[As published in the July 1996 edition of The Electricity Journal. Posted on this Web site with the permission of TEJ.]

The debate over social and environmental policy in restructured electricity markets has suffered from unclear policy objectives and incorrect economic reasoning. The common misconception that efficiency must be sacrificed for other objectives to be attained is wrong. The correct use of economics can fashion policies to structure the market so that social goals of reliability, environmental quality and equity are attained most efficiently.

By Nancy A. Rader and Richard B. Norgaard

In light of the consistent public support[1] for the benefits renewable resources bring to electricity production, many now advocate that policies to promote renewable energy should be integral to electric industry restructuring. To this end, several policy options have been proposed, including green pricing programs, funding renewables through system benefits charges, and adopting renewables portfolio standards.

Others, however, are arguing that renewables should be subject to the "discipline of the market" as other energy sources will be. They argue that the whole idea of restructuring is to let markets determine what is best and that policies supporting renewables would reduce economic efficiency.

To help clarify this debate, we define the relevant questions as they relate to renewable energy: Is policy necessary to improve economic efficiency? Is policy necessary to achieve other objectives that derive from societal preferences? If the answer to either or both questions is yes, what policies would best achieve those objectives?

We discuss how market imperfections will hinder the commercial advance of renewables in competitive markets and show why policy is necessary to promote economic efficiency. We then argue, while recognizing that this is an area of legitimate public debate, that policy to advance renewables in the market is also warranted to respond to strong public concern for the sustainability of development. Finally, we explain why setting market standards for renewables in electricity production is the most promising policy approach for addressing these concerns. Specifically, we discuss why a "renewables portfolio standard" is the most efficient means of correcting market imperfections and for moving toward sustainability.

I. PROMOTING RENEWABLES IS CONSISTENT WITH COMPETITION

Restructuring electricity markets to promote renewable energy resources can be entirely consistent with making markets competitive and efficient. To understand how questions of market efficiency relate to policy questions relating to equity -- and renewables policy involves both -- we must review some basic economic theory that is too often misunderstood or long forgotten.

A. Economic Theory

Two distinct issues arise within the broader question of whether policy to advance renewable energy is justified. The first is whether market imperfections exist. This is an issue of economic efficiency that can, at least in theory, be addressed by economists. The second has to do with equity, or how as a society we choose to distribute resources such as finite fossil fuels, environmental quality and a stable climate between current and future generations. The efficiency logic of economics is insufficient to determine how these distributional choices should be made.[2] For choices about equity and sustainability, we must rely on democratic processes, including commissions to whom public authority has been delegated.

Economic efficiency is typically, but mistakenly, referred to as an objective which must be compromised if other objectives are sought. For example, the Montana Public Service Commission asks in its restructuring docket, "To what extent should efforts to increase economic efficiency be balanced by equity and other public interest concerns?"[3] But equity and efficiency are not traded off. It is not "inefficient" to ensure that all homes are heated on the coldest winter day, nor is it "inefficient" to preserve environmental quality, though these goals can be achieved in efficient or inefficient ways.

There are multiple efficient market allocations of goods and services, depending on how rights to resources are initially distributed. Conserving finite fossil fuel resources and preserving the earth's atmospheric balance are essentially matters of distributing rights to future generations.[4] To understand the implications of redistributing rights to resources to different people, economists use general equilibrium analysis. Energy and environmental economists have been trained to think in partial equilibrium analysis, with the efficient solution being where the supply and demand curves cross when these curves represent social costs and benefits. While this form of analysis is extremely useful, it assumes that the distribution of rights is constant and that sustainability is simply a matter of correcting environmental market failures to make markets work efficiently. General equilibrium analysis shows that achieving sustainability entails making markets work *differently*, but still efficiently, and that criteria beyond economics are necessary to determine whether a sustainable economy is better.

The economics of sustainability using a general equilibrium framework is illustrated in Figure 1. This diagram shows the trade-off between the well-being of the current and future generations. The "utility", or well- being, of the present generation is on the x-axis and the utility of each future generation is on the y-axis. The utility frontier, U, represents the highest levels of well- being possible for future generations given any level of well-being of current generations. Every point on U is efficient, since no generation can be made better off without other generations being made worse off. Points B and C illustrate two efficient market solutions that are associated with different distributions of resource rights among the current generation and each future generation.

