Abundant and cheap power is one of the foundations of modern civilisation and economies. Current changes in energy markets are perhaps the most significant for a long time. It has implications for society in the broadest sense. Energy Destinies is a multi-part series examining the role of energy, demand and supply dynamics, the shift to renewables, the transition, its relationship to emissions and possible pathways. Parts 1, 2 and 3 looked at patterns of demand and supply over time, renewable sources and energy storage. This part looks at economics of renewable energy.
The economics of renewable energy are focused on ‘grid parity’ – a levelized cost of electricity (LCOE) equal to or less than the price of power from the electricity grid. New-age energy gurus and their credulous media acolytes rely on this to advocate the replacement of fossil fuels with renewable energy.
The cost of renewable energy has definitely declined.
But any comparison is complicated by a number of factors:
In practice, identifying the true and full, rather than the marginal, cost of renewables is complex.
Local Problems
LCOE measures the average net present cost of electricity generation for a generator over the life of a facility based on numerous assumptions. It is a financial metric comparing different forms of electricity using a consistent set of parameters.
LCOE is calculated as the average revenue per unit of electricity generated required to recover the costs of constructing and operating a plant during its assumed financial life and duty cycle. It is the discounted costs over the lifetime of a plant divided by a discounted sum of the actual energy delivered. Inputs required include the investment, cost of capital, financing costs, fuel costs, fixed and variable operational and maintenance costs, utilisation rates, operating lives and decommissioning expenses. Taxes or subsidies can be incorporated. It is not uncommon to see one or other input excluded.
As in most large-scale projects, accurate specification of the required elements is not easy. Key issues include:
The regulatory framework is important. Changes in laws and standards can potentially have a major impact on LCOE. Environmental regulations, consumer protection rules, tort liability and interference in market pricing of electricity have the potential to affect LCOEs.
The deficiencies of LCOE have led to alternative measures being proposed. The US Energy Information Administration recommends that levelized costs of non-dispatchable sources such as wind or solar be compared to LACE - the avoided costs from other sources divided by the annual yearly output of the non-dispatchable source. This provides a useful comparison against fossil fuels or nuclear recognising the cost of backup dispatchable sources for intermittent fluctuating power sources. A ratio of LACE to LCOE, referred to as the value-cost ratio, greater than 1 renders a project economically feasible.
However, no measure is perfect and suitable for every context or location.
LCOE – Estimates
Current LCOE estimates are as follows:
A striking element is the wide ranges. It also does not show consistent grid parity.
However, these cost estimates are incomplete excluding important elements.
Impact of Subsidies
Subsidies for renewable energy are common, varying between technologies, countries and regions. For example, some countries seek to encourage renewable investment by giving them preference in terms of projects or grid dispatch. Other incentives include tax benefits or favourable financing terms such as lower borrowing cost or government co-investment.
The level of government support for different energy technologies has changed over time. Pre-pandemic, there was a steady shift from fossil fuels and nuclear to renewables, storage and improved energy efficiency.
The pandemic led to a shift to subsidies for fossil fuels. Fossil fuel consumption subsidies rose to $532 billion in 2021 (a 20 percent increase on 2019 levels). In 2022, they doubled again to all-time record of $1 trillion. Some of this was caused by rebounding fossil fuel prices. Many of these subsidies are concentrated in developing economies, including more than half in fossil-fuel exporting countries. There was an additional $500 billion of extra government spending to reduce energy bills, primarily in advanced economies (Europe alone expended $350 billion) which flowed in part into fossil fuels. These transfer payments lowered the incentives for efficient energy consumption or switching to cleaner fuels.
There is nothing inherently objectionable about subsidies. Energy, like other industries, has frequently been supported to further broader policy objectives, such as promoting new technology or nascent industries, assuring supply security, stimulating particular sectors or segments of the population and, most recently, environmental benefits. Support may be desirable to overcome market imperfections.
However, energy subsidies are inefficient and create side-effects. Most of the benefits accrue to wealthier households, who are larger consumers of power. They encourage higher consumption and reduce efforts to reduce energy intensity. Energy subsidies also distort the allocation of capital and sometimes encourage unsustainable industries.
It creates several problems:
Externalities
LCOE does not take into account externalities; that is, a financial or non-financial cost or benefit of an activity experienced by an unrelated third party.
The enthusiasm for renewables comes from a major positive externality, namely its low carbon emissions. However, this is contestable. Carbon reduction may be overstated.
Renewable energy substitutes material intensity for emissions. The required machinery – solar panels, turbines, dams, batteries, transformers, new transmission lines – will require metals and minerals on scales unprecedented in human history. It will paradoxically require vast amounts of energy fuelled primarily by fossil fuels. There are problems around the disposal of waste, such as scrapped solar panels, which alone could grow to 200 million tons globally by 2050.
