Economics of Renewable Energy Systems

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Economics of Renewable Energy Systems

• Professor Ian G Bryden
• University of Edinburgh

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Important of Cost and Price

• Once engineers have established that a renewable
  energy system works, it is necessary for them to
  assess how much energy it can produce and what
  will be the cost of this production.
• It has been common in the early evolution of
  renewable energy as a serious business to neglect
  serious analysis of costs and to consider that
  financial analysis is simply a tool put into
  place by the opponents of renewable energy.
• Biased analysis may have been used to present
  renewable energy as a pie in the sky concept
  but, increasingly, serious analysis can and
  should be used to determine the future evolution
  of our energy infrastructure.

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Soft and Firm Supply

• A renewable source is defined as hard if it
  could, in principle, be used to displace a fossil
  supply totally. In other words, there was no
  necessity to maintain a backup supply for when
  there was no environmental flux.
• The source is soft if the backup system is
  considered essential.
• Wind power is a soft source because it is
  necessary to maintain a reliable supply such as
  diesel generators for use when the wind is not
  blowing. Similarly wave power, solar power and
  tidal current power systems are essentially soft
  in nature.

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Soft Sources

• Even after many decades of electricity generation
  from renewable sources, experts still disagree on
  even the most basic aspects of the procedure!
• We must establish whether we are dealing with
  firm or soft sources.
• The conversion of energy from an environmental
  flux can be considered diagrammatically as shown.

With a soft source it will not be possible to
guarantee the electrical output flux from the
conversions system, as it is dependent upon the
input ambient energy flux, which is outside the
control of the operator.
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Ensuring Firm Supply from Soft Sources

• If a consumer demands reliable supply on demand,
  it will be necessary to introduce an element of
  storage or an alternative supply for use when in
  the ambient flux is insufficient for a guaranteed
  supply.

This represents an integrated system. We must
considered the cost, not just of electricity
output from the renewable hardware, but output
from the total system.
Input Ambient
Energy Flux
Renewable Energy
Firm Backup
Conversion System
supply
Output electrical
energy
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Cost

• If I, as an individual, or as a corporate entity,
  decide to generate electricity for sale, I will
  have inevitable costs.
• These are what I would pay to generate the
  electricity, which I would then sell.
• This can, under some circumstances, be described
  in terms of p/kWh but, as we proceed, it is
  possible to identify many pitfalls in this
  simplistic approach.
• Costs generally consist of
• Fuel
• Staffing
• Maintenance
• Capital repayment
• Grid connection etc.

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Price

• This is really an entity closely linked to market
  forces.
• Realistically I will sell the electricity for as
  much as I can get for it, so as to maximise the
  profits. If I sell at the cost price, I will make
  no profit.
• In addition, it is possible to consider the
  generation of, say, 1000kWhrs of electricity
  using wind power and by diesel power.
• As a result of the predictability of diesel,
  consumers might be prepared to pay more for
  diesel electricity than wind because they know it
  is reliable.
• On the other hand, environmentally sensitive
  consumers might be willing to pay more for
  electricity generated from sustainable sources
  than from fossil sources!

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Calculating Costs

• In principle, this could be done by establishing
  the capital cost of the necessary hardware(C),
  estimating the working lifetime (L), the
  operating costs in one year and electrical energy
  produced during one year (E).

The cost for one unit of energy would be given by
This is a very simplistic approach and is not
used in commercial analysis.
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Other Factors

• We have a time preference for money.
• Given a choice, most of us would prefer money now
  rather than the promise of money tomorrow.
• We would need to be offered a pound plus some
  additional sum of x next year to forgo the use
  of a pound today.
• If we had the money today we could lend it out
  and charge interest on it!
• Inflation progressively erodes the ability of
  money to buy goods.

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Temporal Value of Money

• If I invest 100 at 10 interest in a bank, I
  will be able to settle a bill of 110 in one
  year!
• Similarly, I could pay a bill of 260 in ten
  years.
• We can say that the present value of 260 in
  ten years at an interest rate of 10 is only 100.

We must establish a method of discounting for
future payments by saying that sums of money in
the future can be expressed in terms of smaller
amounts today.
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• This concept leads to a method of appraisal known
  as Discounted Cash Flow (DCF) analysis. This
  allows us to express a series of bills at various
  times in the future as a single lump sum in the
  present.
• E.g. consider three bills, 100 today, 110 in
  one years time and 260 in ten years. As we saw
  from the graph, the separate Net Present Value
  (NPV) of each of these bills is 100 and
  together, the total NPV is 300 (Based upon 10
  interest rate!).
• The relationship between discount rate and
  interest rate is very close and it is not
  uncommon for them to used interchangeably.
  Strictly speaking discount rate should include an
  assessment of the risk as well as reflecting bank
  interest rates.