B. Economic Efficiency

Energy and environmental economists have typically been concerned with market failures that prevent the economy from working efficiently. An obvious example is the external cost of environmental pollutants. If polluters had to buy the right to pollute from those they harm, there would be less pollution. Policies that correct for market failures can be illustrated in the figure as a move from Point A toward Point B. Point A on the graph is inefficient because both current and future generations can be made better off. Economic efficiency reasoning makes it clear that a move from Point A to Point B improves well-being for all.

Imperfections in competitive markets ought to be corrected through policies that affect how the market works, if the cost of correction is reasonable. If they are not corrected, inefficient outcomes will occur, which means that we are attaining both less energy and fewer environmental benefits than we could. Yet, the problems of market imperfections are seldom acknowledged in discussions about restructuring electricity markets. On the contrary, faced with market imperfections, free marketers simply declare "let the market work." In this journal, for example, guest editorialist Ken Maize wrote, "Clearly, consumerists and environmentalists believe they cannot win in a competitive environment . . . What's needed is economic democracy.[5] Similarly, it is argued that, through the marketing of electricity from renewable energy, those who want cleaner air will have the opportunity to buy it.

Responding to these arguments in human terms, when Connie Consumer ponders whether to pay a little more for electricity from renewable energy, she rightly considers that all her neighbors would benefit as much as she would from the resulting cleaner air, and she is rightfully concerned that her neighbors may not reciprocate. Maize's charge that the policies called for by environmentalists presume "stupid customers" and that these environmentalists "lack confidence in their ability to survive in a free market" ignores Connie's economically rational decision not to pay for other people's benefits. Her reasoning, when she does receive the benefits of her choice, is the same economically rational calculation that makes markets work so well. Her concern that others will "free ride" on her socially preferred choice is well-recognized in economic theory as a reason for market failure. The result for renewables is that their true value is not likely to be reflected in individual choices, and an inefficient outcome results.

Connie Consumer, however, probably does not recognize an important systemic benefit in the form of risk reduction provided by a larger share of renewables in the system. Nor are competitive electricity producers likely to fully recognize these risk reduction benefits. Two types of risk are reduced. First, overall electricity price volatility is reduced when the diversity of energy sources used to produce electricity is greater. Second, renewables face fewer regulatory risks such as the risk that a carbon tax will be levied on fossil fuels in the future to reduce net carbon emissions. Risk reduction is systemic in that it reduces shocks to the economy as a whole. This benefit of renewables is best thought of as a "public good." National defense is the classic example: despite its clear benefits, it would not be provided by the market. The defining quality of a public good is that additional people cannot be prevented from enjoying the benefits of the good that is provided by those who buy it, and the additional cost of providing the benefit to other people is zero. Markets do not provide public goods since individuals will not volunteer to pay for benefits that accrue to everyone.

Obtaining the optimum amount of a public good requires that all contribute. Electricity producers do not have sufficient incentives to diversify adequately to avoid the above risks because their profits depend on their diversity relative to other producers and because most of the costs of the shock reverberate throughout the economy rather than being concentrated among electricity producers. The price and regulatory risks associated with fossil fuel use will easily be passed on to consumers because electricity producers manage risks to ensure that their own exposure is limited *relative to that of their competitors*, the vast majority of whom will also be using fossil fuels. Private risk mitigation measures will tend to center around controlling the price fluctuations of the investor's own investments through financial hedges, such as futures markets. Private actors are less concerned with major fossil fuel price disruptions, whose likelihoods are unknown, because such disruptions will affect all actors in the market and will not change their own *relative* standing.

Renewables are also faced with market barriers, another category of market imperfection. For example, the risk premiums placed on capital in more competitive markets will have a disproportionate impact on renewables, because they are capital-intensive. Further, in retail competition, the marketing costs that renewable energy suppliers will have to absorb to inform Connie Consumer about their product and convince her to switch -- and stay switched -- will be formidable. If competition for the long distance phone market is an indicator, advertising will be the primary means of gaining market share.[6] Competing with multi- billion dollar competitors will not be an easy task for the relatively small renewable energy industries.[7]

The market barriers facing renewables could be addressed through renewables policy if society has an interest in continuing the very substantial technological advancements and cost declines that have occurred over the past decade. The costs of wind and solar technologies are likely to decline significantly as a result of "economies of production" (increased number of units manufactured). A predictable and growing market for renewables will facilitate the establishment of streamlined, state-of-the- art manufacturing facilities and drive costs down. We have an interest in developing the renewable energy industries that, if healthy, can compete for large export markets and aid the U.S. economy. If we do not develop them, in the future we may be importing all of our renewable technologies. In addition, a renewable energy industry infrastructure must be maintained to preserve our readiness to respond to market conditions.

