an expanding and interlinked global economy, with increasing trade in goods, services, and technologies;

the continuing revolution in information technology;

the increasing power of shareholders and financial markets over corporate decisions; and

the expanding deregulation of historically controlled markets.

The energy sector, in particular, has undergone major structural changes to accommodate the return of oil and gas prices to their historical norms, away from the "golden age" boom of the late 1970s and early 1980s (see discussion above, and Figure 2.10). In addition, many parts of the energy sector, particularly utilities, are responding to the enormous implications of the recent regulatory shifts toward unbundling of the electricity and natural gas sectors.

Furthermore, customers and markets now dominate over suppliers. Such domination is creating unprecedented levels of competition and relentless pressure for price reductions, even as financial markets and stockholders demand higher returns and improved short-term company performance. These pressures in the business environment have driven significant corporate restructuring, with substantial decentralization resulting in the creation of powerful autonomous business units and an increasingly short-term focus on the financial aspects of business activities.

The traditional R&D model of maintaining substantial in-house R&D capabilitieseffectively in place since the end of World War II-developed in an economic environment where the balance of power favored suppliers and producers over customers and markets. The primary assumption of this paradigm was that if sufficient resources and talent were put into the R&D system, the resulting technologies would provide the basis for meeting a firm's business objectives. Therefore, traditional internal R&D was protected and supported generously, in part because of its fit with centralized corporate structures and in part because of the then-dominant supply-driven paradigm.

The new business environment has resulted in a shift of the organizational power base away from the corporate center. Now R&D must compete within the business for funds and resources on a value-added basis with other high-risk high-reward investments, and within the marketplace with new global technology suppliers. The R&D effort is expected to demonstrate productivity enhancements, cost reductions, and process improvements.

In response to this environment of rapidly changing market conditions and compressed cycle times, a market-driven paradigm for R&D emerged in the early 1990s. Under this paradigm, there has been a shift within many energy companies to redistribute resources away from broadbased, long-term research toward specific areas of greatest opportunity, resulting in the abandonment of entire areas of traditional R&D. Firms are also increasingly outsourcing their needs to external technology suppliers." Unlike the traditional approach to R&D, the marketdriven model appears to be well suited to the decentralized management systems of most modern

23 Roberts (1995).

companies, and also provides the flexibility to choose between internal and external R&D performers.

An important recent example of the shift toward a short-term competitiveness-motivated approach to energy R&D comes from the utility sector. Many utilities are shifting their R&D from collaborative and longer term projects to proprietary R&D and to projects with a short-term payback. In interviews with R&D managers of 80 U.S. utilities, only two predicted increases in their companies' future R&D spending; whereas about half of the total predicted decreases." Most cited restructuring and competition for the reorientation of R&D toward providing near-term returns. Changes in utilities' attitudes are also responsible for the declines in support for collaborative research institutes like EPRI and GRI (discussed above and in Box 2.3), forcing these institutions to conduct research that will improve short-term competitiveness, and reducing longterm public-good research in areas such as the environment and generation technology.

JUDGING THE ADEQUACY OF R&D EFFORTS

Of course, it is also possible that energy R&D in the private sector, the public sector, or both has become more efficient, in which case declining inputs (funding) need not mean correspondingly declining outputs (innovations that can be successfully marketed or that otherwise improve the human condition). The Panel hopes that this is so, although it is difficult to verify (partly because there are often significant time lags between the conduct of research and its effects on the actual flow of innovations, so that if outputs remained high while inputs fell, this might be a temporary condition).

In any case, that the overall declines in both public sector and private sector funding for R&D are largely explainable, and that some of what has disappeared was not needed or effective, does not establish whether what remains is adequate in relation to current and future needs. Judging adequacy in this sense requires thinking about the challenges and opportunities that R&D could be helping to address and about whether its potential for addressing them is being realized.

In the private sector, energy R&D has been an important engine of progress, enabling firms to improve their products and invent new ones, so as to increase their shares of existing markets, establish and penetrate new ones, and maintain or increase performance while reducing costs. Perhaps these benefits will flow in adequate measure from the new paradigm; but it is also possible that important parts of an industrial R&D system that has served our society extremely well for many decades are now being sacrificed for short-term gain. Concerns have been expressed that the trend toward decentralization of industrial R&D, for example, could crode the interconnectedness between people and between different bodies of knowledge that contributes much to technological innovation in the long term.

