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Why Wind Is Not Coal: On the Economics of Electricity

Author

Listed:
  • Lion Hirth

    (Potsdam Institute for Climate Impact Research and Vattenfall GmbH, Geremany)

  • Falko Ueckerdt

    (Potsdam Institute for Climate Impact Research, Germany)

  • Ottmar Edenhofer

    (Potsdam Institute for Climate Impact Research, Chair Economics of Climate Change, Technische Universität Berlin and Mercator Research Institute on Global Commons and Climate Change (MCC), Germany)

Abstract

The economics of electricity is shaped by its physics. A well know example is the non-storability of electricity that causes its price to fluctuate widely. More generally, physical constraints cause electricity to be a heterogeneous good along three dimensions - time, space, and lead-time. Consequently, different generation technologies, such as coal and wind power, produce different economic goods that have a different marginal economic value. Welfare maximization or competitiveness analyses that ignore heterogeneity deliver biased estimates. This paper provides an analytical welfare-economic framework that accounts for heterogeneity for unbiased assessments of power generators. The framework offers a rigorous interpretation of commonly used cost indicators such as ‘levelized electricity costs’ and ‘grid parity’. Heterogeneity is relevant for all generators, but especially for variable renewables such as wind and solar power. We propose a definition of ‘variability’, derive the opportunity costs of variability, and link that concept to the ‘integration cost’ literature. A literature review shows that variability can reduce the value of wind power by 20-50%. Thus it is crucial that economic analysis accounts for the physics of electricity.

Suggested Citation

  • Lion Hirth & Falko Ueckerdt & Ottmar Edenhofer, 2014. "Why Wind Is Not Coal: On the Economics of Electricity," Working Papers 2014.39, Fondazione Eni Enrico Mattei.
  • Handle: RePEc:fem:femwpa:2014.39
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    References listed on IDEAS

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    1. Nagl, Stephan & Fürsch, Michaela & Jägemann, Cosima & Bettzüge, Marc Oliver, 2011. "The economic value of storage in renewable power systems - the case of thermal energy storage in concentrating solar plants," EWI Working Papers 2011-8, Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI).
    2. Paul Simshauser, 2011. "The Hidden Costs of Wind Generation in a Thermal Power System: What Cost?," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 44(3), pages 269-292, September.
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    4. Neuhoff, Karsten & Ehrenmann, Andreas & Butler, Lucy & Cust, Jim & Hoexter, Harriet & Keats, Kim & Kreczko, Adam & Sinden, Graham, 2008. "Space and time: Wind in an investment planning model," Energy Economics, Elsevier, vol. 30(4), pages 1990-2008, July.
    5. Heide, Dominik & von Bremen, Lueder & Greiner, Martin & Hoffmann, Clemens & Speckmann, Markus & Bofinger, Stefan, 2010. "Seasonal optimal mix of wind and solar power in a future, highly renewable Europe," Renewable Energy, Elsevier, vol. 35(11), pages 2483-2489.
    6. Nagl, Stephan & Fürsch, Michaela & Lindenberger, Dietmar, 2012. "The costs of electricity systems with a high share of fluctuating renewables - a stochastic investment and dispatch optimization model for Europe," EWI Working Papers 2012-1, Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI).
    7. Erin Baker & Meredith Fowlie & Derek Lemoine & Stanley S. Reynolds, 2013. "The Economics of Solar Electricity," Annual Review of Resource Economics, Annual Reviews, vol. 5(1), pages 387-426, June.
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    9. Edenhofer, Ottmar & Hirth, Lion & Knopf, Brigitte & Pahle, Michael & Schlömer, Steffen & Schmid, Eva & Ueckerdt, Falko, 2013. "On the economics of renewable energy sources," Energy Economics, Elsevier, vol. 40(S1), pages 12-23.
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    13. Holttinen, H., 2005. "Optimal electricity market for wind power," Energy Policy, Elsevier, vol. 33(16), pages 2052-2063, November.
    14. Hirth, Lion, 2013. "The market value of variable renewables," Energy Economics, Elsevier, vol. 38(C), pages 218-236.
    15. Martin, Brian & Diesendorf, Mark, 1983. "The economics of large-scale wind power in the UK A model of an optimally mixed CEGB electricity grid," Energy Policy, Elsevier, vol. 11(3), pages 259-266, September.
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    Citations

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    Cited by:

    1. Després, Jacques & Mima, Silvana & Kitous, Alban & Criqui, Patrick & Hadjsaid, Nouredine & Noirot, Isabelle, 2017. "Storage as a flexibility option in power systems with high shares of variable renewable energy sources: a POLES-based analysis," Energy Economics, Elsevier, pages 638-650.
    2. Hirth, Lion & Ueckerdt, Falko & Edenhofer, Ottmar, 2015. "Integration costs revisited – An economic framework for wind and solar variability," Renewable Energy, Elsevier, vol. 74(C), pages 925-939.
    3. Tapia-Ahumada, Karen & Octaviano, Claudia & Rausch, Sebastian & Pérez-Arriaga, Ignacio, 2015. "Modeling intermittent renewable electricity technologies in general equilibrium models," Economic Modelling, Elsevier, vol. 51(C), pages 242-262.
    4. Jacques Després & Patrick Criqui & Silvana Mima & Nouredine Hadjsaid & Isabelle Noirot, 2014. "Analysing the interactions between Variable Renewable Energies, electricity storage and grid in long term energy modelling tools," Post-Print hal-01279461, HAL.

    More about this item

    Keywords

    Power Generation; Electricity Sector; Integrated Assessment Modeling; Variable Renewables; Integration Costs; Welfare Economics; Power Economics; Levelized Electricity Cost; Grid Parity;

    JEL classification:

    • Q42 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Alternative Energy Sources
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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