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Globalizing the Energy Revolution

How to Really Win the Clean-Energy Race

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The world faces a daunting array of energy challenges. Oil remains indispensable to the global economy, but it is increasingly produced in places that present big commercial, environmental, and geopolitical risks; greenhouse gases continue to accumulate in the atmosphere; and the odds that the world will face catastrophic climate change are increasing. These problems will only worsen as global demand for energy rises.

Environmental advocates and security hawks have been demanding for decades that governments solve these problems by mandating or incentivizing much greater use of the many alternative energy sources that already exist. The political reality, however, is that none of this will happen at the necessary scale and pace unless deploying clean energy becomes less financially risky and less expensive than it currently is. This is particularly true in the developing world.

A massive drive to develop cheaper clean-energy solutions is necessary. Indeed, many claim that it has already begun -- just not in the United States. They warn that the United States is losing a generation-defining clean-energy race to China and the other big emerging economies.

They are right that the United States is dangerously neglecting clean-energy innovation. But an energy agenda built on fears of a clean-energy race could quickly backfire. Technology advances most rapidly when researchers, firms, and governments build on one another's successes. When clean-energy investment is seen as a zero-sum game aimed primarily at boosting national competitiveness, however, states often erect barriers. They pursue trade and industrial policies that deter foreigners from participating in the clean-energy sectors of their economies, rather than adopting approaches that accelerate cross-border cooperation. This slows down the very innovation that they are trying to promote at home and simultaneously stifles innovation abroad.

To be sure, clean-energy innovation alone will not deliver the energy transformation the world needs. It can drive down the cost of clean energy and narrow the price gap between clean and dirty sources, but it is unlikely to make clean energy consistently cheaper than fossil fuels anytime soon. Government policies will still need to tip the balance, through regulations and incentives that promote the adoption of alternatives to fossil fuels.

CLEAN BUT COSTLY

Clean energy is almost always more expensive than energy from fossil fuels, and often by a big margin. A recent International Energy Agency (IEA) study found that in the United States, electricity from new nuclear power plants is 15-30 percent more expensive than electricity from new coal-fired plants, offshore wind power is more than double the price of coal, and solar power costs about five times as much. An even more pronounced pattern prevails in China, where nuclear energy costs 15-70 percent more than coal, onshore wind costs between two and four times as much as coal, and solar power is more than five times the price.

Clean energy for transportation fares just as badly in terms of cost. In most countries, ethanol and biodiesel are considerably more expensive than conventional fuels. Cars that run on electricity, meanwhile, suffer from high battery costs that can easily cancel out those cars' lower fuel bills. Compounding the problem, the cost of clean energy is often highly uncertain: the cost of nuclear power, for example, depends strongly on the availability of financing on reasonable terms.

Nor is cost the only problem that demands technological progress. Nuclear power, for example, remains vulnerable to nuclear proliferation and uncertainties over the safety of waste storage. The sun and wind produce electricity intermittently, and battery and grid technologies are not yet able to smooth over the gaps in their delivery of power. No one has even tried to build and operate a commercial coal plant that captures and stores its greenhouse gas emissions.

Yet the world is woefully underspending on clean-energy innovation. The IEA recently presented a scenario in which global oil consumption would be reduced by a quarter and global greenhouse gas emissions would be cut in half by midcentury. To reach this goal, the IEA estimated that the world would need to spend an average of $50-$100 billion each year to support the research, development, and demonstration of clean-energy technologies. Current public spending is a mere $10 billion annually. That number is set to plunge as global stimulus spending, much of which was directed to energy, slows and then stops. Private financing of clean energy is harder to measure but probably contributes only $10 billion more per year. The shortfall is staggering.

Some have found hope in reports that the major emerging economies -- China, Brazil, and India -- are making big investments in clean energy. Yet their innovation efforts, although important, are not as impressive as they may seem.

China has invested in a wide range of clean-energy technologies, pumping unprecedented amounts of money into renewable energy and in 2009 leading the world in financing wind technology. Several of its companies are making big investments in electric vehicles. Three Chinese power plants currently under construction will aim to demonstrate carbon capture and sequestration on a commercial scale. China can also build highly efficient conventional coal plants at costs far lower than in the West.

