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Archive for February, 2011

By LUCIAN BEBCHUK

In a major decision issued last week, William Chandler of Delaware’s Court of Chancery ruled that corporate boards may use a “poison pill”—a device designed to block shareholders from considering a takeover bid—for as long a period of time as the board deems warranted. Because Delaware law governs most U.S. publicly traded firms, the decision is important—and it represents a setback for investors and capital markets.

The ruling grew out of the epic battle between takeover target Airgas and bidder Air Products. Air Products made a takeover bid for Airgas in 2010, increased it several times, and kept it open until last week’s decision. Airgas’s directors argued that defeating the premium offer would prove, in the long run, to be in shareholders’ interests. As the Chancery Court stressed, however, the directors based their opinion solely on information publicly available to shareholders. Why should shareholders, who have powerful incentives to get it right, not be permitted to make their own choice between selling and staying independent?

Chancellor Chandler stated that he would have preferred to let shareholders make the choice at this stage, as they “know what they need to know . . . to make an informed decision.” But he felt that denying shareholders’ right to choose was required by previous Delaware cases, which recognized directors’ right to block offers out of concern that shareholders would accept them “in ignorance or a mistaken belief” concerning the value of remaining independent.

Yet the empirical evidence indicates that when directors use their power to block offers, it often proves detrimental to shareholder interests. A research project I am carrying out with colleagues John Coates and Guhan Subramanian has found that boards that defeated premium offers failed on average, even in the long run, to produce returns for their shareholders that made remaining independent worthwhile.

Moreover, the power of boards to block bids weakens the disciplinary force of the market for corporate control. A substantial body of empirical research indicates that boards’ increased insulation from such discipline is associated with lower firm value and worse corporate performance and decision-making.

Despite the Delaware court’s decision, investors still have recourse—because a poison pill is powerful only as long as the directors supporting it remain in place.

Airgas’s directors were able to use a poison pill for more than a year because Airgas’s board is “classified.” As such, only one-third of directors come up for election in each annual meeting, so replacing a board majority requires waiting through two annual meetings.

If, by contrast, a company’s shareholders could replace a majority of its board more quickly, the board’s power to block a takeover bid would be correspondingly weakened.

Support for changing corporate governance arrangements to allow for board declassification is expressed in the proxy voting guidelines of many investment managers, including American Funds, BlackRock, Fidelity and Vanguard. Indeed, shareholder proposals in favor of board declassification have received average support exceeding 65% of votes cast in each of the last five years. This makes sense given the evidence (documented in a 2005 article I co-authored with Alma Cohen, and confirmed by subsequent research) that board classification is associated with lower firm valuation.

In response, public companies have been agreeing to declassify, thus committing not to block an offer favored by shareholders for too long. The number of S&P 500 companies with classified boards declined to 164 in 2009, from 300 in 2000. Still, there’s a great deal of room for improvement: Among the 3,000 public companies with takeover defenses tracked by FactSet, about half still have classified boards.

While incumbents have for now won the right to use poison pills indefinitely, pressure by shareholders could substantially limit their toxicity. That would produce considerable benefits for investors and for our capital markets.

Mr. Bebchuk is professor of law, economics and finance at Harvard Law School and director of its corporate governance program. He has assisted institutional investors in negotiating board declassification at publicly traded firms.

