Transcript Slide 1

ENV-2A82: Low Carbon Energy
Basic Economic Analysis
Dr. Congxiao Shang
Room No.: 01 30
Email: [email protected]
N.Keith Tovey (杜伟贤) M.A, PhD, CEng, MICE, CEnv
Н.К.Тови М.А., д-р технических наук
Room No.: TP2.09
Email: [email protected]
Recipient of James Watt Gold
Medal for Energy Conservation
1
ENV-2A82 (2011/2012): Low Carbon Energy
Objectives of this Session
To examine methods to assess whether an energy project is
economically viable.
Energy is a multi-disciplinary subject and other criteria are
also needed
PHYSICAL
See Webpage for details
UEA Heat Pump Scheme 1981
SOCIAL
TECHNICAL
ENERGY
POLITICAL
ECONOMIC
ENVIRONMENTAL
Fuel Poverty Issues
2
2.1 Introduction
• An energy project should consider whether to:
1) promote energy conservation, and/or energy efficiency.
Is there a difference between Energy Efficiency and Energy
Conservation?
2) develop low carbon energy resources,
• nuclear, wind, tidal, wave,
• solar, hydrogen , and biofuels etc
• carbon sequestration
3) exploit conventional and cheaper fossil fuels and keep
energy bills low at the present,
But what of the future?
3
How and why do charges for fuels vary?
e.g. Electricity: - Retail Costs made up of several components
1. The cost of actual generation – depends on
•
•
•
fuel used – consequently efficiency
e.g. Coal 35 – 38%, Gas 47 – 55% efficient
Physically limited by Laws of Thermodynamics
– not Technical Limitations
fuel cost – UK is now a significant importer, volatile international
markets affect prices – before 2004 UK was an exporter
Carbon Permit prices – more permits needed for coal
2. A charge for High Voltage Distribution – varies significantly
across UK.
3. A charge levied by each of 14 Regional Distribution Network
Operators - varies depending on industrial mix in region
4. A charge by Electricity Retailer for actual units consumed
5. A charge for meter reading.
Gas: tariffs vary with region
4
Transmission Demand Charges
Distributed Network Ownership
Scottish & Southern
Iberdrola
United Utilities
CE Electric UK
Western Power
UKPower Networks
( Hong Kong Electric)
1
2
4
3
5
6
10
14
8
7
9
12
13
11
Zone
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Energy Consumed
(p/kWh)
0.790954
1.547861
1.993796
2.552189
2.520788
2.625780
2.886193
3.184194
3.026211
3.028765
3.377343
3.602492
3.537180
3.553243
Current charges as of 1st April 2011
5
2.1 Introduction
• How is profitability of electricity generation assessed?
• Clean Spark Spread (CCS) – a measure of profitability of
electricity generation by gas.
CSS = PE - PG /EG - PCO2 * IG
Where PE is wholesale price of electricity
PG is wholesale price of gas
EG is efficiency of gas generation ~ 50% (range 47 – 55%)
PCO2 is Price of EU Emission Permits
IG is Emission Intensity of gas = 0.20196/ EG (tCO2/MWh)
• Clean Dark Spread (CDS) – equivalent for coal generation
CSS = PE - PC /EC - PCO2 * IC
Where PC is wholesale price of gas
EC is efficiency of gas generation ~ 38% (range 35 – 38%)
IC is Emission Intensity of coal = 0.34056/ EC (tCO2/MWh)
* Emission Intensity values are typical from IPCC (2006)
See paper by Abadie and Chamorro (2008) for more information
6
2.1 Introduction
• Decisions as to whether an energy project is viable are often/
usually made on the basis of an economic analysis alone.
• However, imperfect analysis of energy issues can be flawed,
and give misleading answers on decisions made.
• Often different researchers will come up with very different
answers - WHY????
1st
2nd
3rd
4th
5th
£20
£20
£20
£20
£20
?
Is this project viable?
A project costs:
£100
To implement
Annual Saving
We will explore many of the issues in this lecture
7
2.1 Introduction
•
Some concepts for simple cost benefit analyses.
•
Those who have done/are doing Environmental Economics
will know some statements below are somewhat simplified, but
some important questions are raised in context of Energy.
Should traditional ideas about cost benefit analysis – e.g. Pay back
time prevail?
e.g. Example at NKTs house?
How cost effective is
Car Insurance???
Solar PV
Solar Thermal
8
2.2 Discount Rate
This aims to account or the effects of inflation when assessing
the economic viability of a project.
