15ELP044: Energy System Investment and Risk Management Unit 2B: Energy Economics and Markets Paul Rowley 1, Simon Watson 1 and Andy Williams 2 1 CREST & 2 Wolfson School, Loughborough University

Overview In Unit 2, we explore the techno-economic aspects of energy generation and supply, along with the nature of electricity markets. In particular we will: Examine how energy generation is economically evaluated Carry out some simple financial modelling Charaterise electricity markets, with a focus on the UK Evaluate the relevance of carbon markets Use case studies to illustrate key aspects of the Unit Slide 2

Levelised Energy Cost (LCOE) Slide 3 Source: Projected Costs of Generating Electricity 2010 Edition, EIA & Nuclear Energy Agency (LCOE) is a convenient means of comparing the unit energy costs of different technologies over their economic life LCOE is equivalent to the unit cost assuming certainty of future production costs and the stability of a range of external factors Discount rates if used in LCOE calculations reflects the return on capital in the absence of specific market or technology risks LCOE may not reflect true costs where significant uncertainties exist, such as in competitive markets

Slide 4 Levelised Energy Cost (LCOE)

Group Wiki Slide 5 Wiki Questions: Use the NREL LCOE calculator (link below) to Compare capital vs. fuel intensive technologies such as nuclear vs. gas How does varying the discount rate and investment period affect the LCOE? How does varying the discount rate and investment period affect the LCOE? What about the utility electricity price and escalation rate? Are there any other factors that an electricity system operator would need to consider when assessing the LCOE of intermittent renewables such as wind and solar PV? Are there any other factors that an electricity system operator would need to consider when assessing the LCOE of intermittent renewables such as wind and solar PV?

Capital cost of new generation resources Source: Projected Costs of Generating Electricity 2010 Edition, EIA

Capital cost of new generation resources Source: Projected Costs of Generating Electricity 2010 Edition, EIA v v

Levelised cost of new generation resources Source: U.S. Energy Information Administration Levelized Cost of New Generation Resources in the Annual Energy Outlook

Levelised cost of new generation resources Source: Large uncertainty in the estimation of future costs Complexity added by: Minimum load requirements Start-up vs. standby costs- Start-up & shut-down minimum times Ramping limits Non-linearity of production cost curves

Open EI Database – Cost Distributions Slide 10 Source: OpenEI -

Energy Cost and Uncertainties Slide 11 Source: Oxford Institute for Energy Studies

Energy Cost and Uncertainties Slide 12 Source: electricity-and-gas-prices/ electricity-and-gas-prices/ April 2013: ”Power and gas have annual highs last month as the UK experienced freezing weather and dwindling gas stocks, and unplanned outages caused supply concerns. In February annual power prices picked up on the back of rising oil prices. Despite the fall in oil price during March, supply concerns and colder weather have supported prices throughout the month.” v v

Energy Generation Marginal Costs Slide 13 The marginal cost is the “price” of generating one more unit of electrical energy (in kWh or MWh) The marginal cost of generation does not include fixed costs (such as construction loan repayments, O&M contracts, leasing etc) which would be paid anyway, regardless of whether energy is generated or not Marginal cost of generation is heavily influenced by input fuel prices, and other external factors such as carbon emission permit prices Marginal cost plays an important role in electrical energy markets, because it helps to determine the ‘competitive price’ In practice, demand is satisfied first by generating plant with the least expensive marginal cost, and then by plant with sequentially higher marginal costs

Energy Generation Marginal Costs Slide 14 Source: electricity-and-gas-prices/ electricity-and-gas-prices/ A ‘marginal cost function curve’ shows the price of generating one more unit of electrical energy as a function of generation output Consider a small incremental slice under the Marginal Cost Curve. The area of this slice is incremental cost of generation for that amount of energy at a given price ΔCost = P(E) * ΔE Where ΔCost = incremental cost; ΔE = incremental energy generated; P(E) is the price of energy generated

Marginal cost function curve Slide 15 Source: Prof. Osman SEVAİOĞLU, METU

Energy Incremental Costs Slide 16 ΔCost = P(E) * ΔE Where: ΔCost = incremental cost; ΔE = incremental energy generated; P(E) is the price of energy generated Source: Prof. Osman SEVAİOĞLU, METU

Energy Generation Cost Slide 17 Source: Prof. Osman SEVAİOĞLU, METU Generation cost is the total area under the Marginal Cost Curve Generation Cost = ∫ Price(E) d E = ∫ P(E) d E

Energy Incremental Costs Slide 18 ΔCost = P(E) * ΔE Where: ΔCost = incremental cost; ΔE = incremental energy generated; P(E) is the price of energy generated Source: Prof. Osman SEVAİOĞLU, METU

Merit Order Source: and