Of course, correcting all of these market imperfections, while theoretically a technical economic question, is not easily done by economists. Absent the problems of market imperfections, how *would* consumers act? If investors internalized all risks to consumers, how would their decisions change? How high do we believe the cost of pollution to be? On this question, a recent OTA study concluded that

"no clear consensus exists on quantitative estimates of environmental costs of electricity, or on methodologies for making those estimates . . . Some critical disagreements over methodology . . . mask deeper disputes over values, basic policy goals, and the intended role of environmental cost studies. It is unlikely that these disputes can be resolved by technical analysis or scientific research. Instead, these disagreements are more likely to be successfully addressed through public debates in the policy arena."[8]

As this statement indicates, these questions are somewhat amenable to technical analysis, but also require public discussion and collective judgment because they relate not only to questions of efficiency, but also to questions of equity.

C. Equity

Resolving market imperfections is only half of the job of policymaking. In Figure 1, the utility frontier U between current and future generations clearly illustrates that there are many efficient market solutions, and that, therefore, some other criterion than economic efficiency is needed for public decisionmaking. Sustainability -- a matter of equity between generations -- is now a well-recognized criterion that is increasingly being used by many public agencies, from city governments to the World Bank.

Sustainability is not a matter of correcting environmental market failures to achieve existing ends more efficiently. Sustainability entails directing markets to achieve different ends.

Sustainability means that future generations have equal or higher levels of well-being than the current generation. This is represented by any position above the 45 degree line in the figure. While both points B and C are efficient, only point C is sustainable. Since these two points, and all other possibilities along the U curve, represent efficient allocations of resources, efficiency criteria cannot be used to select between them.[9] Picking one point over another is a distributional issue which must be decided politically. Indeed, economic theorists have long argued that a criterion outside economics, some value system beyond economic valuation such as illustrated by the curve W in the figure, is necessary for deciding how an economy should best operate.[10] The figure clearly shows that sustainability is an issue of the distribution of resource rights between generations, not a question of the efficient use of resources per se.

There is, of course, broad concern about sustainability. The likelihood that climate change is a serious problem is central to this concern. Deliberately making a transition to renewable energy sources is a well- recognized component of every proposal to avert, or at least ameliorate, climate change in an effort to protect our future and that of our children. Promoting renewables for the purpose of protecting future generations is not something we *should* do by economic reasoning. It's a matter of whether we *want* to do it, based on our beliefs about how the future will unfold and moral concern for future generations. And, indeed, the public has shown such concern, including strong and consistent support for renewable resources in polls over the past 15 years.[11]

D. The Task for Policy Makers

State regulators are clearly empowered to address questions of market failures -- moving from point A to point B, improving economic efficiency but not deliberately affecting inter-generational distribution. But some commissioners may feel it is inappropriate for them to make value judgments on behalf of society with respect to sustainability. In several states, however, regulatory commissions have been implicitly or explicitly directed by their legislatures to consider future generations. For example, an Oregon statute states:

"It is essential that future generations not be left a legacy of vanished or depleted resources, resulting in massive environmental, social and financial impact. . . . It is therefore the policy of Oregon that . . . development and use of a diverse array of permanently sustainable energy resources be encouraged."[12]

Whether regulators assume this task or not, most state legislatures will be addressing at least some aspects of restructuring, and many will debate the merits of renewable energy policies, as they should.

The task for policy makers, then, is to sort out the rhetoric, separating questions of efficiency from questions of equity. Those who advocate policies to meet environmental or social objectives are often accused of wanting to "distort" markets and of being distrustful of the "discipline" of the market to achieve economic efficiency. Such political rhetoric appeals to, but has no basis in, economic theory; they amount to econom*ism*[13] -- common beliefs which too often pass for proper economic logic. The critical point here is that markets are not "distorted," "uncompetitive," or "inefficient" simply because society makes a decision to protect future generations. A deliberate move toward point C through transferring rights to future generations, achieving the goals of a consensus with respect to the rights of future generations, is compatible with economic efficiency. A policy of maintaining and strengthening the share of renewables in the energy portfolios of electricity suppliers can be entirely consistent with an efficient electricity sector.

