Federal Financial Incentives to Induce Early Experience Producing Unconventional Liquid Fuels

The government, as a principal, may seek to induce a private investor, as an
agent, to build and operate an unconventional-oil production plant to
promote early production experience with such plants. Given this goal,
facing significant uncertainty about the future, the government wants to
limit the cost to the public treasury of doing this. This report offers an
analytic way to design and assess packages of policy instruments that the
government can use to achieve its goal. It starts with general principles of
the economic theories of contracting and agency. Looking across many
alternative futures helps the authors design incentive packages that are
robust from a private perspective and limit costs to the government. As
these principles would predict, cash-flow analysis demonstrates the
cost-effectiveness of using investment incentives rather than operating
incentives and the powerful effect that a higher debt share has on the
private rate of return. Cash-flow analysis also reveals specific
opportunities that the government has to change course among policy
alternatives as it seeks the lowest-cost way to increase the private rate of
return associated with a project.