The Economic Thicket of Generating Cost Comparisons

Comparing the costs of differing electric generating technologies has become popular among advocates for particular technologies and those seeking to find the optimal approach to new generation. While getting attention in policy-making circles, it turns out to be far from simple.

How much does it cost? Seems like a simple question. But when it comes to competing electric generating technologies, it’s an extremely gnarly proposition.

Despite the difficulties, cross-generation cost comparisons are playing a significant role in public decisions at the international, national, and local levels about choices of generating technologies. Advocates for various technologies and businesses with vested interests all claim that they—mirror, mirror on the wall—are the least-cost generating option of all.

Each technology has a valid claim. Hydro, the oldest, has a no-cost, renewable fuel: water. Geothermal, one of the newest, also has a low-cost fuel—steam from the earth. Coal is dirt cheap. Natural gas is cheaper, and is killing coal in competitive markets. Nuclear has low fuel costs and no carbon dioxide (CO2) emissions. Solar and wind have no fuel cost and no air emissions. And so it goes.

Each has cost negatives. Hydro soaks up construction capital, as do geothermal and nuclear. Coal has high conventional and CO2 air emissions, but gas also emits CO2. Solar and wind have high capital costs, take up a lot of land, and are inflexible.

Solar and wind advocates are making the loudest claims. They are behind the concept pushed by congressional Democrats of a Green New Deal, the promise of 100% carbon dioxide-free energy in the U.S. in the near future. The aspirational goal is 10 years. Many energy experts view that as impractical.

Not so Stanford University civil engineering professor Mark Z. Jacobson, an influential figure among Green New Deal supporters. He has advanced the idea that the entire U.S. could be powered by wind, solar, and water. “No natural gas, biofuels, nuclear power, or stationary batteries are needed,” he wrote in 2015 (see sidebar “Jacobson v. Clack: The 100% Solution?”).

Jacobson v. Clack: The 100% Solution?

Stanford professor Mark Z. Jacobson drew attention in late 2015 when he published an article in the Proceedings of the National Academy of Sciences of the United States of America (PNAS) with the provocative title “Low-cost solution to the grid reliability problem with 100% penetration of intermittent wind, water, and solar for all purposes.”

Jacobson posited an end to U.S. CO2 emissions through “low-cost, no-load-loss, non-unique solutions to this problem of electrification of all US energy sectors (electricity, transportation, heating/cooling, and industry).” He claimed this means “no natural gas, biofuels, nuclear power, or stationary batteries are needed. The resulting 2050–2055 US electricity social cost for a full system is much less than for fossil fuels.”

Jacobson’s article prompted Christopher Clack, a physicist and mathematician who specializes in renewable energy, to challenge Jacobson in a 2017 PNAS article with 20 prominent experts as co-authors, “Evaluation of a proposal for reliable low-cost grid power with 100% wind, water, and solar.” Clack said that Jacobson’s energy analysis “involves errors, inappropriate methods, and implausible assumptions. Their study does not provide credible evidence for rejecting the conclusions of previous analyses that point to the benefits of considering a broad portfolio of energy system options.”

Clack added, “Policy makers should treat with caution any visions of a rapid, reliable, and low-cost transition to entire energy systems that rely almost exclusively on wind, solar, and hydroelectric power.”

Then it got nasty. Jacobson in November 2017 sued the National Academy of Sciences (NAS) and Clack, seeking $10 million in damages, claiming that the academy “knowingly and intentionally published false statements of fact” in the Clack article. Clack responded to the defamation suit in a comment to The Washington Post, “It is unfortunate that Dr. Jacobson has now chosen to reargue his points in a court of law, rather than in the academic literature, where they belong.”

In February 2018, facing the likelihood of failure and the possibility of an award of court costs to Clack and the NAS, Jacobson withdrew the suit.

Generation costs include many variables: capital, fuel, site, waste disposal, pollution control, interconnection, reliability, intermittency, and the like. No two technologies are alike. How to square the circle?

Levelized Cost of Energy

Years ago, analysts came up with an approach that attempts to integrate some of the major cost variables across generating technologies. It’s called “levelized cost of energy” (LCOE, Figure 1).

1. This graphic from the U.S. Department of Energy (DOE) shows how the levelized cost of energy (LCOE) is calculated. Source: DOE

The U.S. Energy Information Administration (EIA) said LCOE “is often cited as a convenient measure of the overall competitiveness of different generating technologies. It represents the per-megawatt-hour cost (in discounted real dollars) of building and running a generating plant over an assumed financial life and duty cycle.” DOE’s National Renewable Energy Laboratory has an online LCOE calculator to build a cost profile for any particular project.