II. IF RENEWABLES POLICY IS DESIRED, WHAT ARE THE BEST MEANS?

With a proper understanding of the relationship between questions of economic efficiency and sustainability, policy makers may consider their objectives and develop mechanisms appropriate for meeting those objectives. As discussed above, the possible objectives are as follows:

1. If we are interested in economic efficiency, then policy makers should seek to correct market failures.

2. If we are interested in accelerating the development of technologies with substantial public benefits, then policy makers should seek to correct the market barriers facing these technologies.

3. If we are interested in sustainability and leaving future generations with an environment resembling what we have today, policy makers should set the market on such a course. Once agreement over these policy objectives is achieved, policy mechanisms can be considered, which should meet two additional objectives:

4. Mechanisms should be the most efficient means of meeting intended policy objectives.

5. Mechanisms should be "competitively neutral" by applying to all competitors equally.

Until discussion of restructuring rocked the regulatory landscape, integrated resource planning (IRP), including planned portfolio diversity, provided a mechanism to address market imperfections and, in some states, the sustainability issue. In states that firmly limit competition to the wholesale market, IRP practices can continue. But where retail competition is being considered, we need mechanisms to serve as a market-friendly proxy for IRP.

A single mechanism could potentially meet all of the above objectives, though the magnitude of the intervention may vary according to the objective. Three types of mechanisms relating directly to the electric industry have been discussed for promoting renewables: green pricing/marketing, programs funded through system benefits charges, and portfolio standards. For the reasons discussed next, we believe that portfolio standards are the most effective and efficient means of meeting the above objectives.

At the outset, it should be pointed out that general environmental policies can complement but are not a substitute for policies directly supporting renewables. Pollution taxes, emissions adders and clean air standards will not necessarily result in development of renewable resources,[14] and could result simply in greater reliance on gas. Environmental policies do not recognize the non- environmental benefits of renewables or the economic benefits of creating sustained markets for these technologies which can be expected to significantly lower costs in the long run.

A. Renewables Portfolio Standards

The "Renewables Portfolio Standard" (RPS) has been advocated by the American Wind Energy Association and the Union of Concerned Scientists and was adopted by the California Public Utilities Commission as part of its recent restructuring decision.[15] The distinctive feature of the RPS is that it would rely on competitive markets to achieve policy objectives, whether the objective is to correct market failures, overcome market barriers, or set the electricity sector on a sustainable path.

1. Description

Under the RPS,[16] every retail power supplier would be required to purchase renewable-energy credits (RECs) equivalent to some percentage of its total annual kWh energy sales. A REC would be created when a qualifying renewable- energy resource is used to generate one kWh of electricity. Retail suppliers could own renewable facilities and certify their own RECs, purchase RECs bundled with renewable power, or purchase RECs separately either directly from a renewables generator or from a REC broker. Retail suppliers and renewables developers would conduct business privately to bring the supplier into compliance with the standard most cost-effectively, making all decisions about how to comply - - whether to own, purchase power, or buy credits; which technologies to use; how to value an intermittent resource; what the contract terms should be; whether to use a central, niche or distributed application; and so forth.

Government involvement would be limited to certifying RECs (though this could be contracted out to the private sector) and monitoring compliance. Thus, there would be two separate reporting requirements: the REC certification process, which would apply to generators who wish to certify their renewables output; and the demonstration of ownership of sufficient RECs compared to electricity sales, which would apply to every retail seller.

Setting the Standard. The percentage requirement would be determined by the state legislature or utility commission after considering their policy objectives, market conditions, and the renewable resource supply curve -- in essence conducting a "one-time IRP" that could be reviewed periodically. The standard would be set at different levels, depending on the policy objectives. If the objective is to correct market failures and overcome market barriers, the standard might be set, for example, at one or two percent in a state that currently has few renewables, and rise slowly over time. If the objective were to achieve sustainability, the percentage might increase more rapidly over time.

