With the collapse of cap and trade in the Senate and the prospects dim for a measly renewable-energy mandate for electric utilities in a lame duck session, the dreams and schemes of the climate campaign and energy reformers have hit the wall. As long as oil prices remain moderate and gasoline prices continue to ease off, energy policy is on the back burner again, and the burner has been turned off. The House Republicans’ recent “Pledge to America” makes only passing mention of energy, which is unlikely to be a priority in the next Congress unless it repeals the imminent ban on incandescent light bulbs. The late senator Daniel Patrick Moynihan once derided Bill Clinton’s support for welfare reform as “boob bait for bubbas”; likewise, President Obama’s recent declaration that he would make “piecemeal” energy and climate legislation a priority next year should be understood as “gooey grist for greens” who are furious that the White House didn’t put its weight fully behind cap and trade. More likely the White House and most Hill Democrats never want to hear the phrase “cap and trade” ever again.

One reason energy is about to enter a new epicycle of political neglect is that America does not have an inherent energy problem. We have decades of coal supplies and soaring reserves of natural gas opening new possibilities for diversifying our energy mix. What we do have is a liquid fuels problem—our old friend oil, which is vital for our system of surface transportation. We import 60 percent of our oil, and that figure is likely to increase unless we get serious about more domestic production. But even if we increase domestic oil supplies, we will be affected by turmoil in the oil market. Although the global oil market appears stable for the foreseeable future, the fact that so much of the world’s oil supply is controlled by state-owned companies means oil is susceptible to political manipulation, never mind the nightmare scenario of a general war in the Middle East. Beyond the oil problem, the issue of climate change is not going to go away. Despite the weaknesses of the case for catastrophic global warming, it would be a mistake for responsible political leaders to dismiss any possibility of human-influenced climate change decades ahead.

The problem with seeing a way forward is that existing alternative energy sources such as wind, solar, and biofuels are not only much more expensive than fossil fuels, but also not scalable to meet the energy needs of this country or any other. More nuclear power is fine, but it will do little for our liquid fuels vulnerability. The clichés about “green jobs” are all fluff and no fold, and our massive subsidies and tax credits for “renewable” energy should be thought of as energy Keynesianism. Government energy research programs are making some useful technical progress, but very little seems to get outside the labs to commercial development. Is there a way for government to adopt an energy policy that avoids wasting money on inferior energy sources and unproductive laboratory research and that could gain bipartisan support in today’s bitterly polarized climate? There just might be.

For over a year, an informal working group of conservatives, centrists, and liberals have been meeting regularly in Washington with a view to seeing whether a fresh start can be made on energy innovation. The core group included several of us from the American Enterprise Institute, Mark Muro of the Brookings Institution, and Michael Shellenberger and Ted Nordhaus of the left-leaning Breakthrough Institute, though a wider circle of people from right, left, and center also participated in the process. The group came together initially because of a broad agreement about three points: that cap and trade was a defective idea and unlikely to generate serious energy innovation even if it passed; that the business-as-usual approach of subsidizing existing alternative energy sources was unpromising and wasteful; and that the nation was underinvesting in energy innovation.

Start with the last point. America’s energy sector invests comparatively little in basic research on energy innovation, and most research investment is directed toward improving existing production technologies for fossil fuels (such as the directional drilling that has unlocked shale gas), or increasing electric generation efficiency, rather than developing next-generation technology. The energy industry invests only about 1 percent of revenues on R&D, a small fraction of the 15 or 20 percent that innovation-intensive industries such as semiconductors and pharmaceuticals typically invest. Even with ramped up energy research spending under the stimulus, the government still spends five times more on medical research through the National Institutes of Health, and over ten times more on defense research. While this underinvestment may not be a market failure strictly speaking, the importance of energy to modern life—it is rightly called the “master resource” that makes all other economic activity possible—combined with the geopolitical vulnerability of the sector, makes it an area deserving a serious long-term policy.

Shellenberger and Nordhaus broke with environmental orthodoxy with a blindingly simple insight that became the touchstone for our working group: The path to a green or clean energy future lies not in making fossil fuels artificially more expensive but in making new energy sources cheaper than fossil fuels, and on a large scale. In other words, innovation instead of taxation. Current energy research and deployment policies do little to advance this goal. Federal subsidies and tax incentives for wind and solar power, for example, are primarily focused on supporting the deployment of existing technologies at current high prices, rather than on driving technology improvement to reduce their unsubsidized price. Renewable portfolio standards, which require that utilities purchase a certain percentage of electricity generation from renewable sources, encourage deployment of the lowest-cost renewable energy technology available—generally wind power—while doing little to drive down the price of other, higher-cost clean energy technologies, such as solar panels, that may have the potential to become much cheaper in the long term. Ethanol mandates and subsidies, meanwhile, threaten to make us dependent on an inferior, environmentally damaging fuel that might inhibit the adoption of potentially more promising fuels such as algae-based diesel. All of the subsidies and tax breaks for current-generation renewable energy should be phased out.

So how can the government sponsor energy research and development that delivers the boon without the doggle? The first step is a long-overdue increase in energy science funding, something that liberals and conservatives have long agreed is necessary. This should be targeted to solve the well-known obstacles to improving the performance of energy technologies. Advances in materials sciences could result in future generations of far more efficient solar panels and more powerful batteries. Genetic engineering and advances in biology are required to manufacture clean-burning biofuels more cheaply. The nation should also train and retain a new generation of energy scientists and engineers. We propose a national commitment to spend $500 million annually on energy education scholarships, postdoctoral fellowships, and graduate research grants to create a cadre of “energy engineers” similar to the national commitment that produced a generation of aerospace and computer engineers after Sputnik.