Yet China's innovation in the clean-energy field is following the same pattern as in other sectors of its economy: the implementation of incremental changes in manufacturing processes that are usually developed abroad, rather than the achievement of fundamental homegrown advances. In the area of photovoltaic panels (which convert sunlight directly into electricity), for example, China has lowered the cost of finished modules and panels but has not made big advances in more technologically sophisticated areas, such as silicon wafer manufacturing. Such lower prices help already mature technologies spread more quickly but often fail to deliver transformative advances. The value of Chinese investments in research and development (R & D), meanwhile, is limited by an economic system that has trouble moving ideas from the laboratory to the marketplace.

Brazil has narrowly tailored its clean-energy innovation to biofuels. Commercial investment in innovation has, predictably, flowed mainly into improvements of existing technology, which in Brazil means first-generation sugar-cane ethanol for cars. Yet on the most important international frontier for biofuels -- so-called second-generation cellulosic ethanol, which uses waste or crops grown on land that cannot be used to produce food -- Brazil is relatively quiet. Its Center for Sugarcane Technology, a cooperative consisting of many of the country's sugar-cane producers, has built a small pilot facility; Embrapa, the government organization that supports agricultural research, is scheduled to complete a similar center this year; and the newly founded Brazilian Bioethanol Science and Technology Laboratory is planning a third for next year. The United States, in contrast, is home to more than three dozen commercial or pilot cellulosic ethanol plants. Brazil has also spent money developing indigenous nuclear technology. The result has been not an internationally competitive industry but delays in getting Brazil's domestic nuclear industry up to speed.

India is even further behind. It has not, to date, made major investments in clean-energy innovation. Its science and technology spending in general has also lagged. New Delhi is, however, trying to turn a corner. Its National Solar Mission, announced in 2009, aims to deploy 20 gigawatts of solar energy by 2022 and to back that up with government support for everything from basic innovation to large-scale deployment. Earlier this year, the Indian government upped the ante by proposing a fee on sales of coal-fired power; the proceeds would be channeled into funding for clean-energy R & D. In the near term, however, India is not likely to offer major breakthroughs, but it will create increasingly cost-effective business models for supplying energy in developing economies.

REENERGIZING WASHINGTON

Major scientific advances are still most likely to occur in the developed world, alongside much of the work necessary to commercialize clean-energy technologies and the capital required to support those efforts. Chatham House recently mined patent data for six major clean-energy fields: no emerging-economy company ranked in the top 20 firms in any of the fields. U.S. companies, in contrast, consistently helped make the United States one of the top three clean-energy patent holders, alongside Japan and Europe.

Yet the United States cannot rest on its past successes. The scale and pace of U.S. innovation in clean-energy technology today are not commensurate with the challenges posed by climate change and by the growing demand for oil. According to the American Energy Innovation Council, the U.S. energy industry and the U.S. government together invest a mere 0.3 percent of total private sales in public and private R & D; this contrasts with 18.7 percent in the pharmaceutical industry and 11.5 percent in aerospace and defense. Bringing new clean-energy products to market often takes decades, in contrast to other high-technology sectors, where it takes years. The result is painfully slow progress.

This will not change without government intervention. The question is what kind of intervention makes the most sense. The United States could, in theory, promote clean-energy innovation strictly through measures such as cap-and-trade or renewable-energy mandates that directly drive clean-energy deployment. As technologies were implemented, firms would learn through experience and make incremental innovations. In addition, once firms and inventors anticipated stronger regulations and incentives in the future, they would invest in more ambitious long-term efforts to develop next-generation technologies.

But there are important limits to this dynamic. Companies are likely to underspend on innovation since they cannot always reap the full rewards of their investments. A company that discovers new principles that allow it to make far more effective batteries, for example, may see some of its ideas replicated by others without compensation. A firm that experiments with different schemes for financing rooftop solar panels before finding one that works will probably not be able to stop its competitors from copying it and competing with it. Many of these valuable and necessary innovative activities will thus never happen in the first place, even if the right long-term market incentives are in place.