Compliance. To ensure compliance and to create an automatic incentive to comply and self-monitor, suppliers would be charged a per REC fee for any REC shortfall for the year, allowing a three-month "true-up" period (also, excess generation in one year could be "banked" for use or sale during the next). The fee should plainly exceed the marginal compliance cost, e.g., three cents per REC shortfall. (Under the Clean Air Act amendments of 1990, which is analogous to the RPS, utilities are charged $2,000 per ton for excess sulfur dioxide emissions -- several times the compliance cost, and compliance has not been a problem.) The filing of misinformation would constitute fraud, subject to normal state penalties.

Cost Containment. A cost cap would not be necessary if the RPS is developed with a good understanding of the costs and availability of renewable resources in the region. Standards (such as efficiency standards for buildings and consumer products) are normally set at a level that is considered justified given expected costs; there are generally no conditions under which standards can be avoided. However, if it is politically necessary to guarantee that costs will not exceed some level, there are at least two possible ways of achieving cost containment. One way would be to specify a cents/REC price cap, wherein the standard could be reduced if the price of RECs on the market exceeds some level. Alternatively, the standard could be reduced if it is shown that retail suppliers cannot comply with the requirement without increasing their overall costs by some specified percentage. In either case, retail suppliers would need to demonstrate in administrative proceedings the lack of availability of renewable generation or credits at the prescribed cost containment level. Obvious drawbacks to creating such cost caps are that they could create loopholes, encourage resistance, and increase administrative involvement. A penalty that is too close to the marginal cost of renewables could undermine the REC market.

Emerging Renewables. To encourage renewable technologies that are not yet commercialized, a portion of R&D funds could be used to leverage these emerging renewable technologies into the RPS market. Alternatively, or in addition, a kWh produced from such technologies could count for more than one kWh credit.

2. Advantages

Because the RPS is linked directly with a state's policy objectives -- whether the objectives are to correct market failures, overcome market barriers, or achieve sustainability goals -- it ensures that those policy goals will be met by achieving the intended minimum level of renewables. The flexible, market-based implementation of the standard would ensure achievement of policy goals at least cost. Thus, the RPS meets the fourth objective of efficiency. And, because it would apply equally to all retail suppliers, the RPS is competitively neutral. Because the standard could apply to vertically integrated utilities (the only retail suppliers today) and expand to cover the retail suppliers of tomorrow (distribution utilities, direct access suppliers and power aggregators), it could be easily adapted as market structures evolve. This adaptability would also be facilitated by the ability to trade renewable energy credits.

Perhaps the most important reason to favor the RPS as a mechanism is that it would foster a productive dynamic as compared to other approaches. Under an RPS, suppliers would look to maximize the value of the required renewables in order to minimize the impact on their competitive position, and perhaps gain an advantage. Suppliers would seek out technological applications and combinations which have the greatest system value, and utilize their own financial resources to drive costs down. Thus, by "mainstreaming" renewables into the market, the resources and creativity of the entire electric industry are brought to bear on the cost and system integration of renewables. This dynamic is not fully achieved by programs that require renewables industries to fight their way into the market or rely on bureaucratic administration. In short, for all the reasons that the monopoly utility industry is giving way to competition, so should we rely on competitive markets to implement renewables policy.

Finally, the standard would be a floor, not a ceiling, so "green" marketers could still sell additional renewable energy to consumers who wish to exceed the standard.

3. Meeting Other Policy Goals Through Portfolio Standards

For the same reasons that the portfolio standard concept is attractive for meeting renewable energy policy objectives, standards might also be attractive for meeting other policy objectives. To provide for universal service, for example, all retail suppliers could be required to serve a fraction of the rural market proportionate to their total market share. Similarly, it might be feasible to require retail providers to serve a proportionate fraction of low- income customers with a prescribed service package. Suppliers could be allowed to trade these obligations among each other. It is also possible to conceive of ways that DSM standards could be applied to all retail suppliers. However, methods would have to avoid the obvious conflict of interest inherent in having sellers of electricity seeking to conserve electricity. In addition, economies of scope and the difficulty of monitoring program effectiveness for multiple providers could justify supporting these programs through central programs funded by system-benefits charges. While we have not given these subjects as much thought as we have renewables, it is worth considering how market standards might be applied to them.

