Solar Panels at Dusk

Market Failures

Why can’t markets provide all the innovation we need?

Energy markets are far from free, and their structures inhibit innovation in a number of ways. Regulated, infrastructure-intensive markets aren’t welcoming to innovation; basic research isn’t protected by patent law; and the confluence of market and regulatory forces are driving a “dash to gas” that diminishes America’s energy diversity and forces the private sector to pursue short-term strategies to the detriment of our long-term national interests.

There’s no such thing as a free market in energy today

Governments have meddled with energy markets in dozens of different ways, and governments need to do what they can to fix them.

Energy markets distorted by a host of local, regional, national, and international factors ranging from subsidies to regulations to political conflicts to market manipulations by organizations such as OPEC.

The result is an energy system that is resistant to new entrants, particularly businesses that might bring revolutionary new technologies to market.

Genuine market failures in national, regional, and global energy markets demand a proactive response in critical areas of national interest where the government can intervene efficiently. But the existence of market failures is not a license for unfettered intervention in markets; rather, it is a rationale that can guide and define constructive steps that governments can take to address market failures without succumbing to the temptation to overreach.

The Private Sector tends to Underinvest in Long-Term Energy R&D

Certain kinds of innovation in energy are difficult for the private sector because the essential qualities of the market structure deter new entrants.

Energy is a commodity, not a gadget. It doesn’t have exciting, consumer-friendly features to attract customers willing to pay more for a premium product; by and large, most Americans just want energy to be affordable and reliable. Incremental innovations to bring additional supplies of existing energy sources to market—advances in deepwater drilling, for example—are relatively easy to finance. But revolutionary advances in energy generation technologies, such as advanced nuclear reactor designs or clean coal plants, are much more difficult for the private sector to develop single-handedly, given market dynamics and regulatory processes that inhibit innovation.

Most forms of energy generation and consumption are highly infrastructure-dependent and capital-intensive. Once the infrastructure for a given technology is established, it is difficult for new competitors to enter the market. While optimization of established pathways is incentivized, innovation among competing technologies declines. Yet more open and competitive energy markets and technologies would clearly be in America’s national interest.

Fields such as information technologies—computers, smartphones, the internet—are highly innovative because they produce products with new capabilities that consumers want, and they can attract the capital necessary to bring new ideas to market. Intellectual property laws protect products, ensuring that innovators reap the rewards for the investments. For most IT products, capital costs are relatively low, development times are fast, and the market for productive and exciting new products is enormous.

Energy is just the opposite.

  • New energy technologies typically require expensive, lengthy research and development times, and fundamental research breakthroughs are often not protected by patent law, making it difficult for the sponsors of basic research to capture its value directly—“free riders” can capitalize upon their discoveries.
  • Demonstration projects are expensive and slow, making them difficult to finance; underwriters must bear both technology and regulatory risks. Building a new, advanced nuclear reactor design is, for example, too expensive for all but a handful of utilities, and the construction time is likely to exceed the tenure of the company’s CEO.
  • In addition to the risks inherent in using a new technology, project sponsors have to accept the danger of delays due to regulatory hurdles that can add millions or even billions to the cost of a project. Few publicly traded companies can justify the risks of that kind of investment, given the regulatory and financial climate in the United States today.

These circumstances mean that the dynamics of today’s distorted energy markets force companies and investors to take a short-term perspective on the question of long-term innovative investments that would serve the national interest. Incremental innovation in existing energy technologies is robust—but sustained research on revolutionary technologies is limited.

We conclude, therefore, that it would be appropriate for the government to pursue policies that would promote long-term advances in energy technologies by revitalizing innovation programs in ways that would strengthen the public institutions and policies while empowering and assisting private sector innovators.