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As a society, we spent $6 Billion in government subsidies for solar cell installations in 2010 1. Subsidies include tax credits, rebates and the requirement power companies buy the power at inflated prices which, combined, can total well over the installation cost. Are we getting our money’s worth? Let’s take a closer look. These cells don’t produce much electricity over the expected twenty-five year life for the $25,000 to $35,000 cost of a typical residential installation 2. Although the cost of solar cell installations has been reduced since the 1980’s, without extensive subsidies, hardly anyone would buy them. Here are some key findings that introduce common sense economic practicalities to the subject:
• Further reductions in the cost of solar panels will be marginal as a growing portion of the installation cost lies in materials, labor, and overhead. These costs are unrelated to the cost of the solar cells themselves. Solar cells will not survive in the foreseeable future without massive government subsidies.
• If greenhouse gas reduction is the ultimate goal, nuclear energy has been proven to have ten times the impact for the same cost.
• Solar and other “green” energy subsidies will increase the price of electricity 20%. Other countries, further along on the “green” road such as Spain and Germany, are experiencing resistance to government subsidies when electric power prices increase between 5% and 10%.
• Subsidies have kept solar panel prices artificially high and have become a disincentive to investment in research and capital for improving efficiency and reducing cost. Thus, subsidies played a major role in the loss of the U.S. solar panel global market share from 70% in 1980 to 4% in 2010.
• Solar and wind receive thirty (30) times the subsidies of conventional power sources.
Proponents list the benefits of these solar subsidies as:
1) Solar will lower air pollution and greenhouse gas
2) Solar will stabilize and lower electricity prices
3) Subsidies provide investment assistance for research to improve the product and lower cost
4) Subsidies provide investment assistance to keep the US a world leader in market share
5) Subsidies for solar just equalize the subsidies for other energy sources
They are wrong on every point.

Myth 1: Solar will lower air pollution and greenhouse gas
Solar cells do deliver electricity without air pollution although the need for backup power reduces the benefit. However, they must be compared with other available options that do the same thing to determine if the cost is worth the pollution savings. One dollar invested in solar cells produces about 275 watts a year of electricity. Compare this to annual production per dollar invested for the following; offshore wind produces 390 watts/$, onshore wind 775 watts/$, and nuclear power 3000 watts/$ invested. If reducing greenhouse gas emission and other air pollution is the goal, nuclear power does at least ten times more with the same investment.
Myth 2: Solar will stabilize and lower electricity rates
The US Energy Information Agency recently published a forecast for electric rates for conventional power sources through 2035. They expect rates to fall over the next several years because of lower natural gas prices from vast new production fields. Longer term, prices will only edge up slowly because of the resurgence of nuclear power. By 2035 rates will still be lower than 2009 in constant dollars. Some states, such as Delaware, have passed laws requiring significant use of expensive renewable power sources, such as wind and solar, and have placed a carbon tax on carbon dioxide through a regional cap and trade program, RGGI. We estimate Delaware electric rates will increase 20% because of this legislation. It is ironic the only de-stabilizing force for electric rates is this misguided “green” energy policy.

Myth 3: Subsidies provide investment assistance for research to improve the product and lower cost
The United States government has been spending hundreds of millions of dollars a year on basic research on solar cells to improve efficiency. The budget for 2010 was $300 million. It is likely a high efficiency panel will be invented someday but invention cannot be scheduled. In twenty-five years the efficiency of current generation production solar cells have only increase from about 12% to 15%. Some modified cells have been able to reach 20% but the cost is higher than the savings are worth. The theoretical efficiency level for the current widely used technology is only 25%. This intractable problem has also withstood private research efforts by companies such as General Electric, Exxon, and Shell Oil who have all abandoned the market. Attempts to develop new materials for lower cost and higher efficiency, lenses and reflectors to concentrate sunlight, and mechanisms to allow the panels to track the sun across the sky have all failed to provide enough benefit for the higher cost. Module prices may come down a bit further but they only represent part of the cost of installed systems. Permits, engineering, inverters, installation labor, other materials, and overhead will result in installed cost of at least $3.90/watt 3. At that price and assuming cell efficiency increases to 20%, even in a high sun area like the southwest, the return on investment without subsidies is only 1%. At this rate, there is no incentive to invest in solar.

Myth 4: Subsidies provide investment assistance to keep the US a world leader in market share
In 1980 the US produced 70% of the world’s solar cells. By 1997 US share had dropped to 40% and by 2010 share dropped to 4%. This occurred despite billions of dollars per year spent in subsidies and research. What went wrong? The crutch of consumption subsidies has stunted growth. Solar module prices dropped from $10/watt in 1980 to about $4/watt in 1997 and remained steady throughout 2008 in constant dollars (see Chart 1). Module prices dropped in 2010 to about $3.25/watt (note there is a difference between module prices and installed cost of modules) because of the recession and cheap Chinese imports. High cost, low volume plants in the U.S and Europe are closing. Module prices may go back up after capacity and demand come back into balance. The industry can charge more for their product domestically because of subsidies and government enforced purchase requirements so they don’t invest to lower cost or to improve the product. Meanwhile, China adopted production subsidies such as land cost discounts, loan discounts, and used currency manipulation to allow their manufacturers to be competitive in the world market. Chinese companies concentrated on lowering prices using the economies of scale of higher production volumes. The developed nations’ consumption subsidies kept prices high while China’s production subsidies reduced cost. In seven years China has moved from essentially no market share to 50% of the global market! Our subsidies caused the loss of US global market share.