The EIA’s Annual Energy Outlook (AEO) for 2018 did LCOE calculations for generating plants entering service in 2022, in 2017 dollars/MWh. Here are some of their results, first for dispatchable technologies:

    ■ Conventional gas-fired combined cycle, with an assumed capacity factor of 87% (the ratio of actual electrical energy output over a given period of time to the maximum possible): 48.3.
    ■ Combustion turbines, with a 30% capacity factor, mostly used as peaking units: 79.5.
    ■ Advanced nuclear, 90% capacity factor: 90.1.
    ■ Geothermal, 91% capacity factor: 40.3.
    ■ Biomass, 83% capacity factor: 102.2.

And for non-dispatchable generation:

    ■ Onshore wind, 43% capacity factor: 37.
    ■ Offshore wind, 45% capacity factor: 106.2.
    ■ Solar photovoltaic, 33% capacity factor: 46.5.
    ■ Hydro, 65% capacity factor: 73.9.

These LCOE results have bolstered the popular notion, promoted by renewable energy interests and advanced in Congress, that renewables are a better economic bet for the future than nuclear or fossil generation. That’s reflected in February’s Green New Deal resolution by freshman Rep. Alexandria Ocasio-Cortez (D-N.Y.) and Sen. Ed Markey (D-Mass.). The resolution states that among its myriad goals, many of which have nothing to do with energy or the environment, is “meeting 100 percent of the power demand in the United States through clean, renewable, and zero-emission energy sources.”

Renewables advocates have support for their views of the costs of generating technologies. A November 2018 report from Lazard said that its “latest annual Levelized Cost of Energy Analysis (LCOE 12.0) shows a continued decline in the cost of generating electricity from alternative energy technologies, especially utility-scale solar and wind. In some scenarios, alternative energy costs have decreased to the point that they are now at or below the marginal cost of conventional generation.”

In March 2018, Bloomberg New Energy Finance (BNEF) reported, “Coal and gas are facing a mounting threat to their position in the world’s electricity generation mix, as a result of the spectacular reductions in cost not just for wind and solar technologies, but also for batteries… BNEF’s latest report on the levelized costs of electricity, or LCOE, for all the leading technologies finds that fossil fuel power has an unprecedented challenge in all three roles it performs in the energy mix—the supply of ‘bulk generation,’ the supply of ‘dispatchable generation,’ and the provision of ‘flexibility.’ ”

LCOE Critics Strike Back

Using LCOE to compare generating costs has become mainstream. But prominent critics, including leading academic economists, point out the weakness of LCOE analysis, arguing it can be misleading. The critique is both technical and fundamental. The fundamental objection is that cost does not measure value.

Severin Borenstein of the Energy Institute at the University of California, Berkeley’s Hass Business School, told POWER that LCOE “is useful as a starting point, but is widely abused. It is used to mislead a lot of people about the relative value and cost of different energy systems.” Energy generation occurs at different times and in different places, and “LCOE ignores that,” he said.

Even before intermittent resources came on the scene, said Borenstein, LCOE “was only a piece of the puzzle. It’s like saying a car costs a lot more than a bicycle, so we should all buy bicycles. But they are providing different services.”

Relying on LCOE analysis can lead to large mistakes, Borenstein said, citing the California “duck curve” caused by too much uncontrollable solar generation. At low levels of market penetration, solar doesn’t make much impact overall. “Now we are seeing solar produced at times when it has almost no value. A low LCOE doesn’t solve that problem.”

Criticism of LCOE analysis is not new. A draft 2010 paper by noted economist Paul Joskow, president of the Alfred P. Sloan Foundation at the Massachusetts Institute of Technology, titled “Comparing the costs of intermittent and dispatchable electricity generating technologies,” says that “the prevailing approach that relies on comparisons of the ‘levelized cost’ per MWh supplied by different generating technologies, or any other measure of total life-cycle production costs per MWh supplied, is seriously flawed. It is flawed because it effectively treats all MWhs supplied as a homogenous product governed by the law of one price. Specifically, traditional levelized cost comparisons fail to take account of the fact that the value (wholesale market price) of electricity supplied varies widely over the course of a typical year.”