B. Green Marketing

It is frequently argued in the restructuring debates that once consumers have the ability to choose from among many electric service providers, including those offering electricity from renewables, there will be no need for policies to promote renewables in the electric marketplace, because consumers can "vote" with their dollars. Providing customers with a choice of electric service, whether as an option provided by the utility or in a retail access world, is not undesirable (assuming one accepts the desirability of retail competition). Green pricing alone, however, is insufficient for meeting environmental and sustainability objectives.

While retail competition would allow companies to market renewables directly to consumers, it would not achieve any of the three policy objectives stated earlier. Green marketing programs administered by utilities (perhaps distribution-only utilities) could help overcome market barriers, particularly the transactions costs associated with marketing and perhaps facilitating financing. If successful, these programs could create a market that is large enough to sustain at least some segments of the renewable resource industries. But this is not assured. To date, such utility-sponsored programs have not been very successful, supporting very small installations that would not sustain existing renewable energy producers, even if repeated by many utilities. Several green marketing programs have been abandoned altogether. If program administration costs are charged to all consumers, green marketing would be competitively neutral, though the cost of administration imposes an efficiency penalty as compared to a market standard approach.[17]

No forms of green marketing, whether simple retail competition or utility-administered programs, will adequately correct market failures or set the electric industry on a sustainable path. To argue that providing individual customer choice is enough to satisfy public objectives is to assume that individual choice is the same as societal choice. The very nature of market failure assures us that this is not the case.

As a real-world example, consider Salem Electric in Oregon, whose customers were recently asked whether they would be willing to pay more for renewable power, and, if so, which of two methods they would prefer.[18] The first method would offer each customer the opportunity to raise his or her own rates for the amount of green power desired. The second would raise everyone's rates "somewhere in the 4- 8 percent" range to make Salem Electric 20-40 percent green. Though this was not a scientific survey, nearly 100 of the utility's 14,000 customers responded -- an unprecedented response rate on any issue for this utility.

Over 75 percent of the responses supported paying more for renewables. Of those who expressed a preference for a particular method, only two preferred the individual choice approach while 28 supported the collective decision. Salem Director Steve Weiss said, "It convinced the board that our customers want us to make a collective choice to green our system rather than leave it to individual choice where the outcome would be uncertain."[19] If other regulators were to engage in public discussions of "greening" the resource base, no doubt similar decisions would result.

If the "individual choice is enough" argument is accepted, one would also have to accept that repealing the Clean Air Act is justified, because customers have a choice between dirty and cleaner sources of power generation. Similarly, green marketing advocates often point to the availability of organic produce markets as an indication of the power of consumer demand, but the existence of these markets does not justify repealing minimum state and federal standards that govern pesticide residuals on foods.

In the same vein, we should develop electric industry policy that, at a minimum, corrects for market failures, and, if we so choose, offsets market barriers and begins to put the electric industry on a sustainable course. Individual consumers with strong preferences can then opt for greater reliance on renewables through green pricing or green marketing programs.

C. System Benefits Charges

The most common proposal for maintaining so-called "stranded benefits" (which include low-income programs, research and development, energy efficiency and renewables) in a restructured industry is the "non-bypassable system benefits charge" (SBC). This is a competitively neutral method of creating a pool of funds to support various policy ends. While this mechanism may be appropriate for some of these ends, it is not optimal for supporting commercial renewable energy projects.

SBC-funded programs are appropriate if centrally collecting and spending funds is the most efficient way to accomplish the relevant policy objective. To support R&D with public goods benefits,[20] for example, it makes sense to collect funds so they can be concentrated at a few research institutions to gain economies of scale and scope rather than duplicating efforts across the entire industry. SBC-funded programs for supporting commercial renewable projects can be aimed at a level sufficient to correct market failures and overcome market barriers. And some see SBC-funded programs as advantageous because their costs can be known precisely, as compared to setting a standard without a cost cap. However, market standards would be a more efficient mechanism for achieving public policy objectives because SBC programs require public administration.

Publicly administered programs are not likely to foster the kind of "ingenuity dynamic" that is created with a market standard, and they risk pitfalls of various sorts. The kinds of programs that have been envisioned for dispersing funds involve either contract administration by utilities or the auctioning of per-kWh production subsidies. It is not hard to imagine the potential pitfalls of such programs, such as conflicts of interest if the funds are administered by vertically integrated utilities or paying out "subsidies" to projects that are already cost-effective and may have been undertaken anyway (after all, some renewables are cost-effective now and many more are cost- effective when a broader, long-term view is taken). These are the kinds of problems that restructuring is intended to move us away from by relying on markets wherever possible.

