Is Next Energy the Next Energy Boondoggle?

Citing a threat to national security from U.S. dependence on foreign oil, Gov. John Engler recently proposed state management of alternative energy research. A 16-bill package delegating new government powers and tax subsidies is speeding through the Legislature this week. But even the best of intentions won't necessarily produce sound policy, and the governor's NextEnergy proposal is, unfortunately, deeply flawed.

In unveiling the initiative in April, Mr. Engler vowed to position Michigan as the "world leader" in non-fossil fuel technologies such as hydrogen fuel cells to power vehicles. Absent state intervention in automotive re-engineering, he said, Michigan risks the loss of 200,000 manufacturing jobs.

The United States does import more petroleum today than 30 years ago-54 percent of American consumption compared to 35 percent in the 1970s. But it is also a fact that more oil is now available from a wider variety of sources than ever before. And to artificially restrict energy to domestic sources in the name of "security" would make the United States more vulnerable to power disruptions, not less.

Regardless of the supply outlook, the immediate issue is whether the NextEnergy plan would advance research and development (R&D). Mr. Engler is proposing a new state authority governed by a hand-picked seven-member board to "finance, direct or otherwise aid in the planning, construction, and design of alternative energy technology business and infrastructure." The authority would be empowered to issue revenue bonds and grant a variety of tax credits and exemptions based on very broad criteria.

To generate operating revenue for the venture, the governor intends to transfer to the authority control of 816 prime acres in Washtenaw County which could be leased or sold to select energy-related enterprises. However, should the authority run short of cash with which to repay the notes or bonds sold to underwrite its projects, the state budget (i.e. taxpayers) would have to cover the debt.

For reasons outlined below, promoting energy R&D in Michigan does not require yet another government bureaucracy allocating favors to firms willing to relocate to state-owned property. Michigan could instead become an economic powerhouse were the Legislature and governor simply to improve the overall business climate.

Government involvement in R&D is well established. National labs with multi-billion dollar budgets have long augmented academic and commercial research, both basic and applied. But states and the federal government have largely failed to commercialize nascent technology-despite trillions of dollars in public R&D expenditures.

In the 1970s, for example, the Carter administration created the Synthetic Fuels Corp. to develop renewable energy sources (in the name of energy independence). But the Synfuels program was discontinued in 1982 without generating a dime's worth of new power-despite taxpayers' $1 billion investment. The administration of George W. Bush then formed the Partnership for a New Generation of Vehicles with the intent of producing an affordable zero-emissions family sedan by 2004. Despite $2.5 billion invested by taxpayers and The Big Three, the program's chief goal was recently deemed unrealistic by the National Academy of Sciences.

The U.S. Department of Energy, meanwhile, administers a variety of alternative energy programs upon which hundreds of billions of dollars are annually lavished.

Myriad institutional problems confound government R&D-foremost among them the aversion to risk generally infecting governments' ranks. Lacking the technical expertise of the private sector to distinguish between pipe dreams and real technological promise, public officials routinely allocate public funds to the least-risky projects. But those tend to be the projects most likely to draw private capital, thus supplanting privately funded R&D.

As it is, the automotive industry already is heavily invested in fuel-cell research. BusinessWeek reports that General Motors Corp. hopes to unveil its "Autonomy" prototype by 2010, while DaimlerChrysler is testing hydrogen powered busses in 10 European cities and perfecting its "Natrium" minivan. Ford Motor Co., meanwhile, has developed its "Focus FC5," which relies on hydrogen extracted from methane.

To the extent automakers foresee a competitive advantage in fuel-cell technology, they are unlikely to share their research findings. (After all, advocates of alternative energy have insisted for years that the internal combustion engine is headed for extinction.)

Appearing last week at a Lansing press conference to tout the NextEnergy plan, Doug Rothwell, CEO of the Michigan Economic Develop Corp., acknowledged it's unlikely that GM, DaimlerChrysler, or Ford would directly participate. In other words, the most prominent players in the field prefer to keep their findings out of government hands.

State interference also risks limiting potential advances by effectively endorsing one technology over another through special tax and regulatory treatment. This was precisely the case with California's electric vehicle mandate, which diverted years of attention and billions of R&D dollars from more promising technologies. The Engler plan poses a similar risk in prohibiting subsidization of gasoline or diesel-powered hybrids, for example, while a "bio-diesel" mandate is also pending in the Legislature.

If the governor and lawmakers are adamant about promoting new energy technologies, the more effective approach would be to promote as much experimentation as fiscally possible.

This is especially important given the tangled technical challenges facing fuel-cell development, which will take decades to unravel. These include the potential environmental threat caused by increased concentrations of hydrogen in the atmosphere, which could exacerbate the build-up of greenhouse gases. According to the Center for Automotive Research (CAR),  "(S)ignificant invention and refinement still remain before the fuel cell can be considered a viable candidate for mass production vehicles."

To produce a kilowatt of power with current fuel cell technology costs about $300. The internal combustion engine does it for $30. And building the fueling infrastructure needed to service a fleet of hydrogen fuel-cell vehicles would cost in excess of $100 billion, according to CAR.

Also to be considered are the consequences of the targeted subsidies proposed by the governor. As it is, Michigan ranks second-to-last among peer states in business cost competitiveness. This is largely a consequence of the state's Single Business Tax (SBT). But the NextEnergy subsidies would increase this tax burden for non-favored firms. And there is concern that the credits and exemptions could so deplete the state's "rainy day fund" that the scheduled cuts in the SBT would not take effect. If the governor wishes to underwrite R&D, why not simply sell off surplus state land to fund across-the-board tax cuts? This would eliminate the "need" for a costly new bureaucracy and scores of new tax consultants.

As the MEDC's own benchmark study recently noted: "True economic competitiveness is the sum result of a state's overall business, social, and economic climate."

Alternative energy sources will evolve when the price of conventional fuel exceeds the research and development costs for alternative sources. As Cato Institute scholars Ronald Sutherland and Jerry Taylor have pointed out, private firms may underinvest in "good" R&D, but government is far more likely to overninvest in bad R&D.

At the very least, the Michigan Legislature should not simply cater to gubernatorial whims, but instead carefully consider whether NextEnergy is the next energy boondoggle.