Value for money in tough times?

As the United Kingdom and many other economies contemplate the need for new power generation capacity, a range of options are clearly available. Much has been made in recent years of the potential for offshore wind in the UK and some believe that this should even be the cornerstone of the UK power industry.

There are two issues that will really drive the offshore wind industry in the coming years – cost and capacity (or potential).

The capacity issue has been widely discussed and there is little doubt about the significant potential of onshore, offshore and deep offshore wind in the UK, but also recognizing the limits due to planning approval and intermittency. The cost issue is less widely discussed and in difficult economic times this is arguably where the focus should be. With the need to meet the UK’s 2020 emissions targets as a given,  what is the most cost effective way of achieving this?

Today in the EU the price of CO2 hovers around €15, driven to some extent by the cost of gas vs. coal, but it is also the long term value of the allowances in future years of the ETS that is holding up the price today. This isn’t sufficient to bridge the cost gap for wind, but nevertheless both offshore and onshore wind projects proceed, driven by the various renewable energy targets in EU Member States, which in turn are fed by the EU wide 20% renewable energy by 2020 target. Without these targets the CO2 price would be higher in the EU as they are forcing a particular outcome which is not necessarily the next best option along the abatement curve. That also means the overall cost to society of meeting the 2020 emissions target is raised.

In the UK, an April 2009 government report showed that the levelised cost of offshore wind could be £144 / MWh. In looking at this further, the first  question is whether wind is meeting incremental demand (i.e.  you need to build new wind turbines or if not, something else like gas CCGT) or whether it is substituting existing demand (in which case you could argue that we’re paying for wind to close down gas or coal and only saving the fuel cost). It is probably incremental demand, since the UK does need new build anyway. In the case of new build in the UK, a recent analysis by the IEA puts new gas CCGT around 50 GBP / MWh and coal at 60 GBP / MWh (long run marginal cost). The IEA also give the UK’s 2007 electricity as being 0.90 t CO2 / MWh for coal and 0.38 t CO2 / MWh for gas.

Therefore, if wind is backing out new coal fired power stations, the abatement cost = (144 – 60) / 0.90 = 90 GBP / t CO2 = 140 USD / t CO2 (assuming 1 GBP = 1.5 USD). But if instead, wind is actually slowing the uptake of natural gas as the next best option along the abatement curve then the cost = (144 – 50) / 0.38 = 250 GBP / t CO2 = 370 USD / t CO2.

So at least in the short to medium term, the push for certain renewable energy sources is having an economic impact. As I illustrated in my post last week, quick uptake of natural gas is one way of meeting the 2020 targets, although on its own it is not a long term solution to managing emissions – it will have to be combined with CCS to do that.

Recently, a study by Redpoint for the Energy Networks Association Gas Futures Group, concluded;

  • There are credible and robust scenarios in which gas could play a major ongoing role in the United Kingdom energy mix while meeting both the 2050 carbon targets and the 2020 renewable energy targets. Managing CO2 emissions under these scenarios would require the successful development and roll-out of Carbon Capture and Storage (CCS) technology, supported by the deployment of biomethane injection into the gas distribution network, roll-out of district heating, and / or the usage of combined electricity and gas “dual fuel” systems for domestic heating.
  • Pathways with ongoing gas use could offer a cost-effective solution for a low-carbon transition relative to scenarios with higher levels of electrification. Our baseline assumptions indicate potential savings of almost £700bn over the 2010 to 2050 period on a Net Present Value (NPV) basis – around £20,000 per household or £10,000 per person – with consequential benefits for consumers, the economy, and the competitiveness of UK industry. Sensitivity analysis indicates that cost savings are still present under assumptions of higher commodity price trajectories and faster technology learning rates, although the difference in costs is reduced relative to the baseline.

As noted by Redpoint, these calculations of course depend on the longer term view of energy prices. If high, it makes the case for wind more compelling, particularly as the cost of new wind continues to fall as the technology matures. But basing a renewable energy strategy on the assumption of ever increasing energy prices may not be the prudent thing to do during challenging economic times.

My thanks to my colleague Martin Haigh in the Shell Energy Scenario Team for helping with this post.