 £100 invested in savings giving 5% will generate £105 after 1
year, i.e. 100 * 1.05 = £105
 After 2 years the return will be £110.25
i.e. 105 * 1.05 = £110.25
This is the compound interest return on £100
It is not £100 * 1.05 + £100 * 1.05 = £110 which would be
the simple interest
 Similarly after 25 years, compound interest would generate
£338.64 compared to £225 from simple interest
 If one has to borrow money for a project then these values
also indicate the total amount to be repaid – i.e. £110.25 and
£338.64 respectively – not £110 and £225
9
2.2 Discount Rate
 On the other hand what would be the value of £100 saved in
1 years time in present day terms if inflation were 5%?.
£95.84 - not £95
 or £100 saved in 25 years time would be worth £29.53 in
today’s money
 Here we are using the present time as a reference and the
present value of money to assess future savings.
 This introduces the term Net Present Value (NPV) to
evaluate the present value of future savings.
 In addition the term Discount Rate is used to deflate future
costs/savings to the present day (5% in the example above).
10
2.2 Discount Rates
Supplementary Information:
Mathematically, the discount rate is slightly different from the
interest rate.
In the example given above using 5%
•
£100 in savings would grow to £105 – an increase of £5 in the year.
•
However, £100 in a years time at 5% discount rate would be equivalent to
£95.84 or a reduction of £4.16.
It is the discount rate that is used to project future cash flows
whether these are savings or maintenance costs so that it is in terms
of the Net Present Value.
Mathematically the discount rate (D) is related to the interest rate
(I) as follows:
D=
I / (1 + I)
11
2.2 Discount Rates
The choice of Discount Rate significantly affects the estimated
financial viability of a project.
• High discount rates favour fossil fuels
• Medium discount rates favour nuclear power
• Low/zero discount rates favour conservation/renewables
as will be seen later.
Even though one might think one is being objective in
comparing different energy schemes, the simple selection of
one discount rate over another may end up by biasing the
result in one direction.
However we are jumping ahead – how do we work out the
overall NPV of a project?
12
2.2 Discount Rates
We can assess the economic viability of a project using the
discount rate to determine the Net Present Value in two different
ways:
 The Individual discount tabular method (the sledge hammer
approach)
 The Cumulative discount approach using cumulative discount
factor tables
Example:
A conservation project which has a capital cost of
£100 but saves £20 p.a.
- assume a discount rate, r = 5%:
13
2.2 Discount Rates: Individual Discount Rate Approach
The discount factor of the year n can be computed from the
1
formula:
The NPV of a saving (or cost)
(1  r ) n
Capital fuel Discount
Year
Outlay Saving
actor
NPV of
fuel
saving
= (value of saving in the year n)
 (the discount factor of the year):
The NPV reflects the value the fuel
saving would have if it was
accounted at the present time rather
than some years into the future.
0
£100
1
£20
0.952381 £19.05
2
£20
0.907029 £18.14
3
£20
0.863838 £17.28 The cumulative savings over 5 years
4
£20
0.822702 £16.45 = £19.05 + £18.14 + £17.28 +
5
£20
0.783526 £15.67 £16.45 + £15.67 = £86.59
6
£20
0.746215 £14.92 i.e. project would make a loss if
7
£20
0.710681 £14.21 equipment only lasted 5 years
There would be a profit of £1.51 over 6 years: or £15.73 over 7 years.
Frequently projects will also have annual operating costs/maintenance and
14
these should be treated as future costs in a similar manner to the savings.
2.2 Discount Rates
The approach shown previously is tedious: often
the cumulative discount approach can be used
Example with
5% discount rate
The cumulative discount factor
Cumulative Cumulative
is the sum of the discount
Capital fuel
Year
Discount NPV of fuel
factors up to and including the
Outlay Saving
factor
saving
year n.
0
£100
These cumulative factors are
1
£20
0.952381
£19.05
available in tables such as the
2
£20
1.85941
£37.19
ENV Data Book.
3
£20
2.723248
£54.46
4
£20
3.545951
£70.92
The answer is the same as
previously but it is much quicker
5
£20
4.329477
£86.59
6
£20
5.075692
£101.51 in use as only the life time
7
£20
5.786373
£115.73 number of years is needed.
8
£20
6.463213
£129.26 Note how critical the choice of
9
£20
7.107822
£142.16 the life time of the project is in
10
£20
7.721735
£154.43 assessing its viability.
15
2.2 Discount Rates - summary
How can one calculate cumulative discount rate if tables are
not available?
The Cumulative Discount Factor in year n is the sum of all
the discount factors from year 1 to year n
And this can be shown to be equal to:
1
1

r [r * (1  r ) n ]
The Cumulative NPV to year n is then
Annual saving x the Cumulative Discount Factor
Remember: If annual saving varies – e.g. because
maintenance costs vary, then cumulative approach cannot be
used.
16
2.3 Internal Rate of Return (IRR)
• For a Project to be viable it must have a positive NPV taking into account
capital costs, running costs, savings etc. However, two projects may seem
similar, but because of different times of expenditure, one may be
preferable to another.