Myth 5: Subsidies for solar just equalize the subsidies for other energy sources
This claim usually comes with no specifics and is taken as an article of faith. The claim also assumes there is a large, but undocumented, cost for greenhouse gas induced global warming. The US government is doing research on ways to burn coal cleaner and is offering loan guarantees for the construction of nuclear power plants. Coal is still the largest fossil fuel reserve within our borders and nuclear power needs a kick start after three decades of neglect. A study was conducted of the relative value of federal subsidies for various power sources4, and solar, wind, and refined coal received over 30 times the support of conventional fuels.

David T. Stevenson
Director, Center for Energy Competitiveness, Caesar Rodney Institute

Notes:
1- CRI study showed recent Delaware solar installation proposals had an effective total subsidy of $6/watt considering rebates, tax credits, and SREC’s. The average price of the proposals was $5.75/watt. US 2010 solar panel sales totaled about 1 billion watts of capacity.
2- Certain materials absorb light and release electrons using the photoelectric effect. Most of the solar arrays used today are made of semi-conductor, multi-crystalline silicon, encapsulated in durable materials. They only receive enough sunlight to work about 5 hours a day in mid-latitudes and only convert about 15% of the incoming sunlight to electricity. There are further efficiency losses using an inverter to convert from the direct current produced by the cells to alternating current used in our electrical grid.
3- The cost of installation labor, inverters, and other materials cost about $1.73/watt and it is unlikely those costs will come down. The lowest module cost predicted is $1/watt and solar panel gross margins have been 30%. ($1.73 + $1)/0.7=$3.90.
4- Federal Financial Interventions and Subsidies in Energy Markets 2007, US Energy Information Agency

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The state will award $2.4 million and local officials will provide a ten year property tax break for Johnson Controls to build a second manufacturing and distribution facility in Middletown, Delaware. Is this simply corporate welfare? Well, yes and no.

On one hand, giving handouts to Johnson Controls appears to be like making donations to Bill Gates. In the most recent fiscal year Johnson Controls had total sales of $34 billion from 1,300 locations in 63 countries and 142,000 employees. The return on shareholders’ equity was 16%. Sales in the company’s American automotive power division (the Middletown plant produces and distributes lead-acid batteries) jumped almost 23%.

In addition, no company makes a location decision based upon grants and tax breaks. There are bigger fish to fry such as access to markets, labor costs and utilities.

On the other hand the new Middletown plant will add 150 to 200 UAW jobs, and short term construction employment. Manufacturing, and the UAW in particular, and construction have had a tough time recently in Delaware. Assuming an average wage of $40,000, 20% of the new jobs going to out-of-state residents, a multiplier of 1.5, and an effective state income tax rate of 4.5%, it will take the state about six years to recover its $2.4 million. That is very likely since it is very unlikely that Johnson Controls will walk away from a $70 million investment within that time period.

Why would chump change and property tax breaks be important to a corporate 100 firm such as Johnson Controls? It is an important indicator that they are welcomed and appreciated. And like taxpayers, businesses will take any breaks they can leverage. All things considered, Johnson Controls is a no brainer.

Dr. John E. Stapleford, Director
Center for Economic Policy and Analysis
johnstapleford@caesarrodney.org

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We are taking money from the poor and giving it to the rich! Misguided energy policies have put the state in the role of the anti-Robin Hood.

