Energy and Climate Policy – Lecture 5 Energy Project Economics

Sample analytic questions

What’s the LCOE of a new technology?
When to retire a nuclear/coal power plant?
Should I install rooftop solar or buy an EV?
How long should the government subsidies heatpump?
When can offshore wind achieve grid parity?

Project economics

Simple payback
Discounting
Present/future value
Uniform payments (annuities)
Capital recovery factor
Comparing technologies/costs (LCOE)
Learning curve
Market and technology drivers

Time is money

Money value changes in time: a dollar today worth more than a dollar tomorrow.
When money is invested, its amount changes with the return.
When money is transferred into assets, its value change due to depreciation and/or inflation.
Discounted cash flow is a technique that allow us to evaluate values as they change over time.

Payback period

\(Payback\ Period = Initial\ Investment ÷ Annual\ Cash\ Flow\)

Simple payback: no discounting
Payback: with discounting

Capital Recovery Factor (CRF)

Ratio of a constant annunity to the present value of receiving that annuity for a given length of time.

\(CRF = \frac{i(1+i)^n}{(1+i)^n - 1}\)

Discounting

\(discount\ rate (r) = interest\ rate (i) + inflation\)

The power of discounting

Declining discounting

LCOE

\(LCOE=\frac{\text{sum of costs over lifetime}}{\text{sum of electricity produced over life time}}=\frac{\sum_{t=1}^{n}{\frac{I_t+M_t+F_t}{(1+r)^t}}}{\sum_{t=1}^{n}{\frac{E_t}{(1+r)^t}}}\)

I: Investment costs
M: Operation and maintaince costs
F: Fuel costs

Comparing LCOE

Limitations of LCOE

Fossil: Do not include other costs (e.g. enviromental, carbon, etc.)
RE: Do not include integraton costs
Focus on economics, do not include social cultural acceptance

Learning curve

Empircial relations between unit costs and cumulative production.

\(Y = aX^b\)

\(Pr=2^{b}\)

\(Lr=1-Pr=1-2^{b}\)

Y: Unit costs
a: Cost of first unit
X: Units
b: Slope of the learning curve
Pr: Progress ratio
Lr: Learing rate

Learning of differrent technologies

Drivers of learning

Source of learning

Learning by doing

Economy of scale
Economy of scope

Learning by researching

How renewables are getting cheap

Why nuclear costs are going up?

Role of global supply chain in PV

Summary

Project economics is useful for basic cost-benefit analysis
Getting the price (discounting) right
Understanding technology dynamics will help to model future projections
Aware of the limitations

References

Arrow, K., M. Cropper, C. Gollier, B. Groom, G. Heal, R. Newell, W. Nordhaus, et al. 2013. “Determining Benefits and Costs for Future Generations.” Science 341 (6144): 349–50. https://doi.org/10.1126/science.1235665.

Grubler, Arnulf. 2010. “The Costs of the French Nuclear Scale-up: A Case of Negative Learning by Doing.” Energy Policy 38 (9): 5174–88. https://doi.org/10.1016/j.enpol.2010.05.003.

Grübler, Arnulf, Nebojša Nakićenović, and David G Victor. 1999. “Dynamics of Energy Technologies and Global Change.” Energy Policy 27 (5): 247–80. https://doi.org/10.1016/S0301-4215(98)00067-6.

Helveston, John, Gang He, and Michael Davidson. 2022. “Quantifying the Cost Savings of Global Solar Photovoltaic Supply Chains.” Nature 612 (7938): 83–87. https://doi.org/10.1038/s41586-022-05316-6.

Kavlak, Goksin, James McNerney, and Jessika E. Trancik. 2018. “Evaluating the Causes of Cost Reduction in Photovoltaic Modules.” Energy Policy 123 (December): 700–710. https://doi.org/10.1016/j.enpol.2018.08.015.

Klemun, Magdalena M., Goksin Kavlak, James McNerney, and Jessika E. Trancik. 2023. “Mechanisms of Hardware and Soft Technology Evolution and the Implications for Solar Energy Cost Trends.” Nature Energy 8 (8): 827–38. https://doi.org/10.1038/s41560-023-01286-9.

Weitzman, Martin L. 2001. “Gamma Discounting.” American Economic Review 91 (1): 260–71. https://www.aeaweb.org/articles?id=10.1257/aer.91.1.260.

Yelle, Louis E. 1979. “The Learning Curve: Historical Review and Comprehensive Survey.” Decision Sciences 10 (2): 302–28. https://doi.org/10.1111/j.1540-5915.1979.tb00026.x.