• Two cases both have capital cost of £100,
– Case A has savings of £60, £60, £40, £20, £20 in years 1 – 5
– Case B has savings of £20, £20, £40, £60, £60 – i.e. Same total saving
• Which is more attractive?
Timing
Capital
Expenditure
Year 1
Year 2
Year 3
Year 4
Year 5
TOTAL
5%
discount
factor
0.952381
0.907029
0.863838
0.822702
0.783526
CASE A
Net Cash Present
Flow
Value
CASE B
Net Cash Present
Flow
Value
-£100.00
-£100.00
-£100.00
-£100.00
£60.00
£60.00
£40.00
£20.00
£20.00
£100.00
£57.14
£54.42
£34.55
£16.45
£15.67
£78.24
£20.00
£20.00
£40.00
£60.00
£60.00
£100.00
£19.05
£18.14
£34.55
£49.36
£47.01
£68.12
17
2.3 Internal Rate of Return (IRR)
• The internal Rate of Return IRR is the discount rate at which the NPV
becomes zero over the project lifetime.
£100
If discount rate < IRR then
scheme is profitable –
otherwise a loss will ensue.
£80
£60
£40
Case A
£20
Case B
In case A, IRR is ~ 38%
In case B it is ~ 22%
£0
0%
-£20
-£40
-£60
-£80
10% 20% 30% 40% 50% 60% 70% 80%
Thus option A is a better
investment and
considerably better than
normal savings, against
which IRR should be
compared.
See also http://www.solutionmatrix.com/internal-rate-of-return.html
18
2.4 Discount Rates: A cautionary note when assessing different
energy projects
Fossil fuels have
Net Present Value
relatively low capital
costs, but significant
fuel costs. NPV
significantly affected
by discount rate.
Renewables/conservation
-ve
Capital Costs
nuclear
nuclear
coal
coal
Discount Rate
+ve
Nuclear has medium
capital costs but low
fuel costs. NPV less
affected.
Renewables/
Conservation usually
have high capital
costs but low running
costs. Little effect
on NPV
19
2.4 Discount Rates: A cautionary note when assessing different
Fossil fuels have
energy projects
lowest NPC at high
discount rates
therefore more
financially attractive
Net Present Cost
Renewables/conservation
nuclear
coal
Nuclear lowest NPC
at medium discount
rates.
Renewables/
Conservation have
lowest NPC at low
discount rates.
+ve
-ve
Discount Rate
What about
negative discount
20
rates?
2.5 Example 1: An Economic Assessment of loft insulation
Roof Area of average house = 49m2,
post-war house with no insulation
U-value – a measure of heat loss is ~ 1.6 WoC-1m-2
The lower the U-value the less heat is lost
You will cover U-values later in the course
Insulation
thickness
(mm)
U-Value
(WoC-1m-2 )
Heat Loss through
49m2 roof
(WoC-1 )
Annual
Heat Loss
(GJ)
Saving
(GJ)
0
1.6
78.4
14.90
0%
100
0.33
16.2
3.07
79%
200
0.18
8.8
1.68
89%
300
0.12
5.9
1.12
93%
The annual heat loss is the Heat loss multiplied by number of second in a day
(86400) multiplied by Degree days (typical average 2200). Then divide by 109
to get to GJ
21
2.5 Example 1: An Economic Assessment of loft insulation
Price of Energy [British Gas Standard Tariffs on 12/01/2012]
Gas: (break point 2680 kWh per year)
Tier 1 8.755p/kWh Tier 2 4.036p/kWh
[£11.21/GJ]
Full Rate Electricity (break point 720 kWh per year)
Tier 1 24.806p/kWh Tier 2 11.4536p/kWh
[£31.82/GJ]
Off Peak Electricity
6.919p/kWh
[£19.22/GJ]
Oil BoilerJuice.Com [12/01/2012] 59.3p per litre
equivalent to 5.735834 p per kWh*
[£15.93/GJ]
[* conversion factors1244 litre/tonne and 46.3 GJ/tonne ]
Capital Cost
B & Q 12/01/2012
-£3.00 per roll of 5.5sqm @ 200mm thick
= £1.84 per sqm.
However, cost of 100mm thick was ~ £3.60 per sqm!!!
