels in end-use markets. They include a mixture of standards and subsidies, which up to now has become the most prominent policy mechanism for mitigating climate change. We have seen many of these policies, however, to be seriously flawed, in violating basic economic principles.
Diffusion of new technologies like electric vehicles, advanced heat pumps and water heaters normally follows a gradual, dynamic process, rather than a process where consumers adopt a new technology en masse: The process typically begins with few early adopters, followed by a more rapid period of adoption, and then by a more moderate adoption rate once most potential users have adopted the technology. Not uncommonly, consumers will stay with their current technology, even though a new technology appears superior in performance and cost. A key question for policymaking is whether the actual diffusion rate is a product of rational actors facing dissimilar incentives and other conditions or a consequence of undue market imperfections.
As a prime consideration, rational public-policy intervention in consumer markets should pass a cost-benefit test. This requires evidence of serious market problems; for example, consumers making poor choices for themselves or market prices that fail to reflect costs. Otherwise, government actions to promote electrification would likely make matters worse. The tough task for policymakers is to identify and quantify the appropriate benefits and costs.
Any public-policy actions should mitigate or eliminate any undue obstacles that hamper electrification. A core principle for intervention is that any action or policy should redress any market problem as directly as possible. The first step should be to identify features of a well-functioning market and determine whether energy end use markets lack any of those features. Tailoring subsequent intervention to a particular market problem would have the best chance of achieving a positive outcome. Policymakers must therefore exercise prudence to ensure that any action targets the core problem and does so cost-effectively.
Most markets confront barriers themselves by expending resources and finding ways to overcome barriers to an industry’s technologies. If heat pumps and electric vehicles need further improvements to become more marketable, then suppliers should have the incentive to make this happen. In fact, manufactures are constantly working to improve the efficiency and recovery rate of heat pumps to make them more competitive, even in cold climates.
The rationale for governmental intervention must therefore rest with evidence of the social desirability of technologies to penetrate the marketplace more intensively and quickly than what would occur under market conditions. This is ostensibly the core argument for governmental intervention to accelerate the marketability of electric appliances and cars.
If electrification is to have a profound change on climate change, electric generation will increasingly have to rely on clean energy. It is seemingly premature to believe that electrification (outside of transport) would have a major effect on reducing carbon in the next few or even several years.
That said, technological advancements are moving in a direction that favors electrification with its emphasis on digitization and clean energy. If these developments continue to evolve, we should see a more electrified economy with less dependency on fossil fuels to meet future direct-energy demands.
Instead of "artificially" promoting electrification, we should wait to see where the technology takes us. Technology will determine the ultimate success of electrification — not subsidies and other governmental actions that could distort the diffusion of electric appliances and vehicles, with possible obstruction of their long-term viability.
Artificially promoting electrification with subsidies and other monetary inducements can be a win-win for electric utilities and environmentalists, but questionable for the rest of society. The problem of new electric technologies subsidized by utility customers and taxpayers with only a distinct minority benefiting is hard to ignore, both politically and economically.
Overall, "artificial" electrification could have a regressive effect by disproportionately benefiting higher-income households, while being funded by all income groups. It can also lower economic efficiency, especially when it misaligns public policies with actual market problems.