The role of capital costs in decarbonizing the electricity sector

Abstract

Low-carbon electricity generation, i.e. renewable energy, nuclear power and carbon capture and storage, is more capital intensive than electricity generation through carbon emitting fossil fuel power stations. High capital costs, expressed as high weighted average cost of capital (WACC), thus tend to encourage the use of fossil fuels. To achieve the same degree of decarbonization, countries with high capital costs therefore need to impose a higher price on carbon emissions than countries with low capital costs. This is particularly relevant for developing and emerging economies, where capital costs tend to be higher than in rich countries. In this paper we quantitatively evaluate how high capital costs impact the transformation of the energy system under climate policy, applying a numerical technoeconomic model of the power system. We find that high capital costs can significantly reduce the effectiveness of carbon prices: if carbon emissions are priced at USD 50 per ton and the WACC is 3%, the cost-optimal electricity mix comprises 40% renewable energy. At the same carbon price and a WACC of 15%, the cost-optimal mix comprises almost no renewable energy. At 15% WACC, there is no significant emission mitigation with carbon pricing up to USD 50 per ton, but at 3% WACC and the same carbon price, emissions are reduced by almost half. These results have implications for climate policy; carbon pricing might need to be combined with policies to reduce capital costs of lowcarbon options in order to decarbonize power systems.

Reports of coal’s terminal decline may be exaggerated

“…The feasibility of a transition away from unabated coal will also depend on available technological alternatives and accompanying policy instruments. For example, policies that de-risk investments into lowcarbon technology can significantly lower the carbon price level necessary to induce a coal phase-out [44]. In addition, increased deployment of low-carbon energy sources will require improved grid integration to be able to deal with the variable availability of solar and wind power appropriately [32].…”

“…Countries refraining from coal use or extraction should be compensated accordingly. Otherwise, poor countries are unlikely to bear the additional costs of clean energy sources [45], especially with regard to the required high initial investment costs in the face of capital constraints [44]. Such support could take the form of e.g.…”

The Social Costs of Electricity Generation—Categorising Different Types of Costs and Evaluating Their Respective Relevance

“…This is because society as a whole can effectively reduce the non-systematic risk that individual investors bear to zero by pooling risks across the entire population [45,46]. Lower discount rates lead to lower LCOE, with this effect being more pronounced for capital-intensive technologies, especially nuclear power plants, compared to plants with higher operational costs, such as natural gas [47].…”

How regional differences in cost of capital influence the optimal design of power systems

“…However, Brückmann [34] found that no tightening of this WACC gap has occurred in recent years. An interaction between the WACC and the price for CO 2 emissions has been found by Hirth and Steckel [35]. Accordingly, higher WACC require higher CO 2 prices to achieve the same reduction target.…”