The poor and middle class can’t afford solar panels but they pay for them anyway. A typical solar installation costs about $35,000. Even after government subsidies, a homeowner would need a $19,000 down payment to install solar panels; this is serious money lower income people don’t have. A typical government purchase subsidy is $16,000. This is equal to the entire federal, state, and local tax bill of two average American families being transferred to one affluent family. The panel owner can also sell Solar Renewable Energy Credits (SREC), worth several thousand dollars a year. The total value of subsidies and SREC’s, all paid by others in higher electricity and tax bills, can be as high as $58,000 for the $35,000 system.

The pain for Americans in the bottom half of earnings does not stop with subsidizing the solar panel purchases. The cost of Delaware participation in the regional cap and trade program, and government dictates that require your electric company to buy high cost renewable power are also included in your electric bill. For example, power from solar panels cost six times power from conventional sources. We estimate these “green” initiatives will add at least 20% to electricity bills.

The economic consequences go on. A recent study1 by the Delaware Economic Development Office found Delaware industry is threatened by high electricity costs, 50% higher than other states. We have already lost tens of thousands of manufacturing jobs over the last two decades. High electricity prices make it less likely factories will expand or locate here. Thanks to job killing environmental over regulation, electric generation capacity has not kept pace with our electric consumption, so we now import 60% of our electricity from out of state sources. This situation, by itself, has cost the poor and middle class opportunities for a thousand jobs in the power generation sector.

There is some money available for help with utility bills, weatherization programs, and the purchase of solar panels for the very poorest families. However, the weatherization program has been run so poorly it was shut down for over a year. Ending these expensive renewable energy programs would help more with electricity bills than the utility assistance funds. Proponents say renewable energy programs will add jobs. The problem is the “green premium” for renewable power has been shown to eliminate two to eight jobs elsewhere for every “green” job created2.

The 40% of Delaware families earning less than $50,000 a year have discretionary income of about $2000 a year 3. Discretionary income is what is left after taxes and the basics of life are paid; it is sometimes called “happy money”. State energy policies could eat up half the discretionary income for those families. There is another way. We need clean, affordable generating capacity in Delaware fired by nuclear power and natural gas! We also need to repeal expensive energy legislation that hurts the poor and middle class, such as the Regional Greenhouse Gas Initiative and the Renewable Portfolio Standard, to reduce the cost of electricity in Delaware and to secure our economic future. It is time for practical, common sense solutions.

David T. Stevenson, Director
Center for Energy Competitiveness
Caesar Rodney Institute

1 – Analysis of Delaware’s Economy, Delaware Economic Development Office, Sept 2010
2 – Study of the effects on employment of public aid to renewable energy sources Gabriel Calzada Álvarez PhD., Universidad Rey Juan Carlos, The Impact of the Delmarva/Blue Ware Wind Power Purchase Agreement on the Delaware Economy, Edward C. Ratledge, Director, Director, Center for Applied Demography & Survey Research at the University of Delaware
3 – The Conference Board, 2007 Report on Discretionary Income

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Delaware is very close to if not already beyond the point of no return regarding manufacturing, financial and agricultural jobs. It is almost entirely the fault of the General Assembly, the Governor’s cabinet and the Governor. (The greater Northeast also has the same anti-manufacturing viewpoint and has contributed to the job losses.) I was part of this loss of jobs. My employer shut down operations at a manufacturing facility November 14, 2005 due to high costs (electricity, rail, etc) and lack of customers in this region.

I graduated from the University of Delaware in 1970 with BS degrees in both Chemical Engineering and Chemistry. The Delaware manufacturing sector was booming during that period. In fact employers had a very difficult time holding on to hourly employees, there was that much demand. A high school graduate could get a job as a chemical plant operator at one of a number of plants in Delaware. This continued through the late 70’s, and then things began to fall apart. The energy situation was partly to blame. I worked for Diamond Shamrock Chemical Corp, later to be purchased by Occidental Chemical Corp (1986).

When the Delaware City plant was constructed in the mid 60’s and through the 70’s, our regional shipping orbit was a net importer of our major products, elemental Chlorine and Caustic Soda. When the plant shut down, essentially all the chlorine was being shipped by rail car to the gulf coast, there was very little regional demand for the product. The electric deregulation in 2002 was a disaster for us. We used large amounts of electricity. We had a tariff with Delmarva that allowed us to take advantage of cheap power on the off-peak hours, nights and weekends. After de-regulation, Delmarva unilaterally canceled our tariff. We were operating the plant at about 80+ percent capacity at the time. Our power bills under the tariff were over $1,000,000 per month.

