This week's energy wonk-thread: Why discussions about "when renewables will reach cost parity?" and levelized cost of electricity (LCOE) calculations are nothing but - per Antonin Scalia - "interpretive jiggery-pokery" #energytwitter
1/ First, for those not familiar with the term, google it. Lots of academics & think tanks who write lots of stuff about if/when renewable sources will reach cost-parity with existing, dirty power sources.
2/ It sounds like a really helpful metric. It's not. And it's irrelevant to people who actually build, own and operate power plants.
3/ To understand why, reframe the question as "at what point will my backyard vegetable garden be cost competitive on a $/calorie basis with the take out food options in my neighborhood?"
4/ A reasonable person my say "Sean, that's a dumb question". One is always available, the other is seasonal. One is healthier. One has easier access to all the food groups. One has more protein. One gives more personal satisfaction. One tastes fresher and better. Etc.
5/ To normalize all those values down to a single $/calorie metric is algebraically possible, but intellectually useless. But let's assume we want to do the math anyway.
6/ All those take-out restaurants presumably price their food to recover their upfront costs. But how should you factor in your upfront costs for seeds, mulch, rabbit fencing and labor? How to convert those sunk costs into a variable $/cal?
7/ Economists will tell you that's easy. You add up the initial costs, amortize them over the life of your garden based on your weighted average cost of capital, derive an annual capital recovery charge and divide that by your annual calorie production.
8/ To which any non-economist will reasonably ask... WTF are you talking about?
9/ Now let's ask how we determine whether renewables have achieved cost parity with the competing grid price of electricity. It's bedeviled by the exact same problems.
10/ The grid price is for an always-available kilowatt-hour (kWh) that factors in whatever historic capital recovery the upstream generator and wires needed and comes with (non-monetized) negative environmental externalities.
11/ Your solar panel (or wind turbine, or efficiency upgrade, etc.) requires upfront capital, but then requires no on-going operating cost and avoids most/all of those environmental externalities.
12/ In other words, once you build that renewable asset, you are (a) going to run it whenever you can, regardless of grid price and (b) by displacing more expensive grid electricity will shut dirty, more expensive power sources off thus lowering everyone's cost of energy.
13/ And note that that's true REGARDLESS of how much you paid for your clean generator. There is no market guarantee that you'll earn your target rate of return, but there is a practical guarantee that the deployment of that generator lowers energy costs for everyone.
14/ (As an aside on that, there's a painfully true saying in the power industry: "everyone wants to be the third owner of a power plant". Because most 1st and 2nd owners fail to earn their target return on capital. But I digress.)
15/ But leaving those practicalities aside, surely there is some macro societal value in calculating the total cost for competing sources to ensure that we are deploying the lowest all-in cost generation.
16/ That's academically true, but the problem is that WHO owns a power plant has a much bigger impact on your cost of capital than WHAT kind of power plant you build.
17/ Utility-funded generation is built by companies that have monopoly service territories and guaranteed revenue. Deep access to debt and equity markets. Local generation is more often funded with cash, and has no utility-commission-guaranteed return.
18/ Some clean energy sources have tax incentives, but most non-utility developers don't have enough profit to use them, so they have to do really complicated tax-equity deals to use them; a big utility by contrast has lots of profits they can shield with lots of tax structuring.
19/ I could go on, but the point is that the utility investments have an implied cost of capital that is far < than renewable power, just because of who is likely to build those assets. Any number that accurately describes the market is telling a distorted story about the tech.
20/ But there's another bigger issue: what is your cost of capital? Economists assume that's a fixed thing because otherwise their math is impossible. But it isn't! If it was, people would spend a lot more on window insulation and a lot less on Teslas.
21/ Because the former gives a much higher rate of return as measured by annual energy savings / invested capital. Turns out sometimes people buy things for reasons that are not economically "rational"!
22/ (The proof of this by the way is the existence of the advertising and marketing industry, notwithstanding a lot of neo-classical economic theories to the contrary...)
23/ So... What happens when you build a clean power plant that has no marginal fuel cost? Your annual energy costs go down. The environment improves. Dirty power gets shut down. Energy prices fall. Which means (ironically) that the amount you save will decline over time.
24/ That in turn means that there is no guarantee that you will earn your target return on capital. And of course, no guarantee that you can even articulate your target return on capital, so who knows whether that's a bad thing. :)
25/ By contrast, the LCOE tells you NOTHING of value to inform your initial investment, NOTHING to inform whether or not you should run that plant once it's built and NOTHING about net social benefit. But it is fun to do math. /fin
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