Here are some thoughts on the American Recovery and Reinvestment Act recently unveiled by House leaders — specifically, the appropriation of Section 451 (aka “Subtitle E”) from the 2007 Energy Bill.

For obvious reasons, we’ve been following this bill very closely, which not only provides $10 per MWh to waste heat recovery and high-efficiency cogeneration projects, but it also provides a nice suite of carrots to induce the states to reform their paleolithic electricity regulatory laws. Often these laws have long been perhaps the biggest barrier to reducing the carbon footprint of U.S. electricity generation and distribution.

For less obvious reasons, it’s hard to get programs like this through the Congress. This is the result of some peculiarities of the way the federal government makes decisions to spend money:

  1. Tax bills require one vote to enact (OK, technically three, since they have to be approved by both houses and then signed by the President, but it is a single vote on a single decision throughout). All other fiscal bills require two votes: the first authorizes the funding, and the second appropriates the money through the budget process. Since no vote is certain, this makes it much easier for regulators to get things done by tinkering with tax policy than through any other measure. In no small part, this is why the tax code is so full of complexity, loopholes, and social-engineering run amok. But I digress.
  2. Grist thanks its sponsors. Become one.

  3. Any appropriation process must be “scored.” This is the process by which the Congressional Budget Office estimates the cost of the legislation to the Treasury for the purpose of figuring out whether we can afford it. That’s quite reasonable, but the nature of the process is such that it tends to ignore most of the upside because it does not readily differentiate between good and bad investments. (It is as if you made a decision to buy a stock based on the price per share without any consideration of whether it was likely to rise or sink in the future.) This becomes especially problematic when the economy sours, as the stimulative effects of investments are not readily quantified or evaluated precisely at the time when they are most needed.

Frustrating as this may be, the good news is that the limitations are well-understood by those inside the Beltway. Setting aside what the scoring rules say, here is what Section 451 will actually do for the U.S. economy … with lessons broadly applicable to investments in all flavors of enhanced resource efficiency.

Section 451 will stimulate private-sector lending.

Grist thanks its sponsors. Become one.

In the current liquidity-constrained environment, manufacturers and clean-energy developers are finding it difficult, in some cases impossible, to secure debt against their investments, driven in no small part by lenders’ concerns about borrowers’ long-term solvency. This grant effectively provides $166 million per year of revenue from a triple-A credit offtaker (the federal government). Banks like that, which means that the individual investing in that power plant immediately can borrow more money from his bank than he otherwise would, even in the current environment. Based on current debt markets, this program will pull something on the order of $200-450 million of debt into the economy. Or, if you prefer, $0.40-0.90 of private sector stimulus for every $1.00 of federal stimulus. (Note that this cash will support hard assets generating clean energy, which are much healthier places for the U.S. to be investing its cash than dodgy financial instruments!)

Section 451 will install additional (and cleaner) U.S. electricity generation.

We are facing a train-wreck in the U.S. power system, caused by the fact that while electricity consumption has grown inexorably at 1-2 percent per year, we haven’t invested in the baseload generation needed to keep up. Outside of the Luddite community, setting aside the environmental consequences of certain types of generation, this is a really bad situation, which can lead to blackouts and economic crises if not addressed. Along came the economic crisis, which effectively accelerated the unraveling process by limiting people’s ability to obtain the capital necessary to build new generation.

By paying an incentive for power generation that is at a minimum twice as fuel efficient as the U.S. grid, Section 451 not only provides an added inducement for new generation, but also provides an inducement for clean generation. From an economic perspective, it only gets spent if the generation gets built, which creates some rather interesting economics:

  • $500 million, spread over three years and paid out in $10 per MWh units, will bring onstream an additional 16.7 million MWh per year of clean generation. This implies an additional construction of 2,000-3,000 new MW of generation capacity.
  • On average, these projects cost about $2,500 per kW to install. This means that our $500-million federal investment will bring about $6.25 billion of private sector investment in the U.S. economy. That’s a hell of a leverage ratio!
  • One of the requirements of Section 451 is that these projects be economically viable, so we do not simply throw federal money after boondoggles. This is accomplished by requiring that any eligible project demonstrate a simple payback of no more than five years in order to qualify. In turn, it means that this $6.25 billion worth of private sector capital is generating at least $1.25 billion in annual cash for U.S. energy consumers.
  • Here’s the neat part: Those $1.25 billion in annual cash flows are ultimately taxable. Clearly, not every beneficiary will be a taxpayer. Equally clearly, there will be tax offsets in the early years from depreciation and interest payments. But these investments are long-lasting, typically operating for 20 years or more, which means that the federal government will get its money back many, many times over from its initial $500 million investment.

Section 451 will create targeted green and gray jobs.

This bill provides highly targeted funding directly to those organizations who are investing in clean energy resources. Not only does it facilitate the installation of green power sources, but it also (a) provides employment to the manufacturers and installers of those technologies, and (b) provides additional income to those organizations who install these technologies from the innate savings (the five-year payback) and from the grant itself.

Unlike tax credits which on average only provide about 70 percent of the federal payment to the asset owner (with the balance going to the transaction fees common to tax equity markets), this revenue-driven grant provides 100 percent of the federal investment directly to those who are investing in clean technology.

The short summary: Section 451 is really good.

The takeaway lesson: so is any investment in U.S. energy efficiency, despite what the fiscal scoring process may say!

The bill still needs to be passed and signed into law, of course. But we’re close to something really good: This bill represents the beginnings of an economic policy that stimulates by reforming our energy sector.