After canceling the tariff the rates essentially doubled as we had no option other than buy power off the PJM grid by the hour, there were no other suppliers who would/could serve us. In June of 2003 we idled half the facility, laying off a few people. Our power bills while now operating at half the previous volume remained at $1,000,000 per month. This was unsustainable. The company tried many things to help the situation, but to no avail, resulting in total shut down on November 14, 2005.

The bottom line is that Delaware along with the greater north-east does not want heavy manufacturing; they only want “good industry” whatever that is. These manufacturing jobs are gone forever. Partly at fault is an act passed in 1971, The Coastal Zone Act. At the time it sent a huge message that Delaware was closing its doors to industry. Environmental regulations since that time have long superseded the need for this regulation. Again my company in the 90’s had an opportunity to start a new business. Bleach is essentially mixing the two main products we make with water, chlorine and caustic soda. We wanted to construct a bleach plant; we had both raw materials on site. The Coastal Zone act prohibited
this; my company went to great lengths to appeal this, but to no avail. After we lost this battle, the legislature made some modifications to the Coastal Zone act a year or so later that would have allowed this. The business opportunity for us had already passed, so we lost.

When Tom Carper was governor he had a little line that he used to describe Delaware’s economic base. He used the comparison to a 4 legged stool, he told us at numerous meetings how important each leg was and how he was committed to keep all of them healthy. He and the governors following him did not really carry through with this commitment to keep all four legs whole.

The 4 legs were:

Manufacturing – Chemical, refinery, auto, steel, etc. This leg as heavy industry is essentially gone today; it doesn’t take much research to see how far the employment has dropped. This is almost insignificant to the state’s economic base as compared to a few decades ago.

Financial – You don’t have to look too far to see how this has fared. Traveling through Ogletown and observing the empty former MBNA buildings pretty much tells the story for this entire segment. Again, another leg that has been cut off by probably 2/3.

Agriculture – DNREC, EPA and the “new people” moving to the rural areas are working overtime to destroy this sector. As it stands now, it is down from the 80’s and 90’s. Whether its nutriment management or trying to regulate the ventilation from the chicken houses, DNREC’s actions indicate no interest in their long term stability.

Tourism – This is the one leg standing. It cannot support the financial needs long term, however.

A huge risk is on the horizon with all the federal financial regulations being promulgated (Sarbanes/Oxley; Dodd/Frank). We are conceivably facing the loss of our business advantage and all the revenue from this corporate legal advantage. If you take away this revenue from the state budget, we are truly doomed. As it is, if you follow the Chancery Court schedule each week, their caseload seems to be slowly decreasing. It is hard to see why we need the number of vice chancellors we now have.

When you compare employment by sector between the 80’s, 90’s to today, one thing really stands out: Government employment has skyrocketed while other sectors have declined. I’ve worked with DNREC for many years. This is one agency that has far too many layers of management, with far too many people. DNREC should have substantially fewer employees now as compared to the 80’s based on the amount of industry operating. I’m sure you could say the same about DelDot or any other department. DNREC seems to spend more time trying to prohibit activities versus serving as a resource to determine how business could make things work. We can reasonably ask why Delaware’s Governor Markell hired an inexperienced 29 year old from California to head DNREC?

What has California done to facilitate industry or retain jobs? They have done just the opposite; their numerous special standards have driven manufacturing out. California is now losing jobs with large numbers leaving the state. It was informative to read comments from the DNREC Secretary immediately after the refinery shut down. He said his top priority was to avoid lay-offs in DNREC. This was exactly the time to cut his costs. Instead we allow DNREC to make superficial changes that reduce a few unfilled positions and call it progress.

By bringing in the California model we get rulings on auto emissions that take us to California standards adding over $1,000 per vehicle as a cost to our residents. We have the participation in the Northeast Carbon trading. I tried to find out how much this cost customers; I couldn’t get there even after calling a number of people from the power company to the state. Thank you to the Caesar Rodney Institute for clarifying the impact of this carbon program in your publications.