In an email, William Hogan, research director of Harvard Electricity Policy Group at the Kennedy School of Government, pointed POWER to Appendix B of a 2016 NAS report—“The Power of Change: Innovation for Development and Deployment of Increasingly Clean Electric Power Technologies.” Hogan was a member of the NAS committee that oversaw the 340-page study. Appendix B is “Benchmark Levelized Cost of Electricity Estimates.”

The appendix examines how the Department of Energy (DOE) uses LCOE in its AEO reports, highlighting assumptions behind the DOE analysis: “Ideally, the levelized cost estimates would be computed in a way that eliminates the impact of policies that cause market distortions, such as those that preferentially subsidize one technology or a class of technologies over others. A second-best option would be to include the effects only of policies that are technology neutral, such as the income tax.

“The cost estimates in AEO 2016 include two important assumptions reflecting selective policies that affect the capital cost estimates. First, the weighted average cost of capital … is 5.6 percent in real terms. But for new coal plants, there is an additional 3 percent added to proxy for anticipated carbon restriction policies [EIA, 2015f, p. 3]. Second, certain technologies, particularly wind and solar, use accelerated tax depreciation that is not available to other technologies. This produces substantially lower fixed-charge rates for renewable capital costs.”

The NAS study also faults the DOE’s analysis for not including environmental “externalities,” such as waste disposal, pollution reductions, and the like. “The LCOE excluding marginal externalities provides a benchmark for comparison. However, a central point of the consideration of clean energy technologies is the impact of externalities.”

The appendix concludes, “The data without the effect of selective policies indicate that existing technologies for clean energy are not competitive with new natural gas. And without accounting for the costs of externalities, the principal renewable technologies of wind and solar are not cost-competitive with new coal plants.”

How to Proceed?

Is there a process to improve cross-technology cost comparisons? Berkeley’s Borenstein, in a 2011 paper, has several suggestions. One is eliminating direct subsidies and tax breaks from LCOE calculations. Borenstein wrote, “Excluding direct subsidies and tax breaks from levelized cost analyses is relatively straightforward, though it can be challenging in practice. Indirect subsidies that occur upstream and affect the price of inputs are somewhat more difficult to sort out.” He noted, “Advocates for renewable electricity argue that fossil fuel extraction receives special tax treatment in the United States. While that is likely true, and subsidies for fossil fuels are larger than for renewable energy in aggregate, the subsidy per kilowatt-hour for fossil fuel generation is quite small.”

Incorporating environmental externalities is also on Borenstein’s list. He said, “In a first-best economic world, pollution rights would be just another input to the production of electricity from a given technology and would automatically be included in the levelized cost calculation. In most of the United States and the world, however, markets for rights to emit greenhouse gases or local pollutants are spotty at best.” He added, “Absent government intervention, the external costs will not be borne by producers and will not affect choices among electricity generation technology. The obvious solution is to price the externalities—either through a tax or tradable permit program.”

More difficult to include in cost analyses, said Borenstein, are “non-environmental externalities,” such as “energy security” however that’s defined, intellectual property rights, and “green jobs,” whatever that means.

Perhaps the way ahead should abandon the Sisyphean task of detailed cost comparisons and market approaches to incorporate externality costs. Externalities are a product of the seminal work of the late British economist Arthur Cecil Pigou (1877-1959). In his 1920 treatise “The Economics of Welfare,” Pigou introduced the concept of externalities, arguing that the best way to deal with their economic dislocations is through prices set by markets. That’s been a staple of microeconomics ever since.

In his 2011 paper, Borenstein said that since Pigou, “economists have understood that pricing externalities is likely to be the best way to move behavior towards efficiency. In the context of electricity, this means taxes on emissions or a tradable permit system, but such market-based policies have garnered limited political support in the U.S. and elsewhere. Instead, many governments have created policies to promote renewable electricity generation directly, through either subsidies or mandates.”

In January, Georgia State University economics professor Garth Heutel, who teaches the principles of microeconomics, in a blog post offered a heretical notion: “Preferring Pigouvian pricing to command-and-control policies is fine, and most probably taxes are more cost-effective. But economists may be guilty of letting the perfect be the enemy of the good by constantly reminding everyone around them of the inferiority of alternative policies…. Alternatively, environmental economists could think more carefully about making environmental pricing more popular and therefore implementable.” ■

Kennedy Maize is a long-time energy journalist and a frequent contributor to POWER.

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