Second, we should transform the way energy innovation is carried out. Currently, most energy research is pursued in settings and through programs that keep it divorced from the demands of the private sector. Universities and national laboratories need to work much more closely with private firms, entrepreneurs, and investors. The need to transform America’s energy innovation system has been broadly recognized in a slew of recent studies. While the details may vary, the consensus is clear: America should create a national network of decentralized energy innovation institutes—whether we call them Energy Discovery Innovation Institutes or the National Institutes of Energy or something else—that can bring corporate, university, and government scientists together to tackle big energy problems, while strengthening diverse, regional clean technology clusters. Modeled after sustained federal investments made in the ’40s, ’50s, and ’60s that assisted the rise of Silicon Valley, this effort would cost about $5 billion annually.

Third, driving innovation and price declines requires that the government act directly as a demanding customer to spur the early commercialization and large-scale deployment of cutting edge technologies. Today, firms get subsidies that reward production of more of the same product, instead of innovation that results in lower prices. This framework should be turned on its head. Energy technologies should receive federal deployment funding only to the extent they are becoming cheaper in unsubsidized terms. Either technologies continue to come down in price or they are cut off from future public investment.

The Department of Defense has a long track record of using the power of procurement successfully to drive the commercialization and improvement of everything from radios and microchips to camera lenses and lasers. In contrast, the Department of Energy has never really played this role. Energy Secretary Steven Chu deserves applause for his efforts to make his department a more effective funder of breakthrough research, but the agency has no way to either procure or use energy technologies at commercial scale. The Department of Defense should help fill this void, once again using procurement to advance a range of potential dual-use energy innovations.

There are good national security reasons for the Pentagon to play an expanded role in securing America’s new energy future. The U.S. military uses more oil than Sweden and more electricity than Denmark, and every $10 increase in the price of oil costs the Department of Defense more than $1 billion, sapping money that should be used to equip our troops for their critical missions at home and abroad. With fuel convoys costing both lives and money every day in Iraq and Afghanistan, questions of energy are understandably high on the list of the Pentagon’s priorities.

The department should help establish closer linkages between research and procurement. This close connection was key to the successful history of the Defense Advanced Research Projects Agency (DARPA), famous for having invented the Internet, GPS, and countless other spin-off technologies we now take for granted. Congress made a good move in funding an ARPA-E program for energy. But while the Department of Energy is not set up to be a major user of energy technologies, the Pentagon has both the opportunity and the urgent need to use them. The Defense Department can play a greater role in administering ARPA-E and making sure that breakthrough energy discoveries become real-world technologies.

The Pentagon is already looking at the potential of next generation nuclear reactors. For decades, small reactors between one-tenth and one-twentieth the size of existing power plants have been used to power American aircraft carriers and submarines. New modular reactor designs are smaller, safer, and cheaper than older designs and have the potential to be affordably mass-manufactured. We should not bank everything on a single technology or design; the Defense Department should have the budget to do the same for other promising energy technologies, from advanced solar and geothermal to biofuels and batteries. But longtime opponents of nuclear power must rethink their opposition given the potential of new nuclear plants to solve several energy problems—economic, environmental, health, and safety—at once.

All told, this framework would cost between $15 and $25 billion per year, less than one-third what we spend on defense research. In today’s fiscal climate, any new spending should be paid for and should be linked to the affected sector. This could be done through several mechanisms, starting with a phaseout of subsidies for wind, solar, and fossil fuels alike, an increase in the royalties charged to oil and gas companies for production on public leases, or a $5 a ton carbon tax. The mention of a carbon tax will set off some alarm bells, but this low level (about five cents a gallon of gasoline, less than the seasonal fluctuation in pump prices) would neither affect consumer behavior nor change the economics of fossil fuels. Several environmentalists have expressed disappointment in this modest proposal, unable to grasp that it is intended as a revenue measure, not a behavior- or market-changing measure.

No doubt critics will say this level of state involvement in promoting technological innovation doesn’t sound very Reaganite, but they are wrong. Just as Reagan’s Strategic Defense Initiative was intended to be a long-range game changer rather than just another weapons system, this energy strategy is intended to reestablish the United States as the global leader in energy innovation and potentially upend the geopolitics of energy. I share all of the general reservations and skepticism about

government-sponsored research and development. Yet for all of the boondoggles one can rightly point to, such as Jimmy Carter’s hapless Synfuels Corporation, there is also a record of government-sponsored technology achievement that it would be churlish to overlook. The lesson is that government investments succeed not when they are blanket subsidies but when they are targeted to specific outcomes, such as developing computers to enable rocket systems, building a communications network to survive a nuclear attack, or creating increasingly efficient and powerful jet engines. These public investments and supporting regulatory changes paid off handsomely in personal computers, the Internet, and both commercial air travel and the gas turbines used in modern natural gas power plants. Government-sponsored research in biochemistry has played a substantial role in the development of new pharmaceuticals.

There are no guarantees that this framework will deliver quickly or be free of failures along the way. (To the contrary, if there are few failures it will mean the program isn’t bold enough.) But with China committing as much as $740 billion to basic energy research over the next decade and South Korea dedicating 1 percent of its GDP for the same purpose, the United States risks being a laggard in the energy sector. And that’s more than just an economic risk.

Steven F. Hayward is a resident scholar at the American Enterprise Institute and the author of the forthcoming Almanac of Environmental Trends.

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