The Governor tells us how committed to jobs he and the General Assembly are one day, then he, his cabinet employees or General Assembly members do the same old things. One good example is Karen Peterson’s call for a tax on oil lightered from the tankers in the Delaware Bay to add revenue. Before the Coastal Zone Act was passed, one of the proposed plans was to construct a deep water port off Big Stone Beach in the Delaware Bay where the tankers would lighter at a dock. Coal was to be loaded on ships for export also. This would be much safer as compared to the current practice of anchoring the super tankers then pumping the crude oil to smaller ships. Had Delaware done this, we could have charged for a service. Instead we want to maintain our purity, even if it is only an illusion.

Another area that is promoted is that industry should use the state resources to help cut costs. Are you kidding me??? When has anyone ever experienced government employees more knowledgeable regarding operating costs as compared to industry people? This is a total joke. The government is an example of how not to manage anything, especially with their default position of adding people. If the state government is so good at helping reduce costs, why haven’t they applied this knowledge to state government operations? If they think they can help others reduce costs, a good justification would be to show where they have been successful in cutting government costs.

My former employer was intense on controlling costs. I’ve told people that about 5 years of their management at the state level would cure the excess spending problems as long as they had the authority. On years where we were not given specific reduction targets (real spending, not projected), our budget process gave us an increase of 1/2 of the anticipated inflation. We were expected to find savings at least equal to half of inflation. We always found ways to cut costs.

Richard Timmons
Middletown, DE

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NRG, the owners of Bluewater Wind, will have to seek a significant rate increase to justify the investment in its’ Delaware offshore wind project. The attempt could fail bringing the project to an end. The good news is this will save Delaware electricity consumers hundreds of millions of dollars a year in avoided price increases and could save hundreds of jobs.

Delmarva Power was basically forced to sign a long term power supply contract with Bluewater Wind by the Delaware Public Service Commission (PSC). The deal was finalized after Bluewater reduced their price. The earliest start-up date for the offshore wind facility is now 2016 when the price will be $.142/Kilowatt-hour (KWh). Similar projects off the coasts of New England and Europe have set contract prices between $.19 and $.24/KWh. There is nothing magic about the waters off the coast of Delaware to justify the difference in price.

The higher prices in other locations already account for government construction subsidies which will come to $800 million for the Bluewater Wind project. However, the subsidies only extend to facilities built by the end of 2011. The US Congress, exhibiting symptoms of subsidy fatigue, may not extend the subsidies further for a mature industry that accounted for 39% of all new generating capacity in 2009. So an even higher price increase may be needed to sustain the project next year.

The wind project is expected to provide about 1.1 billion KWh of electricity a year. Wholesale power from conventional sources costs about $.06/KWH. The “Green Premium” for offshore wind power could range between $.08/KWH and $.20/KWh at full price with no government subsidies. This will cost Delaware consumers between $90 and $220 million a year. This does not include the built in contract price escalator of 2.5% a year. Power from conventional sources is expected to be quite stable over the next decade because of the huge increase in the proven reserves of natural gas and the resurgence of the nuclear power industry.

The offshore wind project is expected to add 170 permanent jobs in Delaware. A very sound study1 by Professor Edward Ratledge, at the University of Delaware, estimates the “Green Premium” could cost one to eight jobs elsewhere for every “Green” job created.

There was very little organized public opposition to forces pushing for offshore wind when the contract was finalized in 2007. That will not be the case this time. We need clean, affordable generating capacity in Delaware fired by nuclear power and natural gas!

David T. Stevenson
Director, Center for Energy Competitiveness
Caesar Rodney Institute

Note 1: The Impact of the Delmarva/Blue Ware Wind Power Purchase Agreement on the Delaware Economy, Edward C. Ratledge, Director, Center for Applied Demography & Survey Research at the University of Delaware

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Delaware’s Economy is Struggling: This is a poor time to experiment with new energy regulations such as the RPS (Renewable Energy Portfolio Standards). The stark reality is that Delaware’s economy is in very serious straits. Delaware has fewer jobs today than it did a decade ago. Over that decade unemployment has gone from 3.3% to 8.5%. Under the best scenario it will take Delaware 3 years to regain its peak pre-recession level of employment, and it may take as long as 5 years. Nearly 19,000 discouraged workers have left Delaware’s labor force.

