Viewpoint: Why a zero-subsidy future means looking past LCOE

Just when we had all (sort of) got our heads round the idea of the levelised cost of energy (LCOE), we need to do more.

Cost reduction in renewables has been so successful that we are starting to see projects developed without subsidy, even in offshore wind.

Once politicians realise they can have renewables with "zero subsidy", we can be certain they will want to see a lot more of it.

By definition, LCOE is a levelised cost, which is very helpful when the revenue is also levelised by a fixed-price power purchase agreement (PPA).

In this context contract for difference systems, such as that seen in the UK, act as a fixed-price PPA. The lower your LCOE, the lower you can bid in an auction to win a PPA.

Once you’ve won and are supplying energy, every megawatt hour supplied is worth the same amount. In a zero-subsidy world, however, the price the supplier receives depends entirely on market forces.

Many countries now have significant renewable generation capacity in their energy mix. Frequent news stories from across the world tell of how "renewables generate more than coal" or "renewables account for a record share of total generation".

This renewable generation capacity operates with very low marginal cost because its "fuel" is free. In such countries, everything else being equal, the more the wind blows, the higher the supply of energy, and the lower the price will be.

This fundamental shift to power prices being dependent (at least in part) on wind speed is why we need to go beyond LCOE.

What will this exposure to the red tooth and claw of the market mean in practice for the wind supply chain? For example, what would be the optimum rotor size?

With no subsides, it is likely a turbine with a larger rotor will show a better project internal rate of return (IRR) because it delivers more energy at lower wind speeds, when the market price is (on average) higher.

The optimum rotor size in this scenario is likely to be very different from that in an LCOE world.

Other examples of actions that could improve IRR in a zero-subsidy world include: changes to operations and maintenance strategy; changes to turbine operating strategy; "overplanting" a wind farm, and the addition of energy storage.

All will optimise possible production in a different way to that required for fixed-price PPA scenarios. Of course, the wonders of the invisible hand of the market means that if the whole market adopts such strategies, supply will increase and price rises will be smaller when wind speeds are low.

Such complexities reinforce the need for a strategic approach to cost modelling in these exciting times for the renewable-energy industry.

Increasing project returns

Cost modelling tools have to be extended and adopted to better describe this beyond-LCOE world.

They will need to include hourly analysis of wind speed, market price and curtailment, and power curves for operating farms.

This will allow an accurate average annual power price achieved by the wind project to be assessed.

But this will just provide one half of the story. The power then has to be converted into expected revenue. In an LCOE world, this would be simply multiplying output by the fixed price given for each MWh.

In the zero-subsidy world, the price, and hence revenue, is itself a variable that needs to be modelled, with the ultimate goal of increasing project returns. LC-EMp (levelised cost of energy at market price) has emerged as a useful concept.

LC-EMp is dependent on the factors above, and, when optimised, will deliver the best project returns while avoiding the need to model full project cash-flows at every stage.

Generating these new models requires a combination of academic rigour and real-world experience.

A useful and robust model will give potential investors more confidence in project revenues and overall returns, lowering perceived risk from projects by at least partially countering increased risks from being exposed to market prices.

Of course, being exposed to market pressures and having to model optimum output in the face of variables impacting both supply and demand is a reflection of the increasing "normalisation" of wind-energy markets, as this is how commercial markets normally operate.

While LCOE is still an essential concept, it is clear that we need to go beyond to the world of LC-EMp.

This brave new beyond-LCOE world requires a fundamental shift in thinking, business models and approach to the wind market.

History has shown us that the wind industry has the individuals to rise to that challenge and continue the drive for a sustainable global electricity generation mix founded on renewables.

Giles Hundleby is a director of BVG Associates