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A Note on Inflation

• It is important to realise that discounting is
  not the same as inflation.
• It relates rather to the issue of expectation
  and risk.
• Discount rates are quoted exclusive of inflation
  and refer to a hypothetical zero inflation
  currency.
• Inflation is such that we really should refer to
  the date at which the currency value is
  evaluated.
• It is not uncommon for large projects to have
  their costs quoted as, for example, (1982) or
  any other particularly relevant year.

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Methodology

• Given a discount rate of r, then a sum of Vp
  today, will have a value of

This can be inverted to yield
This is the net present value, today, of a sum of
money Vn, n years into the future.
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Annuitisation

• It is likely that we will pay the capital costs
  over the anticipated lifetime of the system or
  project.
• If we know the capital cost of a renewable energy
  system then it will be possible to determine an
  annuity, which is an annual payment over a know
  number of years to repay the initial capital.
• In effect we would establish n equal payments of
  value A.
• The NPV of each of these payments would be given
  by

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• The total payment in terms of NPV would be given
  by

Assuming that there will be N payments, with the
first payment at the commencement of the project.
This is obviously the sum of a geometric series
and is given by
The annual payment is given, therefore by
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Annual Cost of Energy

• The annuitised capital cost can, therefore, be
  used to determine the annual cost of energy by
  combining it with the annual operating cost, O to
  give an annual generation cost of

The cost per unit of electrical energy produces
is given, therefore by
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Costs of Generation in a Combined Renewable and
Fossil Based System

• It is interesting and useful to consider the
  costs of maintaining a firm backup to a renewable
  supply. The cost of electricity from a fossil
  system can be determined in exactly the same way
  as for a renewable system but with the addition
  of fuel related costs so that

AF is the annuitised cost for the fossil
system, OF is the annual operating cost of the
fossil system, FF is the annual fuel cost and EF
is the annual energy produced by the fossil
system.
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• Similarly and using the same notation, the cost
  per unit for the renewable system can be
  expressed as
• Consider these combined in an isolated grid

It should be possible to determine the total
generating costs
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• If we assume that the total energy demand for the
  grid in one year is given by ETtotEREF, then
  the cost of generation of this electricity will
  be
• (FC is the fuel cost in a combined
  fossil/renewable system)
• If we assume that the operating costs of a fossil
  fuel plant are independent of the amount of
  electricity generated then, the difference
  between the cost of electricity produced in a
  combined scenario and a fossil only scheme is
  given by
• (?F FF-FC Cost of fuel saved by including a
  renewable generating capacity)

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• It can be seen in this equation that it only
  becomes economic to include renewable generators
  into a grid if the cost of the renewable
  electricity per unit is less than the cost of the
  fuel saved in the fossil plant.
• This depends upon the assumption that operating
  costs are the same for the fossil plant in both
  scenarios.
• This assumption is generally correct when the
  proportion of the total energy which renewable
  systems deliver is a relatively small proportion
  of the overall energy.
• Once the proportion of renewable energy exceeds
  approximately 10 of the total, this assumption
  starts to break down as the operating costs of
  the fossil plant start to vary and, indeed, the
  operating efficiency of the fossil plant is
  likely to fall, thus increasing costs.

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External Costs

• The concept of external costs relates to costs,
  which might not immediately and directly be borne
  by the producer.
• eg costs resulting from
• air pollution (measured in terms of damage to
  human health, crops and buildings, etc.),
• noise pollution (measured in terms of the
  reduction of property prices in noisy areas), or
  costs resulting from the risk of major accidents
  in mines or power stations.

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• External costs may be negative for example, the
  security of supply resulting from an energy
  source being indigenous can be treated as a
  benefit, with an associated negative cost.
• Conversely, it has been suggested that the costs
  of the 1991 Gulf War constituted an external cost
  to oil of 23.50 per barrel imported into the USA
  (House of Commons Select Committee on Energy,
  1992).
• Some external costs are already to some extent
  internalised (i.e. incorporated into market
  prices) by means of taxes or the cost of
  complying with government regulations.
• In the future, other external costs, such as
  those of' global warming', may be reflected in
  new taxes, like the proposedEuropean carbon tax,
  or new regulatory measures.

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Results of one study of the external costs of the
production of electricity from various different
technologies in the UK. Units are p/kWhr
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Comments on External Costing

• How can we possibly put a value of the
  environment? Just what is the value of an
  individual puffin killed in an oil spill?
• Who has the right to say who is right and wrong?
• What should or should not be included in the
  'real' cost?
• Even if everyone could agree on a costing for
  wind energy, for example, it may be argued that
  it is not valid to apply the same criteria to
  tidal energy, and even for a given technology the
  cost can vary depending on how it is operated
  within a system
• Whenever quoting comparative costs, therefore,
  all the above factors should be borne in mind,
  and wherever possible the assumptions behind the
  costing should be stated in full.