Delaware manufacturing has plummeted from 73 thousand jobs to 26 thousand jobs. The road back for housing from the last recession remains steep. The volume of residential permits is one-third of the pre-recession peak, the value of permits 38% of the peak, and house prices 23% below peak. The unemployment rate in Delaware’s construction industry is still above 20%.

Over the last decade Delaware per capita income has fallen from 5% above to equal to the nation and ground is not being regained. After decreasing for three quarters during the recession, Delaware personal income has grown at increasing rates through the three quarters of 2010. The increases of 1.4%, 2.3%, and 3.2% are well below the historic average year over year growth rate of 9.2%. Transfer payments such as unemployment insurance, Medicare and Medicaid, and Social Security, have become the major driver of Delaware personal income. Year over year transfer payments rose 8.3%, earnings only 1.5%, and dividends and interest 0.5%

Finally, as noted in the report of the Delaware Senate Energy and Transit Committee on affordable and environmentally friendly energy, the increase in electric prices from the RPS will most disadvantage low and moderate income Delaware households. The recent recession was especially harsh on such households.

Electricity Costs Will Further Constrain Delaware Economic Growth: According to Moody’s Economy.com, energy (i.e., electricity) is the least competitive component of the cost of doing business in Delaware. High electricity costs are the most frequent complaint from businesses to the officials in the Delaware Economic Development Office. The cost of industrial electricity is nearly 50% above the national average and commercial electricity 17% above the nation. In a recent survey of more than 400 Delaware businesses, electricity ranked third in dissatisfaction following transportation and public education.

At the national level, analysis of government imposed targets on use of renewable energy are, under optimistic supply assumptions for renewable energy, expected to raise inflation-adjusted electric rates 90% over 25 years (Heritage Foundation, No. 2438). This would mean that after inflation the application of RPS would raise electricity prices 3.6% a year (or 2.6% at a compound rate).

According to the literature, the short-run price elasticity of commercial demand for electricity ranges from -0.17 to -1.18. (Price elasticity is a measure of the sensitivity of quantity demanded to a change in price. In other words, what will be the percent decrease in quantity demanded from a one percent increase in price.) The Department of Energy assumed a short-run commercial elasticity of -0.25 in the models used to generate its 2010 Annual Energy Outlook. Research by the RAND Corporation demonstrates that across regions in the U.S. the commercial elasticity is highest in the South Atlantic region (including Delaware).

While the Delaware RPS exempts municipal electric companies, co-ops, and large industrial customers, the rest of the firms in Delaware will reduce their electric consumption almost 1% a year in the face of the rising costs imposed by the RPS (3.6 times 0.25 = 0.9). Since the short-run estimate of commercial price elasticity already incorporates changes in technology and cross-price sensitivities (e.g., natural gas), it is unlikely that Delaware commercial users can readily find dramatic electric savings through substitutes. Moreover, in the face of declining demand, Delaware electric utilities will be losing economies of scale, which may further drive up electric prices.

While most energy intensive manufacturing has disappeared from Delaware (e.g., chemicals), some import high energy manufacturing industries remain (e.g., food processing, poultry farming). And energy is also a notable portion of the costs in a number of Delaware’s important non-manufacturing industries such as hospitals, leisure and hospitality, food service, and education.

CONCLUSION: This is a time in Delaware to do things more effectively, more efficiently, and more sensibly, and rejuvenate our state’s economy. While the exact cost to Delaware’s economy, firms, and citizens of the RPS experiment cannot be estimated to a decimal place, its effect on the economy is like throwing an anvil to a drowning person. The timing for such a policy experiment is poor, and at the least it requires rethinking by the legislature in the face of the facts from substantive and professional analysis.

Dr. John E. Stapleford, Director
Center for Economic Policy and Analysis

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