On Tuesday afternoon I attended a session at the annual NARUC meetings on the potential for IGCC Integrated Gasification Combined Cycle technology and impediments to investment and implementation. IGCC essentially is a process for turning coal into synthetic natural gas, which puts the coal through a gasifier, extracts pollutants like particulate matter and sulfur dioxide, and leaves a gas that can be used in the same way as natural gas.
This technology is important and has a lot of potential to address many potentially conflicting objectives. If you are worried about energy independence and want to reduce U.S. reliance on foreign energy supplies, IGCC can reduce the demand for liquefied natural gas (LNG) imports. If you are worried about high natural gas prices and believe that they will continue at around $6/million BTUs, then IGCC could provide a cost-effective alternative to natural gas. With natural gas prices around $6, even if you have to expend resources to gasify the coal it can be cost effective (if the presentations I saw today are realistic, and I think they are). If you are concerned about the environment, IGCC allows you to use even high-sulfur coal while producing very low emissions. I know of one chemical manufacturer that has been using IGCC for a while because of the combination of these features. Plus, one of the presentations on this session suggested the opportunity to sell 99.9% pure sulfur, which means that firms using IGCC can turn polluting waste into a revenue stream.
Yet the technology is sufficiently new and unproven that few IGCC facilities are being built. This slow adoption is a bit of a conundrum to the panelists I heard today, especially if you think about the possibility of basically bolting on a gasifier to an existing natural gas power plant. With high natural gas prices, the ability this technology gives you to substitute from expensive natural gas to synthetic gas from cheap coal should be very valuable.
One presenter in particular, David Berg from the DOE’s Office of Climate Change Policy, attributed this lack of investment to market failure. Apparently any time someone does not invest in a technology that looks beneficial but is high risk, thatís a market failure.
Hereís my first question: why is that a market failure? If investors attach a particular risk premium to a particular opportunity, and you donít like that risk premium or think that it is inaccurate, what makes that a market failure? Perhaps if you can show at a range of discount rates and over a range of risk preferences that the internal rate of return on the investment is positive, yet itís still not happening, then you can argue market failure.
But in both Mr. Bergís presentation and the subsequent presentation from Bill Rosenberg (JFK School of Government, Harvard University) (the link is to a pdf that discusses his 3-party covenant idea for investment financing), when they attempted to substantiate the claim of market failure, all of the factors they highlighted were regulatory barriers facing the investment market.
First, building IGCC plants typically costs more than alternative technologies, so often state PUCs hesitate to allow the costs to be incorporated into the rate base. How is that a market failure? Sounds to me like the application of the prudency standard for evaluating utility costs is the barrier, and is the transaction cost in this case.
Second, this technology is not as mature and proven as alternatives, so investors tend to go with others. How is that a market failure? It sounds to me like the way the world works, and the way the world has always worked. New technologies have always faced implementation hurdles when competing with more mature, known technologies. Why is IGCC relative to, say, pulverized coal technology any different from the steam engine relative to the water wheel in the late 18th century? New technologies compete uphill. Get over it.
Both Mr. Berg and Mr. Rosenberg advocate federal government loan guarantees to change the risk calculation of the potential investor. I have a simpler suggestion: if one of the valuable features of this technology is its cleanliness, let retail customers choose whether or not they want to buy power generated from clean technologies. If they value clean air, they should be willing to pay more for IGCC-generated power relative to pulverized coal-generated power. That customer willingness to pay should make the economics of the IGCC plant make sense, making it a more prudent investment.
It all comes back to customer choice and customer preferences. Itís unfair to them to leave their preferences out of the policy discussion, and out of the determination of the technologies that are used to generate the power that they purchase to fuel their various and diverse uses.
Itís also wrong to call something a market failure when the transaction costs that are preventing a market from behaving the way you think it should are the consequence of either regulatory constraints or risk preferences.