At the heart of restructuring is the notion that we should rely on competitive markets to deliver what they are capable of delivering because, once imperfections are corrected, markets are the most efficient way of achieving the ends we desire. Therefore, if we want markets to deliver renewables (and, by accepting the need for an SBC to support commercial renewable energy projects, one accepts this proposition), then markets need only be instructed to do so, as with a market standard.

The SBC clearly is not aimed at creating a sustainable energy future, because it would make no sense at all to accomplish that goal as an aside to the market, rather than directly through the market. This is most clear in California, where the SBC being discussed by some is envisioned at a level of $100 million per year to pay for the "above-market" costs of new renewables projects. If successfully administered, this would fund an estimated 440 megawatts over five years. Such an SBC policy would not prevent significant erosion of the 3,600 MW of existing renewables capacity (geothermal, biomass, small hydro, wind, and solar), which supplies about 10 percent of California's total electric consumption. The state's substantial existing resource diversity could disappear and it wouldn't matter under this policy, because the policy is aimed at providing funds to new renewable energy projects and not at achieving diversity.

III. Conclusion

The debate over social and environmental policy in restructured electricity markets has suffered from unclear policy objectives and incorrect economic reasoning. A common misconception is that efficiency must be sacrificed for other objectives to be attained. The correct use of economics, however, addresses which policies will structure the electricity market so that the social goals of reliability, environmental quality and equity are attained most efficiently. The continued public concern with the sustainability of development in general and energy use in particular indicates that a sustainable energy system is also an important social objective. Energy and environmental economists too often have assumed that sustainability is simply a matter of making the market work more efficiently. We have shown that sustainability is a distributional decision that cannot be made using efficiency criteria; it must be a political choice.

The existence of market imperfections clearly justifies renewables policy. Beyond that, we recognize that there is debate over whether the electric industry should be put on a sustainable course (despite international scientific consensus about serious global warming risks). We should have that debate, and invoke the "discipline of democracy," by informing and involving the public and soliciting their opinions directly. Educating the public could be done through polling, as Salem Electric did, through an approach more akin to a grand jury process, as was recently used successfully by TU Electric,[21] through legislative hearings directed at the question of sustainable energy policy, or by direct vote.

As with any environmental policy, the public and its policy makers will have to weigh the extent to which they put themselves at a short-term competitive disadvantage (real or perceived) with states (and other nations) that choose to sacrifice long-term economic and environmental health for short-term economic gain. To promote regional consistency, states can work with their neighbors to develop regional policies, such as a regional RPS that would allow credits to be traded regionally. Working with Congress to develop a national RPS with a national trading system is another option.

In this country, markets operate within a democracy. Good economics works within what society deems to be good social and environmental policy. Economism is bad economics used against democracy. All available evidence indicates that most people want environmental safeguards and support renewables. The only question is whether and how public preferences will figure in electric industry policy as it evolves. The renewables portfolio standard is simply a means of reflecting public values within a more competitive market, relying on the market to efficiently deliver the goods people want. Yes, it "picks winners," but the "winner" is the broad category of resources that the public wants to promote because they know it facilitates their goals. Within the renewables category, the specific technologies and companies that win will do so because their merits have been sorted out in the merciless market.

Endnotes

1. Barbara Farhar, Trends in Public Perceptions and Preferences on Energy and Environmental Policy (Nat'l Renewable Energy Laboratory, NREL/TP-461-4857, Feb. 1993).

2. The distributional choice can be informed by economic analysis, however, in the sense that the public can make a better decision if it knows the trade-off between current and future well-being.

3. Montana PSC, "Notice of Issues and Amended Schedule," Question #I.7, Docket No. D95.7.96. October 6, 1995.

4. Richard B. Howarth and Richard B. Norgaard, "Intergenerational Choices Under Global Environmental Change", Handbook of Environmental Economics (Daniel W. Bromley (ed), Oxford, 1995); see also Howarth and Norgaard, "Environmental Valuation Under Sustainable Development", 82 AM. ECON. REV 473-77 (1992).