Politics can also prevent those long-term incentives from being created. If people cannot be convinced that radically improved cars will be available by 2030, their elected leaders will not be willing to mandate big cuts in oil consumption by then; if politicians cannot be persuaded that eliminating greenhouse gas emissions from power plants is possible by midcentury, they will not condone cap-and-trade systems that purport to do just that. Yet this creates a vicious cycle. Firms and inventors will not pump enough money into game-changing technology without the right long-term goals and strong policy support. Wariness about achieving ambitious long-term goals can quickly become a self-fulfilling prophecy.

A U.S. strategy to break this cycle requires two basic elements. First, the U.S. government must create incentives that promote the widespread adoption of efficient energy technologies and alternatives to fossil fuels. These incentives could take the form of pricing instruments (such as gasoline taxes or cap-and-trade systems), focused financial incentives (such as tax credits for electric vehicles and grants to wind-farm developers), or direct regulation (such as fuel-economy standards for cars or pollution limits for power plants). Such policies would not only increase the use of clean-energy technologies but also encourage innovation, since inventors would have much larger markets for their technologies. In many cases, these policies would also encourage domestic manufacturing, since for many clean-energy technologies (such as advanced wind turbines), there are significant commercial advantages to locating manufacturing near deployment.

In addition to creating market incentives, the U.S. government should also support innovation directly by helping fund clean-energy research, development, and demonstration projects. It should also adopt policies that encourage investors to finance companies that operate in the "valley of death" between invention and commercial viability. Washington could, for example, support R & D in U.S. government laboratories and in private companies, pay for first-of-a-kind advanced biofuels and clean-coal facilities, and reduce risk for financiers who back early stage clean-energy commercialization. The United States should also encourage other countries to take similar steps.

THE GLOBALIZATION OF INNOVATION

Even with extremely ambitious programs, no one country will produce the majority of the clean-energy innovation that the world needs. Different countries' efforts need to be tightly connected so that they can build on one another. U.S. utilities, for example, will need to utilize Chinese advances in clean-coal implementation; Indian solar manufacturers will need to benefit from basic research done in the United States in order to meet their government's targets; and Brazilian biofuel engineers will need to be able to tweak the inventions of Danish enzyme companies to make them work with local sugar cane.

This is already happening in certain places. California-based CODA Automotive, for example, was able to move ahead quickly with its plans to field an electric vehicle thanks to a partnership with the Chinese battery maker Lishen Power Battery, creating jobs in both the United States and China and improving the potential for more affordable electric cars. Amyris, another California start-up, is developing synthetic biofuels in Brazil through partnerships with local sugar-cane producers, allowing it to strengthen its technology before applying it to more difficult challenges in the United States. This sort of cross-border fertilization needs to happen faster and on a much larger scale.

Yet many governments may instinctively move in the opposite direction, particularly if they worry that they are engaged in a clean-energy race with other nations. Aggressive government support for innovation is typically sold as support for domestic workers and companies. That can quickly lead to "green protectionism," with politicians coming under pressure to wall off domestic markets or to discriminate against foreign firms. Governments also promote their own local technology standards in an effort to ensure that their domestic companies can control markets and collect royalties. This sort of Balkanization of clean-energy markets blocks the free flow of technology.

The most heated debate over cross-border flows of clean technology has focused on intellectual property rights. When they think about intellectual property rights, many policymakers in emerging economies look to HIV/AIDS drugs as their model. In the early years of the HIV/AIDS epidemic, expensive intellectual property associated with the most effective drugs prevented their rapid diffusion to patients in Africa and elsewhere. Eventually, under considerable political pressure, Western pharmaceutical companies granted significant concessions on intellectual property rights, leading to much wider availability of the drugs.

With this experience in mind, policymakers from the emerging economies have used global climate change negotiations to push the developed countries to relax their patent rules. The developed countries, in turn, have responded by arguing that poor intellectual property protection is actually a major reason that clean technology does not spread more quickly. (Their lesson from the HIV/AIDS experience is that even small concessions on intellectual property rights lead to much bigger demands.) They have therefore advocated strengthening that protection. But both sides overstate their claims.

