These slides cover the levelized cost of electricity, and the simple economics of energy imports.

1. Electricity Pricing and Other Topics
Environmental Economics II Spring 2014
Lecture based on Borenstein and Field Ch. 11
Prof. Maggie Winslow

2. Levelized Cost of Electricity
• LCOE is the price for electricity required to
equate the NPV of the revenue from
electricity production with the NPV of the
cost of production.
N
LCOE
Cn(qn ,...qN )
å qn ´ (1 + r )n = å (1 + r )n
n=1
n=0
N

3. N
Cn (qn ,...qN )
å (1+ r)n
LCOE = n =0 N
qn
å (1+ r)n
n =1
• This is the discounted stream of costs
divided by the discounted stream of
quantity produced.

4. Why is LCOE Important?
• These estimates can affect policy
decisions regarding alternative energy
production options.
• However, LCOE is difficult to estimate.

5. Difficulties in Estimating LCOE
• Forecasts of future fuel prices important but lots of
uncertainty. High variance in forecasts.
• Some generation just for peak times, other for base times so
LCOE not comparable (capacity factor issue)
• Timing of generation is important due to difficulties with
storage – how do you value this?
– Electricity demand is fairly inelastic in the short term so supply
must be very elastic to avoid brownouts.
– Dispatchable vs. intermittent
• Location of generation can make a difference in value due to
cost of transmission.
• Doesn’t include changes in price of electricity year to year
which is relevant to timing of costs and generation.

6. LCOE and Externalities
• Cost of externalities not included, but
costs of meeting regulations are.
– Would including cost of externalities matter in
choice of generating facility?

7. How to Promote Renewables?
• Subsidies for green power helpful but not the
right approach:
– Makes power cheaper so doesn’t promote energy
conservation,
– Doesn’t recognize the variations in the power
being replaced. e.g. replacing coal fired plant
more beneficial than replacing gas fired plant.
– Not clear that it helps develop the industry for the
international market.
• Not the same as taxing brown power

8. Energy Subsidies (Field, pg.197)
• Reduced taxes for producers to encourage certain
types of production (ethanol, domestic)
• Public support for R&D (ex. coal gasification)
• Public insurance (nuclear power)
• Not charging for externalities (free use of public
goods)
• Direct payment for adopting certain technologies.

9. Energy Subsidies (Borenstein
pg.12)
• Fossil fuel subsidies from 2002- 2008 =
$72 billion
• = about $0.0011 per kWh

10. Shadow Pricing
• When true value does not show up in the
market, shadow pricing provides a proxy
value.
• This could be used to include the cost of
externalities when evaluating the cost of
various generation options.

11. Electricity Generation and Environmental Externalities:
Case Studies, DOE/EIA-0598
1995

13. Net Metering
• Small scale electricity generators being paid for the electricity
they generate.
• Varies in different areas.
• Difficult due to high fixed cost associated with electricity
generation and distribution.
• Fixed costs can vary little when customers generate their own
electricity.
• Off-setting peak power could reduce fixed cost needs.

16. fiid.org/wp-content/uploads/2012/11/Electricity-production-from-different-sources-US-Japan-China-and-Brazil-2010%C2%A0.png

20. Current Issue – Energy
Independence

22. http://www.eia.gov/forecasts/aeo/er/early_production.cfm

23. Import Dependence: The Simple Economics of
Petroleum Importation (from Field Chapter 11)
P
SD
SI
P*
Demand
q2
q1
Q

24. Increase ratio domestic and decrease
imports through decreased demand
P
SD
SI
P*
Demand
q2
q1
Q

25. Increase total domstic amount and
decrease imports through investing in
domestic extraction
P
SD
SI
P*
Demand
q2
q1
Q

26. Increase the cost of imports
through tarriffs
P
SD
SI
P*
Demand
q2
q1
Q

27. In Class Exercises