The estimated reductions of carbon emissions do not fully incorporate the emissions from the complete supply chain and life cycle of renewable sources. For example, emissions from bulk energy storage required where renewables are a significant part of the grid contribute ‘non-trivial’ emissions. These may reduce or eliminate the positive externality of renewables depending on location, storage operation mode, and assumptions regarding carbon intensity. Only when these are included can the benefit or cost of different technologies be understood.
Renewable energy sources also exhibit certain negative externalities:
Other negative externalities include ecological changes and effects on biodiversity. Large solar arrays and wind farms fundamentally alter the environment and threaten ecosystems. In the US special permits are granted for the killing of endangered wildlife threatened by turbines.
Cost Evolution
LCOE is, at best, a convenient approximation of the cost of different generating technologies. It has shortcomings especially as its focuses on the hardware in isolation without fully incorporating many real-world system costs and externalities essential to modern energy supply systems. Irrespective of measurement issues, renewable energy costs have declined over time. Actual falls in LCOE since 2009 are significant.
The falls are driven by scientific progress, improvements in technology and scale, and the experience curve effect. LCOEs for a given generator tend to be inversely proportional to its capacity. Increasingly, larger solar and wind plants have brought down costs.
Forecasts for further rapid declines in renewable energy and storage costs, based on the last three decades which saw a near 10 times fall, may be overly optimistic. The law of diminishing returns, which applies to most physical systems and technologies, will reduce incremental gains as has been seen in other areas, such as semi-conductors.
A major factor will be efficiency limits determined by the laws of physics. Solar farms are limited by the energy arriving from the sun. Turbines cannot extract more energy than provided by wind kinetics and existing battery types are limited by chemistry.
Energy conversion efficiency is not unrestricted. Just as the Carnot Efficiency Theorem limits the conversion of fuel-to-power to around 80 percent in ideal conditions, solar and wind plants face boundaries. The Shockley-Queisser Limit states that around 34 percent of incoming photons can be converted to electrical energy. The Betz Theorem limits turbine capture of wind energy to around 60 percent. In practice, these levels are difficult to attain due to engineering and cost constraints. For example, the best internal combustion engines after centuries of development are around 50 to 60 percent efficient with most in common use falling well short of that level.
Solar and wind are already relatively efficient with current focus on incremental engineering improvements – larger turbines and bigger solar arrays. One reason for the slower rate of future improvements in renewables is that many of the underlying raw materials for solar (silicon, copper, and glass) and wind (concrete, steel, copper and fiberglass) are already mass produced efficiently with limited scope for further cost reductions.
Where electricity must be stored or converted into hydrogen fuel, further losses are likely. Production of hydrogen gas via an electrolyser can lose 30 percent or more of the embedded energy. A further 10-15 percent would be lost to compress or liquefy the gas for transportation. Another 30 percent may be lost in the process of generating an electric current in the fuel cell. It is possible that 70 percent of the electricity used to power the system is lost.
In the absence of major scientific or manufacturing breakthroughs, further large cost improvements are unlikely in the foreseeable future.
Renewable Hope
Despite the hyperbole of advocates, renewables are currently a significant but modest component of global energy sources. Between 2011 to 2021, renewable energy increased from 20 percent to 28 percent of global electricity supply. Its share of total global energy use is much smaller (around 10 percent). The use of fossil energy shrank from 68 percent to 62 percent, and nuclear from 12 percent to 10 percent. Amongst renewables, hydropower decreased from 16 percent to 15 percent, solar and wind energy increased from 2 percent to 10 percent. Biomass and geothermal energy grew from 2 percent to 3 percent.
Forecasts for adoption of renewable energy are ambitious.
The case for renewable energy rests on the limited remaining reserves of fossil fuels and lower emissions. However, intermittency, low energy and surface power density, and locational challenges mean that, were a significant share of energy to come from renewable sources, there would be a need for bulk energy storage and a major reconfiguration of the energy system. Other factors that constrain the application of renewables include the fact that it can only generate electricity, which makes up a small part of energy consumption, and the need for conversion into usable fuels for high power or transportation uses.
Despite claims to the contrary, renewable energy, whose costs have improved dramatically over time, may not yet be at grid parity as LCOEs are sensitive to assumptions, financing terms, technology, location and subsidies. In particular, the lack of proper accounting for externalities means comparisons are frequently spurious and vehicles for partisan lobbying.
It means that the ability of renewables to totally supplant fossil fuels for powering the modern global economy at an acceptable cost is far from established. As American science-fiction writer Robert Heinlein observed: "Anything free costs twice as much in the long run or turns out worthless."
© 2023 Satyajit Das All Rights Reserved
Satyajit Das is a former banker and author of numerous works on derivatives and several general titles: Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006 and 2010), Extreme Money: The Masters of the Universe and the Cult of Risk (2011), A Banquet of Consequences RELOADED (2021) and Fortune's Fool: Australia’s Choices (2022). His columns have appeared in the Financial Times, Bloomberg, WSJ Marketwatch, The Guardian, the Independent, Nikkei Asia and other publications. This is part of the web-only series of columns on newindianexpress.com.