Unlike in the case of HIV/AIDS drugs, the patents that protect intellectual property are only a small part of the cost of essentially all clean-energy technologies. Relaxing them would not do much to change total costs in most cases. Even in the few instances in which companies strategically withhold licenses in order to deny market entry to potential competitors, forcing them to give up control over those patents would not speed up technology diffusion. Most advanced clean-energy patents are relatively useless without the accompanying trade secrets, know-how, and expertise, and thus active collaboration between the patent holder and the firm wishing to acquire the patent is necessary. That cooperation is unlikely to occur if governments strip companies of their patent rights.

Nor would fixing weaknesses in developing-world intellectual property protection be a panacea for clean-energy companies. Although they usually leave their most advanced technologies at home, foreign companies are already active in the clean technology sector in Brazil, China, and India, despite problems with intellectual property rights in all three. Better protections for intellectual property could accelerate and expand the spread of technology, and should be encouraged, but there is no reason to believe that intellectual property rights are more important to the flow of technology than other factors.

Open investment and trade policies are critical complements to improved intellectual property rights. The power of open investment is most clearly on view in Brazil and India. Brazil, for example, allows unlimited foreign investment in biofuels, evidenced most recently by a $12 billion joint venture between Shell and Cosan, one of Brazil's biggest ethanol producers. The deal will give Cosan access to two cutting-edge U.S. and Canadian biotechnology firms with investments in second-generation ethanol, while offering Shell new markets. India, meanwhile, is open to foreign investment in renewable-energy projects, granting automatic approval to joint ventures with up to 74 percent foreign equity participation.

Brazil and India have uneven but relatively open approaches to trade. The wind sector provides a useful illustration: Indian tariff structures and quality-control systems tend to promote the domestic assembly of wind turbines but still allow components to be sourced abroad. Brazil, meanwhile, has traditionally used high tariffs and nontariff barriers to encourage independence from imports across its economy. It tried this approach for several years in its wind sector but failed. Brazil's government opted last year for a more nuanced mix: it barred imports of small wind turbines, removed all restrictions on imports of bigger, more advanced ones, and strengthened subsidies for the domestic production of turbines and their component parts.

China, in contrast, has taken a much more aggressive approach to trade. For the last two decades, foreign companies have faced pressure to grant critical intellectual property rights to Chinese firms as a condition of market access. Until recently, for example, wind turbines produced in China had to have at least 70 percent domestic content, and Chinese-owned companies were given preferences in wind-power contracts. And since 2006, under the rubric of "indigenous innovation," Beijing has adopted a range of policies designed to raise the technological capabilities of Chinese firms, including the use of government contracts and the development of competing technology standards, which favor Chinese intellectual property. China also continues to provide inexpensive capital to domestic firms, helping them outperform U.S. and other foreign companies. China's currency policies add to the advantage that its firms find in international markets, by making Chinese exports cheaper.

The result of all this forced technology transfer has been an unprecedented backlash from foreign companies that do business in China. The risk to China is that these efforts could backfire; foreign firms might shy away from investing in China or selling goods there, potentially slowing the flow of foreign clean-energy technology and thus hampering China's ability to quickly replace fossil fuels with clean energy on a large scale. A hostile environment also makes it politically difficult for Washington to support policies that actively accelerate the spread of clean-energy technology to China.

The United States should push back strongly against Chinese protections while encouraging Brazil and India to open up their markets even further. This means protesting promptly and loudly if and when China first announces a new protectionist policy; there is often a significant lag between Beijing's proclamation of a policy and its implementation, offering a window of time during which the United States can try to alter Chinese policy. In addition, Chinese protectionism typically affects clean-technology innovators in Europe and Japan. The United States should work closely with other concerned parties to pressure China to reverse or moderate its policies.

The United States should be careful, however, not to kill off policies that support clean energy in the process of promoting openness. Sometimes, rules requiring domestic content may be a necessary price for getting clean-energy schemes off the ground. If the United States were to succeed in persuading developing nations to end such requirements, it might gut domestic political support there for clean-energy programs in the process. That would be a Pyrrhic victory, on environmental, technological, and commercial grounds.