Public sector R&D funding has the responsibility for addressing needs and opportunities where the potential benefits to society warrant a greater investment than the prospective returns to the private sector can elicit. Such needs and opportunities relate to public goods (such as the national security benefits of limiting dependence on foreign oil), externalities (such as unpenalized and unregulated environmental impacts), and economic factors (such as lack of appropriability of the research results, or the structure of the market, or the size of the risk, or the scale of the

*GAO (1996).

investment, or the length of the time horizon before potential gains can be realized) dilute incentives for firms to conduct R&D that would greatly benefit society as a whole.

Needs for public sector R&D can increase over time if the public goods and externality challenges grow or if changing conditions shrink the incentives of firms to conduct some kinds of R&D that promise high returns to society. What has been said above is enough to suggest that both things might recently have been happening. But the real test of whether the current portfolio of public energy R&D is adequate comes from asking whether the R&D programs in the portfolio are addressing, effectively and efficiently, all of the needs and opportunities where the prospects of substantial societal benefits are good and the prospective returns to the private sector are insufficient to elicit the needed R&D.

The Panel's thinking about the adequacy of the current portfolio has been shaped by the understanding of the challenges and opportunities for energy R&D outlined in Chapter 1 of this report and presented in capsule form here in Table 2.3. The aim has been to analyze the appropriateness and effectiveness of the DOE energy R&D portfolio in relation to these challenges and opportunities and to recommend changes where warranted. The remainder of this report presents the results of that effort.

This table was prepared by the DOE in support of the study of the government's energy R&D portfolio conducted

by the Secretary of Energy Advisory Board in 1995 (SEAB 1995).

REFERENCES

Corey 1997: R. Corey, Technology Fountainheads (Boston, MA: Harvard Business School Press, 1997).

CTI 1997: Critical Technologies Institute, communication to the Panel.

DOE 1997a: U.S. Department of Energy, Office of the Chief Financial Officer, FY 1998 Congressional Budget Request: Budget Highlights and Performance Plan (Washington, DC: U.S. Department of Energy, 1997).

DOE 1997b: U.S. Department of Energy, Interlaboratory Working Group on Energy-Efficient and Low-Carbon Technologies, Scenarios of U.S. Carbon Reductions: Potential Impacts of Energy Technologies by 2010 and Beyond (Washington, DC: U.S. Department of Energy, 1997).

Dooley 1996: J. Dooley, "Trends in U.S. Private-Sector Energy R&D Funding 1985-1994", Report PNNL-11295 (Washington, DC: Pacific Northwest National Laboratory, 1996).

DTI 1991-1997: U.K. Department of Trade and Industry, The U.K. R&D Scoreboard (Edinburgh, U.K.: Company Reporting Ltd., series 1990-1997).

EIA 1996a: Energy Information Administration, U.S. Department of Energy, Annual Energy Outlook 1997 (Washington, DC: U.S. Government Printing Office, 1996).

EIA 1996b: Energy Information Administration, U.S. Department of Energy, Annual Energy Review 1995 (Washington, DC: Department of Energy, July 1996).

EIA 1997a: Energy Information Administration, U.S. Department of Energy, Performance Profiles of Major Energy Producers 1995 (Washington, DC: U.S. Government Printing Office, 1997).

EIA 19976: Energy Information Administration, U.S. Department of Energy, Monthly Energy Review (Washington, DC: Department of Energy, April 1997).

EPRI 1997: Electric Power Research Institute, private communication to the Panel, 1997.

Frosch 1996: R. Frosch, "The Customer for R&D is Always Wrong", Research Technology Management (November-December 1996).

GAO 1996: U.S. General Accounting Office, Federal Research: Changes in Electricity-Related R&D Funding (Washington, DC: U.S. General Accounting Office 1996).

GRI 1997: Gas Research Institute, private communication to the Panel, 1997.

IEA 1996: International Energy Agency, The Role of IEA Governments in Energy (Paris: OECD/IEA, 1996).

2