Energy & Policy: The Story of Incentives

The intention of policy makers to reduce greenhouse emissions is a story of incentives. It’s always a story of incentives - the question is, incentives for whom and at what cost? Incentives and waste; cost and benefits, can be seen as determining the productivity of public choice. As in all human endeavors means need to be fit to ends. So the institutions and infrastructure of the energy sector need to be enabled to deliver a low carbon future.

The telecommunications sector offers a real precedent for such a transition. FA Hayek said,

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. To the naive mind that can conceive of order only as the product of deliberate arrangement, it may seem absurd that in complex conditions order, and adaptation to the unknown, can be achieved more effectively by decentralizing decisions and that a division of authority will actually extend the possibility of overall order. Yet that decentralization actually leads to more information being taken into account.”
The Fatal Conceit (1988), p. 76

Billions alive today enjoy the highest average standard of living in human history. It is the direct product of an energy revolution that occurred in the last 250 years. Freed from the grinding poverty of a 1 ‘human’ power existence, individuals have been able to literally reach for the stars. It is therefore unsurprising that messing with our affordable access to power is such a political hot potato. Beyond the name calling in the climate change debate, on the one hand we have earnest, well-intentioned people foretelling an environmental end of days if our approach to energy generation remains unchanged. Dug into the trenches over the other side, we have equally earnest people with an equally unattractive vision of a future without plentiful or cheap access to energy.

Coordinated human action in society is a complex order, as Hayek suggests. Every day, individuals pursuing their own intentions make decentralized decisions. These intentions have however been pursued on a substratum; designed, managed and frequently directed as a centrally planned structure. The limits of 19th Century technical design met and merged with the politics of the day. The electricity system is an instance where two models of design and social order have played out for the last 130 years. Along with railways and telephone systems, the electricity sector slipped from the realm of leading edge innovators to being state owned or at the very least deeply regulated monopolies.

Peter Thiel looks across the arch of our technological history and sees that innovators and entrepreneurs were herded away from the realm of the physical world by that regulation. Driven out of town, innovators and entrepreneurs settled the new digital domain and moved us into an information economy. That information economy takes the energy revolution that preceded it for granted. Thiel and others highlight how regulation has acted as a disincentive to innovation in the physical world. It is interesting to note, that as the focus of innovation shifted to the digital world almost by accident, a huge centrally planned network that was resistant to change was restructured beyond recognition. The switched network of rotary dial telephones and manually operated exchanges gave way to the Internet and smart phones. Telecommunications has become a highly efficient system for peer-to-peer value creation. This has driven huge leaps in productivity and prosperity, as Hayek would have predicted.

Faced with pressures like those applying to the 20th Century telephone system, the power grid cannot cope with the demands of decentralized variable energy generation. With the intention of addressing climate change, the same governments that control regulated centrally controlled energy grids around the world, have provided significant incentives to households and investors to produce solar and wind power. It is acknowledged by all concerned that the volatile and intermittent nature of that power generation is beyond the design limits of today’s centrally managed power grid.

It is therefore clear that if policymakers intend to actually reduce carbon emissions, by adding renewable energy to the grid, then it is an imperative that the nature of the grid reflects the demands of modern generation and consumption. We do not expect a manually switched telephone system to support a 21st Century information economy, why should we anticipate the 19th Century’s centrally controlled power grid to be able to manage the instantaneous demands of today’s renewable power generation?

To continue to deliver prosperity, health and human happiness based on low cost power we must ensure that we minimize waste of incentives, capital investment and electricity generation.

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