10 November 2016

It seems that it was a good day to get reports out yesterday; alongside the CfD Allocation Round announcement the UK government has also published its revised assessment of the critical Levelised Cost of Energy (LCOE) for energy generation technologies.

For those unfamiliar with the term, the Levelised Cost of Energy (or LCOE to its friends) is a standard measure of the full lifetime (discounted) cost of generating technologies from construction to decommissioning, divided by its lifetime energy generation. The LCOE, therefore, gives a cost per MWh, which is, as much as it can be, comparable across all technologies.

There are problems with the LCOE measure; arguably it tends to penalise those technologies with high upfront capital costs but lower operating costs. This applies to most renewables, since they typically have higher construction costs but the fuel to operate them – wind, sunshine etc. - is free. However, the UK government, especially the treasury, has put a lot of stock into the LCOE measure as a key indicator of energy costs. It is also considered a good indicator of the level of revenue return needed to incentivise investment in building new generating plants.

Cheaper than gas!

The new Department for Business, Energy and Industrial Strategy (BEIS) Electricity Generation Cost report shows that there has been a massive turnaround since the last full LCOE assessment was done in 2013. The key table in the report shows that for future projects expected to be commissioned in 2025, onshore wind and large scale solar generation will have lower levelised costs than the next generation of Combined Cycle Gas Turbine (CCGT).

There are two key factors driving this turnaround. Firstly, as the report highlights, since 2013 there has been a dramatic fall in the projected lifecycle cost of onshore wind, offshore wind and large scale solar. The table below shows just how far costs have fallen; for example, for offshore wind, the central assumption of £155 MWh has fallen to £109 MWh for projects commissioned in 2016.

The second factor has been a reality check on the cost of developing new gas fired power stations. The conventional wisdom was that the generation cost of gas power would be at or around the wholesale price of electricity. But that was largely based on legacy assets.

In reality, at the prevailing wholesale price, new gas-fired power stations will not be built. Instead energy analysts have been saying for some time that investors would need a higher level of revenue, perhaps as high as £80 per MWh or more, in order to build new plant. In other words, as the report confirms, the LCOE of gas is far higher than previously thought. For new CCGT plants to be commissioned in 2025, the central case LCOE is £82 MWh, compared to onshore wind at £61 per MWh and large scale solar at £63 per MWh (note LCOE figures quoted are as taken directly from the BEIS report which for consistency are in 2014 values). Even the low cost scenario for CCGT commissioned in 2025 is as high as £80 per MWh. The central figure for new nuclear in 2025 is £95 per MWh.

Even Cheaper?

There is a tendency for BEIS work on LCOE to already be out of date by the time it’s published.

The central LCOE estimate for offshore wind in 2025 is £100 per MWh, but already this seems high, especially compared to recent projects in Europe. We will know a lot more after the next CfD auction in April 2017, when the bids for offshore wind projects in 2021-23 could well break the £100 per MWh barrier.

Our conversations with industry suggest that a central estimate of £67 per MWh for solar commissioning in 2020 is already achievable. It was interesting to see Ofwat recently highlighting that solar auctions have recently cleared at £25/MWh in Chile and £17/MWh in Abu Dhabi. Whilst not directly comparable with the UK LCOE these are striking figures.

Meanwhile, wind projects are being developed in Scotland based on the wholesale price of power (around £40 per MWh) as we speak. These may be the exception, but it makes a prediction of £60 per MWh by 2030 look conservative.

What does this mean?

Having complained that the LCOE is a poor measure for several years, it would be wrong to overstate its importance now that the figures are more favourable. Direct comparisons between technologies are problematic - the LCOE does not include the value of flexibility or energy security, and the LCOE has always undervalued the externalities of pollution and carbon emissions. It can also be argued that the BEIS LCOE calculation does not fully account for the cost and underwriting of decommissioning and waste management of nuclear energy.

Nevertheless, the new generation cost analysis ought to have a profound impact on policy makers both in terms of the future energy mix and on how we consider the cost of decarbonisation.

It begs the question of why the government continues to exclude the cheapest forms of energy generation from the CfD market. It highlights once again that ALL forms of new generation – renewables, fossil fuels and nuclear – need some form of revenue support. It also sheds light on the fact that of all the technologies, it is only renewable energy whose costs are falling.

So as an industry we should be very proud to shout it out – “Renewable Energy is both cheap and clean” – it would be great to hear government do the same!

BEIS is partnering with Regen on our Renewable Futures conference, to discuss the energy policy priorities for the new government and to hear your views on the new smart power call for evidence:

Renewable Futures and the Green Energy Awards: pathways to decentralised, flexible energy

29 November 2016, Assembly Rooms Bath

Author: Johnny Gowdy

Contact: [email protected]