22
2.5 Example 1: An Economic Assessment of loft insulation
Capital Costs
Case 1
Case 2
Case 3
Case 4
Case 5
Case 6
No insulation
Provide 200 mm insulation – capital cost = 49 * £1.84
Provide 300 mm insulation - capital cost = 49 * £5.44
Existing 100mm insulation
Top up to 200mm insulation – capital cost = 49 * £3.60
Top up to 300mm insulation – capital cost = 49 * £1.84
Energy Requirements
Heat Lost
= £90
= £266
= £176
= £90
From slide 21
Efficiency No Insulation 100mm
200mm 300mm
3.07
1.68
1.12
14.90
Energy Required (GJ/annum)
100%
14.90
3.07
1.68
1.12
90%
16.56
3.41
1.87
1.24
Electricity
Gas Condensing
Oil Non
70%
21.29
Condensing
Energy Required = Heat Lost / Efficiency
4.39
2.40
1.60
23
2.5 Example 1: An Economic Assessment of loft insulation
Annual Energy Running costs using Tier 2 values from slide 22
No Insulation
100mm
200mm
300mm
Electricity Full rate
£474.05
£97.67
£53.45
£35.63
Electricity Off Peak
£286.37
£59.00
£32.29
£21.53
Gas Condensing
£185.66
£38.23
£20.96
£13.90
Oil Non Condensing
£339.21
£69.95
£38.24
£25.49
Annual Savings
Initial
Status
No
insulation
100 mm
Upgrade Full Rate
to
Electricity
200mm
300 mm
200 mm
300 mm
£421
£439
£44
£62
Off Peak
Electricity
Gas
Oil
£254
£265
£27
£37
£165
£172
£17
£24
£301
£314
£32
£44
24
2.5 Example 1: An Economic Assessment of loft insulation
Simple Payback time – no discounting
Initial Upgrade Capital Full Rate Off Peak
Gas
Oil
to
Cost Electricity Electricity
Status
200mm
£90 2.6 months 4.3 months 6.6 months 3.6 months
No
insulation 300 mm £266 7.3 months 12.1 months 1.5 years 10.2 months
200 mm £176
4.0 years
6.6 years 10.2 years 5.6 years
100 mm
300 mm £90
1.5 years
2.0 years
3.7 years 2.0 years
Note: cost effectiveness is very much less if there is 100mm loft
insulation, but grants favour those with no insulation
Payback using 5% discount
Initial Upgrade Capital Full Rate Off Peak
Gas
Status
to
Cost Electricity Electricity
200mm
£90 2.7 months 4.5 months 6.9 months
No
insulation 300 mm £266 7.6 months 1.1 years 1.7 years
200 mm £176
4.6 years
8.2 years 14.6 years
100 mm
300 mm £90
1.5 years
2.6 years 4.2 years
Oil
3.8 months
0.9 months
6.7 years
2.2 years
25
2.5 Example 1: An Economic Assessment of loft insulation
• Always add the most insulation possible – incremental upgrades
are much less cost effective.
• Grants are available 50%+, but only if insulation is fitted
professionally. Analysis on previous slides is DIY, for which
there are usually no grants.
2.6 Example 2: Solar Photovoltaic
What is cost of generating electricity– e.g. solar Photovoltaic???
In is income in year n
n
E is annual energy generated
n
r is discount rate
u is unit charge for electricity
I  Eu (1 r)
In absence of maintenance
charges, income over life time of
n years must >= capital cost C
n
I  C  Eu  (1  r) x
x 1
26
2.6 Example 2: Solar Photovoltaic

C
r
u 
n 
E  1  (1  r ) 
Rearranging gives:
PV array has a gross output of 1.25
kW and after inverter losses ~
1.15kW
At Load factor of ~ 10% this will
generate ~1000 kWh per annum.
Solar PV
Solar
Thermal
The capital cost was £6500
What is unit cost which would make
scheme profitable over 25 years.
For simplicity – ignore maintenance
costs.
Load factor = Net output over year as % of theoretical generation
– see notes on this slide
27
2.6 Example 2: Solar Photovoltaic
Unit Cost of generating electricity by Solar PV to ensure
investment is recouped over life span of project
Life time
Discount Rate
years
2%
4%
6%
8%
10%
15
50.2
58.0
66.4
75.4
84.8
20
39.5
47.5
56.2
65.7
75.8
25
33.0
41.3
50.5
60.4
71.1
Notice how dependent actual cost o generation is on:
• Discount rate chosen
• Life Span of project (note – some of cells on ZICER are
having to be replaced after 8 years
28
2.6 Project life and Choice of
Discount Rate
Project life for an installation in industry:
Small Schemes: Usually must have pay back in
no more than 9-18 months
Definitely Cost effective in 2 years
Exceptional Schemes: with pay back period over 5
years are rarely considered
unless the existing equipment is nearing the end of
its life and has to be replaced anyway
29
2.7 Summary Conclusions
 The project must have a net positive present value over its
life span
 The project should have the most favorable rate of return
when compared to other projects, or to direct investment
(i.e. use IRR as an indicator here).
 If money has to be borrowed to undertake the project, then
the rate of return must be greater than the borrowing rate.
 The choice of specific discount rate can often bias an
answer towards a particular option
 The choice of discount rate and life span of a project affects
estimates of future costs of generating electricity
 Other considerations are also relevant
– What price SECURITY of SUPPLY??
An Economic assessment should be only one of several
considerations when assessing a project
30