The United States should also set a good example with its own domestic markets. Several senators have called for barriers to the use of imports and for foreign investment in clean-energy projects supported by the economic stimulus package. Their stated goal is to maximize the returns to U.S. firms and workers. Yet such policies would make it more difficult for the United States to build on overseas innovation -- and for foreign firms to access technology developed in the United States. In addition, by cutting off U.S. firms from cheap clean-energy solutions developed overseas, these policies could raise U.S. energy prices, thus damaging competitiveness and employment throughout the economy.

JUMP-STARTING THE GREEN REVOLUTION

An open innovation system is essential to speeding up the development and diffusion of clean-energy technologies. But even in an open system, energy technology tends to spread slowly, making openness alone insufficient. Moreover, although U.S. firms may applaud a push to strengthen intellectual property rights and increase trade and investment, many developing countries will resist, fearing that it will cost them their own positions in the clean-energy race. The U.S. government needs to lend a hand, actively helping spread advanced energy technology, something that developing countries have demanded for years.

Shortfalls in the chain that spreads energy technology around the world exist from the R & D stage, to demonstration and commercialization, to the eventual diffusion of mature technologies. Even in the most advanced developing countries, scientists often lack access to resources comparable to those in the United States. Brazilians working on R & D in sugar-cane biotechnology, for example, report that even limited access to U.S. scientific facilities and personnel could yield big returns. Moreover, since early stage R & D is disproportionately conducted by governments or on government contracts, relying on market mechanisms such as trade and investment to create cross-border R & D collaborations will invariably fail. Instead, governments will often need to arrange collaborative projects by providing targeted financial support and linking government laboratories. The United States has taken some initial steps toward strengthening joint R & D programs with Brazil, China, and India through efforts such as the U.S.-China Clean Energy Research Center, launched in late 2009, but much more could be done in all three countries if more government money were available.

Another important target is small and medium-sized enterprises, which play critical roles in experimenting with and commercializing new technologies but have limited capabilities in much of the developing world. In India, for example, large, vertically integrated conglomerates dominate the clean-energy industry, and in China, big state-owned enterprises are the major players. Venture capital and private equity, on which smaller companies normally rely to support innovative activities, are also relatively weak in all three countries. U.S. policy cannot fix all these gaps, but it can help.

First, the United States could partner with the Brazilian, Chinese, and Indian governments to provide intellectual property insurance for initiatives involving small or medium-sized clean-technology enterprises. Intellectual property rights are often critical to the survival of small U.S. technology firms, and worries about the protection of intellectual property can deter them from partnering with foreign firms. Smaller companies in the big emerging economies, meanwhile, face greater barriers than large companies to establishing trust with U.S. companies; intellectual property insurance could help break down those barriers. The United States should only pursue such programs, however, if its counterparts have not adopted a hostile approach to intellectual property rights, as China has done in recent years.

Second, the United States could strengthen its efforts to help familiarize U.S. companies and researchers with potential partners in the big emerging economies. The U.S. Department of Commerce has already taken some first steps, creating guidebooks on doing clean-energy business in China and India and hosting several popular sales trips to Asia. These efforts could be extended -- in number, geographic scope, and the participation of early stage companies -- leading to more profitable connections between U.S. and developing-country firms.

Third, the United States could help create permanent hubs in developing countries where researchers and firms could exchange ideas and identify joint opportunities. A similar idea was proposed by India in advance of the December 2009 UN climate negotiations in Copenhagen, where it received broad support.

Fourth, U.S. policymakers should help establish cross-border demonstration projects and commercialization efforts. These might, for example, include demonstrating the viability of U.S. carbon capture and sequestration technology in India or commercializing U.S.-developed biofuel enzymes by applying them to Brazilian sugar cane in commercial-scale pilot plants. Good ideas often die because they cannot get money to help them grow; as is the case in the United States, financial support for demonstration projects and commercialization efforts abroad will help new clean-energy technologies become commercially viable.

Cross-border commercialization may at times boost foreign manufacturers at the expense of manufacturers in the United States, but the benefits to U.S. companies are likely to outweigh the losses, particularly if those efforts are packaged with increased access to growing clean-energy markets. Many U.S. inventions that might fail at home, or only spread internationally after several product cycles, could find robust demand abroad, where consumers have different needs and preferences. Moreover, participation in demonstration projects helps U.S. firms gain insight into foreign markets. The alternative is not U.S. dominance in those markets but, more likely, stronger roles for companies from more flexible developed countries, such as Japan.

