Wednesday, November 22, 2017

LCOE - why it's unfair on renewables technologies and how wind is cheaper than you think

I've been playing around with Levelised Cost of Energy and have seen that some arbitrary choices in its application can unfairly discriminate against renewables projects.  Renewables projects are long term and have low operating costs, and high capex, whereas conventional thermal projects have lower capital cost as a proportion of total costs, and higher operating costs (because of their fuel costs).

LCOE is conventionally calculated as NPV(costs)/NPV(energy) - the discounted sum of costs divided by the discounted total energy production.  Hidden within this are two critical factors - discount rate, and inflation rate.  There's a third one, too, which is a bit more difficult to handle - uncertainty in fuel gas prices.

LCOE is usually calculated without any inflation and BEIS' most recent Electricity Generation Costs report applies a discount rate of 7.8% to gas, but 8.9% to offshore wind.  On this basis, BEIS has CCGT's LCOE (exceeding carbon taxes) at £47/MWH, and offshore wind at over £100.

It gets interesting when you scale back the offshore wind costs, to get an LCOE equal to the recent strike prices under CfD2 of £57.50.

Current HMG inflation forecasts are about 2-3% - and it seems that adding inflation at 2% to the BEIS figures increases the CCGT LCOE to £60/MWh and the offshore wind one to £64/MWh - a much closer gap.

Discount rate
Given that the revenue risk in offshore wind CfD projects is much mitigated by the CfD (and its Government backing), and there is real variability in future gas prices, it seems reasonable to use the same discount rate for CCGT and offshore wind.  Especially if the offshore wind develop can mitigate capex risk through its contract structure.  At the same discount rate, the offshore wind LCOE (in an inflation free work) falls from £57.50/MWh to £54/MWh.

If you accept my points on both inflation and discount rates, the LCOE's for the technologies align at £60/MWh!

And that's before you consider the fuel price risk faced by CCGT projects (or the intermittency of offshore wind, to be fair).

But this does suggest that offshore wind isn't just miles cheaper than nuclear, it's also competitive with the backbone technology of CCGT!

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