5. Kennedy P. Maize, "`It's the Customer, Stupid' Not 'The Stupid Customer,'" ELEC. J., June 1995, at 85 (guest editorial).

6. The long distance competitors spend about $800 million in advertising annually. The New York Times, May 19, 1994, at C4 (cited in "Affected with the Public Interest", NARUC, Sept. 1994).

7. One could argue that the major competitors will acquire renewables in order to gain a marketing edge, but whether renewables would be used as window dressing or to significantly diversify the resource base is an open question.

8. U.S. Congress, Office of Technology Assessment, "Studies of the Environmental Costs of Electricity", OTA-ETI-134 Washington, D.C. U.S. Government Printing Office, September 1994.

9. Economic reasoning can help inform the political process with respect to the likely increases in well-being possible for future generations given different reductions in well- being of present generations through, for example, avoiding climate change, but economic reasoning cannot determine whether point B or C is "best."

10. For a review of the history and properties of the social welfare function, see Paul A. Samuelson, Foundations of Economic Analysis, 219-28 (Harvard U. Press, Cambridge, 1947).

11. Supra, note 1.

12. ORS 469.010.

13. Richard B. Norgaard and Richard B. Howarth, "Economism, Economic Logic, and the Assessment of Renewable Energy Technologies", ECOLOGICAL ECON. (forthcoming). (Paper commissioned in 1993 by the Office of Technology Assessment project on the Assessment of Renewable Energy Technologies.)

14. Indeed, state efforts to incorporate environmental externalities as "adders" have not had much impact on resource selection. See ENERGY INFORMATION ADMINISTRATION, ELECTRICITY GENERATION AND ENVIRONMENTAL EXTERNALITIES: CASE STUDIES (DOE/EIA-0598, Sept. 1995); and GENERAL ACCOUNTING OFFICE, ELECTRICITY SUPPLY: CONSIDERATION OF ENVIRONMENTAL COSTS IN SELECTING FUEL SOURCES (GAO/RCED-95-187, May 1995).

15. See Calif. PUC, Order Instituting Rulemaking on the Commission's Proposed Policies Governing Restructuring California's Electric Services Industry and Reforming Regulation, D.95-12-063 (Dec. 20, 1995) as modified by D.96-01-009, and "Comments of the American Wind Energy Association and the Union of Concerned Scientists on the Alternative Proposals Issued May 24, 1995, to Restructure California's Electric Services Industry and Reform Regulation," Docket No. 94-04-031, July 24, 1995.

16. Portfolio standards implemented by states would not be in conflict with the Commerce Clause or the Federal Power Act. See Scott Hempling and Nancy Rader, State Implementation of Renewables Portfolio Standards: A Review of Federal Law Issues, prepared for the American Wind Energy Association under contract to the U.S. Department of Energy (Jan 1996); and Richard A. Rosen et al., PROMOTING ENVIRONMENTAL QUALITY IN A RESTRUCTURED ELECTRIC INDUSTRY ch. 6 (Prepared for the National Association of Regulatory Utility Commissioners by Tellus Inst., Dec. 15, 1995).

17. Developing green marketing programs and setting a portfolio standard would both entail a public process. However, green marketing programs would entail ongoing program administration and funding decisions, which are avoided with a standard.

18. Compilation of responses received from Salem Electric customers regarding their interest in renewable energy. (Provided by Robert J. Speckman, Assistant General Manager, Salem Electric, June/July 1995).

19. "Salem, Ore., Residents to Get What They Want -- Renewables", Wind Energy Weekly, Nov. 13, 1995.

20. For a discussion of the need for public goods R&D, see CALIF. ENERGY COMM'N, RESEARCH, DEVELOPMENT AND DEMONSTRATION AND ELECTRIC INDUSTRY RESTRUCTURING (June 1995).

21. TU ELECTRIC, TU E PLAN 2004: AN ENERGY GUIDE TO THE FUTURE. (TU's 1995 IRP plan was created by 30 representatives of its customer base, including residential, commercial and industrial customers, assisted by TU's technical staff. The group used quantitative data and qualitative information to guide the judgments it ultimately made. It decided on a portfolio of resources that included 340 MW of renewable resources, or seven percent of total new resources to be acquired in the next decade.)

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