U.S. support for cross-border demonstration and commercialization projects should not be unconditional, however. Before supporting costly, large-scale demonstration projects, the United States should make sure that the host country is on its way to developing the necessary policy infrastructure to support widespread adoption of the technology under testing. U.S. firms should also be promised access to the new clean-energy markets in exchange for these commercialization and demonstration projects. And such efforts should be co-financed by the host countries, since their firms and economies will benefit as a result. The United States should be flexible when it comes to sharing any financial burden, particularly in the case of India, where government resources are severely limited.

The last area in which the U.S. government should provide support is in directly encouraging U.S. clean-energy exports and overseas investment by U.S. companies. The U.S. Export-Import Bank and the Overseas Private Investment Corporation both currently support these missions, but their financing and mandates could be expanded. They should also be given stronger roles in policy promotion. The Export-Import Bank helps finance U.S. exports regardless of any trade barriers imposed by the destination countries; a new strategy should more actively connect U.S. financial support to reduced trade barriers. Similarly, OPIC must tie its support for clean-energy investment to more open investment climates for clean-energy companies. Both organizations should also encourage recipient countries to strengthen their backing for clean energy.

Many of these initiatives -- particularly those that focus on the more commercial end of the innovation spectrum -- could cost a considerable amount. But they would have their benefits -- not only in terms of cutting global oil consumption and reducing greenhouse gas emissions but also in helping U.S. clean-energy innovators and companies. And when it comes to climate change, they might present a more attractive alternative to the other options, which tend to involve financial support for clean-energy deployment in the developing world with few strings attached. Money that boosts U.S. clean-energy companies while helping the big emerging economies adopt advanced technologies is likely to be much easier to sell politically than funds that are not tethered explicitly to U.S. economic goals.

WINNING TOGETHER

None of these policy initiatives will reduce demand for oil, lower greenhouse gas emissions, or create bigger markets for U.S. clean energy unless they ultimately boost demand for clean energy around the world, and, in particular, in Brazil, China, and India. A system that drives down costs for clean energy should go a long way toward promoting the creation of bigger markets: the cheaper clean energy is, the more likely countries are to enact policies that promote its adoption. Moreover, an approach that helped ensure that the big developing countries became producers rather than just consumers of advanced technologies would lower those costs even further, since those countries can often exploit lower local labor costs and economies of scale, particularly when producing for their own markets. In Brazil, China, and India, empowered clean-energy producers can also be an important constituency pressing for stronger clean-energy regulations and incentives, just as they are in the United States. In China, for example, solar manufacturers have been pressing for strong domestic solar requirements, in order to mop up excess supply.

To be sure, active U.S. government intervention to make clean-energy markets work better is not without its own risks. Even smart and well-informed policymakers are bound to make mistakes. Some technologies that they support will turn out to be commercial dead ends, and the interests of U.S. firms and potential partners in Brazil, China, and India will sometimes conflict. Resources will no doubt be wasted. But the costs are dwarfed by the perils of inaction.

The success of other nations in clean energy does not imply U.S. failure. The United States can benefit greatly from clean-energy innovation around the world, so long as it also pursues its own robust efforts at home. Each major economy has its own natural advantages when it comes to energy technology innovation and development. An enlightened U.S. strategy should aim to create a global innovation environment that weaves together those distinct strengths in pursuit of common energy goals. Not everyone will like every part of the package. Some U.S. firms will chafe at efforts that might help competitors in the developing world. Some emerging economies will resist opening up their markets to those same U.S. firms. Only by enlarging clean-energy markets can everyone enjoy a bigger piece of the pie.

The alternative is not a world in which the United States dominates the clean-energy field alone, or even one in which another country solves the United States' problems for it. It is more likely to be one in which the cost of clean energy does not drop as quickly as needed, particularly in the developing world, and in which massive markets for clean-energy technologies do not materialize. In that case, the United States and the world will both lose.

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