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The economics of power generation

Last updated on: August 08, 2014 13:11 IST

Studies suggest net benefits of hydro-power, nuclear energy or natural gas as sources of electricity are greater than those of wind and solar, says Suman Bery.

India's electricity system is already one of the largest in the world. This is despite the country's low per capita income and relatively low household electricity penetration.

For these very reasons growth in Indian electricity demand over the coming decades is expected to be rapid. Meeting this demand through a system that is robust, reliable, resilient, affordable and clean will be a substantial challenge for the present government and those that are to follow.

The electricity challenge is only one part of the larger energy picture: in terms of final energy services consumed, electricity is currently around 13 per cent of the total.

This compares with just four per cent in 1980, and could in time rise to 30 per cent of the total. This would bring its share of the total close to that prevalent in the currently rich countries.

Despite this comparatively low current share, electricity provision tends to get considerable, perhaps disproportionate, attention from energy planners.

This is because of its attractiveness and flexibility as a source of final energy services, as well as its association with enhanced quality of life. By the same token, failure in electricity service is extremely politically visible, as recent grid breakdowns in parts of India have demonstrated.

The electricity utility industry is under stress across much of the globe, although the source of that stress differs between advanced countries and poor ones.

In the advanced countries, the principal challenge is to finance the transition to a low-carbon electricity system at a time when nuclear energy has fallen out of favour and renewable sources remain relatively high cost and, therefore, in need of subsidy, at least in the absence of effective carbon pricing.

In the poor countries, the challenges are the more traditional ones: financing the generation and transmission infrastructure needed to expand electricity penetration, while ensuring adequate cost recovery to ensure long-term viability.

What is common is that in both settings, electricity utilities find themselves unloved and distrusted, despite the essential nature of the service that they are expected to provide.

Quite apart from these political challenges, the underlying economics of power generation are also evolving in response to technological change, shifting fuel prices and the decarbonisation challenge.

An important recent contribution to this debate was recently showcased in The Economist newspaper 1, summarising a working paper issued by the Brookings Institute in Washington earlier this year.

2 As its title indicates, the paper evaluates the relative attractiveness of a range of electricity generation technologies in reducing the carbon footprint associated with new generation capacity.

Without wanting to burden the lay reader with excessive technical detail, it is worth noting that the approach used is that of cost-benefit analysis (CBA). The discipline of CBA compares a given project (in the present case, the installation of new generation capacity) against a specific alternative ("counter-factual" in economist-speak).

In this case, five alternative no- or low-carbon electricity generation technologies are considered: wind, solar, hydro-electric, nuclear and natural gas combined cycle. These are compared with the counter-factual case of base-load, coal-fired electricity production.

Consistent with the framework of CBA, the "benefits" of each generation technology are considered under three heads: avoided emissions; avoided energy cost; and avoided capacity cost.

The analysis is calibrated using recently updated estimates provided by the United States Energy Information Administration. As the Brookings working paper notes, the market for power plant construction, operation and maintenance is global, and there are few major differences in such costs among countries.

The same is broadly true of markets for coal and oil; divergences arise largely as a consequence of domestic trade policy choices. However, this homogeneity does not extend to other energy sources: natural gas prices do differ substantially across the major regions reflecting high transport costs, and there are large differences across countries in capacity (or load) factors associated with wind, solar and hydroelectric resources. (The same could also be said for biofuels, not a primary energy source considered by the paper.)

Based on this analysis, the findings of the paper are striking. To quote from its summary, "assuming that carbon dioxide emissions are valued at $50 per metric ton, and the [landed] price of natural gas is not much greater than $16 per million Btu [British thermal units]" the net benefits of new nuclear, hydro and natural gas combined cycle plants far outweigh the net benefits of new wind or solar plants.

"Wind and solar are very costly from a social perspective because of their very high capacity cost, their very low capacity factors, and their lack of reliability." To some degree, these results echo the findings of the report on a low-carbon growth strategy for India submitted to the Planning Commission in April this year.

The paper's analysis has been designed to contribute to the policy debate in advanced countries. It is nonetheless worth reflecting on any implications it may carry for thinking about electricity fuel choices in India.

I expect that the specific conclusions of the paper will be fiercely challenged by supporters of renewable energy, and such a debate is all to the good.

I do believe, though, that the framework offered is a useful one for assessing the all-in costs of alternative power generation technologies, and is one that should be carefully examined by Indian planners, to be suitably adapted for local circumstances.

Many Indian commentators will challenge the appropriateness of including the avoided costs of carbon dioxide emissions in any such comparative calculus, on the grounds that India has not exhausted its "share" of global carbon space and need not adopt more expensive technologies for power generation at this stage of its economic development.

Third, as pointed out in the Economist article, there are many considerations other than emissions that determine fuel choice. In the Indian setting, concerns to limit energy imports loom large in decisions on natural gas, while, on the other side, concerns on particulate pollution will have an impact on the use of coal.

Finally there is the vexed issue of how to drive the electricity system in the desired direction, given the multiplicity of actors involved. There is enough work here to keep many Indian think tanks in business for years to come!

1. "Sun, wind and drain", at economist.com/blogs/freeexchange Also in the July 26 print edition

2. "The net benefits of low carbon and no-carbon electricity technologies", Charles R Frank, Jr; May 2014. The writer is a former student of Dr Frank

The writer is group chief economist, Royal Dutch Shell. These views are his own

Suman Bery
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