I take a back seat to no one in my condemnations of subsidies and other policy distortions of state and regional electric power markets, a stance that I have maintained for decades. And so one might assume that I would have applauded my friend and colleague Mark Perry in his recent criticism of Energy Secretary Rick Perry’s proposal to the Federal Energy Regulatory Commission (FERC) that it consider a system of direct ratepayer payments to baseload generators, in the form of cost-recovery plus a rate of return for on-site stockpiles of fuel. That would amount to an extra payment for coal and nuclear generators, assuming state regulators do not confiscate such payments by reducing allowed rates of return to other capital investment or through other regulatory machinations.

Mark’s reaction, and those of most of our fellow supporters of freer markets in electricity—government ought not pick winners and losers—is just a bit too Pavlovian in this case, because of the subsidies and favoritism now bestowed on unconventional electricity, wind and solar power in particular, by federal and state policies.

Competition of Ideas: Read Mark Perry’s take: Don’t Meddle in the Energy Market

Those subsidies and favoritism are massive, varied, and deeply distortionary. First, there is the production tax credit (PTC) for wind generation, now $23 per megawatt-hour (mWh). The wind PTC provides powerful incentives for the wind producers to underprice their power in markets in which they compete with nuclear and coal plants—they receive the $23/mWh regardless of the market price of electricity at the moment—so it is not unheard of for prices to be negative. If that does not qualify as predatory pricing, then the term has no meaning. It is a straightforward distortion created by the wind PTC.

Nuclear generators face a unique problem: They cannot be cycled up and down except for scheduled maintenance. Because the nuclear operators literally cannot shut down their plants, they are stuck losing money. One does not have to be a sophisticated economic analyst to perceive, at least qualitatively, the adverse implications for longer-term investment incentives. To a lesser extent, coal plants face the same problem: Cycling up and down is possible from an engineering standpoint, but costly. True enough, both coal and nuclear plants face severe competitive pressures from natural gas generators in an era of historically low natural gas prices, so the problems facing coal plants are substantially the result of those low gas prices. But there is little doubt that the subsidies bestowed on wind plants are a nontrivial part of the problem, to the reliability implications of which we return below.

Credit: Twenty20

Notice that the wind PTC under current law is preserved for the next 10 years. Yes, in principle Congress could roll it back or eliminate it, but given that several Republican senators are from wind states—the PTC truly is a bipartisan boondoggle—that would not seem to be a smart bet.

The PTC is only the beginning. There is the investment tax credit for solar generation capacity. There are the renewable portfolio standards (RPS)—guaranteed market shares for wind, solar, and other unconventional power—in 29 states and the District of Columbia. There are the “must-take” requirements in many states forcing system operators to buy renewable power for their respective grids when available, even if cheaper conventional power is available. There are the net metering subsidies for rooftop solar systems, a truly perverse system that drives electricity costs up even as it subsidizes the upper-income classes at the expense of those lower on the income distribution.

Because wind and solar systems must be sited where the wind blows and the sun shines—unlike conventional plants, which can be sited almost anywhere—they invariably impose substantially higher transmission costs than is the case for conventional generation. But current federal policies impose those higher transmission costs on the entire grid rather than the consumers or producers of wind power: FERC, in a 2010 case involving the Midwest Independent Transmission Operator, ruled that the transmission costs attributable to wind generation may be allocated to consumers regardless of the amount of wind power actually consumed by any given ratepayer. This ruling essentially spreads such costs across the entire grid; accordingly, the transmission costs associated with wind generation are not reduced but instead hidden somewhat from calculations of the marginal cost of wind power.

More important, because wind flows and sunlight are intermittent, the same holds for wind and solar generation. In a word, they are unreliable. Data from the Energy Information Administration show that capacity factors—essentially, the percent of the time that a particular generation type actually produces power—are 85 percent or higher for coal plants, 87 percent for gas generators, over 90 percent for nuclear plants, 38 percent for hydropower, 35 percent for wind farms, and about 25 percent for solar facilities.

This unreliability of wind and solar systems means that they cannot be scheduled—they are not “dispatchable”—and must be backed up with conventional power generation capacity so as to avoid blackouts and other system interruptions. My estimate of those backup costs from several years ago was around $368/mWh given the then-prevailing capacity factors and heat rates for the backup units. Other estimates are lower, but still very substantial.

Secretary Perry’s proposal to FERC justifies the resiliency subsidy on the grounds that “regulated wholesale power markets are not adequately pricing [the] resiliency attributes of baseload power.” That premise is problematic because most regulated generation investments deemed “prudent” in rate base cases include some backup capacity designed to preserve system reliability in case of unplanned outages, and traditional rate regulation allows the “fair and reasonable” rate of return to those backup investments. More fundamentally, power consumers value reliability, for obvious reasons, so electricity prices either negotiated contractually or emerging from spot market conditions must reflect the marginal value of the expected reliability of the given supplier.

Accordingly, the stated rationale for Secretary Perry’s proposal is backward. The problem is not that the positive resiliency attributes of conventional baseload generators are undervalued; the problem is that the negative reliability attributes of unconventional power and its attendant high costs for backup generation are not counted against the supposed value of that electricity. In other words, unreliable power imposes an externality upon the grid in the form of higher interruption risks. Unconventional electricity is massively overvalued because the necessary backup costs are spread across the system writ large, in addition to the overvaluation created by the subsidies, the RPS and must-take requirements, and the spreading of extra transmission costs. Federal and state policies that subsidize investments in unconventional power merely exacerbate the problem, and the reality that the federal subsidies shift some of the costs away from local ratepayers onto federal taxpayers does not reduce those costs. Instead, they hide them.

Many assert, without evidence, that renewable electricity—“clean power”— yields environmental advantages relative to conventional power, thus justifying the subsidies and other policy favoritism. The clear reality is that there is nothing “clean” about renewables. There is the heavy-metal pollution created by the production process for wind turbines. There are the noise and flicker effects of wind turbines. There is the large problem of solar panel waste. There is the wildlife destruction caused by the production of renewable power. There is the land use both massive and unsightly, made necessary by the unconcentrated nature of renewable energy.

And above all, there is the increase—yes, increase—in the emissions of conventional effluents caused by the up-and-down cycling of the backup generators needed to avoid blackouts caused by the unreliability of wind and solar power, a reality curiously underreported in the popular discussion.

That the production of renewable power consumes vastly more resources than is the case for conventional electricity is incontrovertible, as is the reality that investment in renewable power would collapse in the absence of the subsidies and other policy favoritism. Accordingly, the sound principle put forth by my friend Mark Perry—government ought not pick winners and losers—rather begs the question in the context of Secretary Perry’s proposal, given the ongoing favoritism imposed on electricity markets by government, meddling that is massive and massively distortionary. As unconventional power generation, driven upward relentlessly by government, increases the risks and likely future costs of power outages, it is an unfortunate reality that a second-best policy of additional offsetting favoritism is likely to be the best that we can do. The analytic question is whether the effects of such a second-best policy are likely to move the system writ large away from or toward greater allocational efficiency in power markets. There is a strong case to be made that it is the latter.