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Energy price competitiveness & energy security

The case for renewables and energy efficiency Dr. Oliver Probst
Physics Department and Center for Energy Studies / Research Chair for Energy Instituto Tecnolgico y de Estudios Superiores de Monterrey

Contents
The coming scarcity of fossil fuels Natural gas: The preferred fuel for electricity generation Discounting, least-cost electricity planning and riskadjusted cost of electricity Portfolio theory as a tool for combined least-cost/leastrisk electricity planning Generating portfolios including renewable energy technologies Future strategies

Discovery of oil in giant fields worldwide


Giant Fields (>500 Millio barrels/field)
Initial reserves by discovery year

The coming scarcity of fossil fuel

>60% of all oil found in giant fields

1965 The golden age


Reserve revisions dated back to discovery year

1995 Almost no new oil found in giant fields


Source: C. Campbell, The Coming Oil Crisis 1997, p.52

The coming scarcity of fossil fuels

Canadian gas reserves


includes confidential pools
25

Reserve replacement
10

Pool size and number


Alberta/Canada
1600
Pool count Pool size 15 1400 1200 1000 800

Total Alberta (raw),


Connected new reserve additions

20

6 4

1998 consumption level

Consumption

10

600
400 200

1960

1965

1970

1975

1980

1985

1990

1995

0 1960 1970 1980 1990

Only in two years since 1959 (!) have new connected reserve additions surpassed the 1998 consumption level. Most of presently produced natural gas is coming from pools discovered in the sixties or earlier!

An ever-decreasing pool size has generated a frantic drilling activity with numbers averaging 1000 pools/year since the mid-seventies.

Source: R. Woronok, Canadian Gas Supply: Going up? Or down?, Canadian Gas Potential Committee

Natural gas: Price volatility


8 (US$/Mbtu) 7 6 5 4 3 2 1 0 Rocky Mountains Northwest Domestic California Southern California Border Average Northeast - Niagara East Texas Houston Ship Channel

Mexican monthly natural


gas prices over four years (Jan 2000 March 2004)

Monthly natural gas prices PEMEX (central zone) $10

March 28, 2003

March 26, 2004

$8

US$/MBtu

Source: Natural Gas Intelligence, http://intelligencepress.com/

$6 $4 $2 $01/00 01/01 01/02 month/year 01/03 01/04


Source: PEMEX

US weekly natural gas

prices over one year (March 2003 March 2004)

Discounting and least-cost planning


Simplified view of electricity cost assessment
500

NPV [a.u.]
0

S E NPV I 0 k kk k 1 1 i
NPV= net present value N Sk Ek I0
= financial horizon = income from sales year #k = expenses year #k = initial investment

i = 0%

-500

i = 5%

-1000 0

10

15

Time [years]

= (fixed) discount rate

What is the correct discount rate? 1. Investors view: Lowest interest rate at which money can be borrowed (of the order of 7%) 2. Consumers view: Highest interest rate obtainable for savings at no risk (of the order of 4%)
Source: R. Newell, W. Pizer, Discounting the benefits of climate change mitigation, Pew Center for Global Climate Change, December 2001

Traditional cost of electricity estimates

The effect of fuel cost


CCGT-US$4/GJ CCGT-US$5/GJ CCGT-US$6/GJ Wind 30%

0.070

0.065

Wind

1GJ 1MMBTU i = 5% Wind farm plant factor = 30%

Cost of electricity [US$/kWh]

0.060

0.055

US$6/GJ
Even traditional COE estimates show wind energy to be competitive with CCGT for fuel prices in the US$56/GJ range.

0.050

0.045

US$5/GJ US$4/GJ

0.040

0.035 10 12 14 16 18 20 Amortization period [years]

Traditional cost of electricity estimates

The efect of discount rate


CCGT-5%

0.085

0.080 CCGT-10% Wind 5% Wind 10% 0.070

0.075

Cost of electricity [US$/kWh]

Wind

0.065

(Arbitrarily) choosing higher discount rates heavily affects renewable energy technologies like wind, but does little to fuel-based technologies like CCGT.
Moreover, discount rates must be tied to risk (see next sections)
18 20

0.060

0.055

Gas

0.050

0.045 10 12 14 16 Amortization period [years]

Risk-adjusted cost of electricity from finance theory


Electricity cost [US cents / kWh]

Adding risk to the picture:

The basic idea: Risky cost-streams have to be discounted at a lower rate Example: CCGT fuel cost
Approach Traditional (arbitrary) Based on historic fuel 2.3% price volatility Contractually 3.9% guaranteed prices Discount rate 7%

Coal boiler

Coal IGCC

Gas CC

Gas GT

Nuclear

Bio

Conventional Solar Wind thermal hydro

Geo

Risk-adjusted cost of electricity estimates (Europe/IEA countries) based on historical fuel price risk
Source: Shimon Awerbuch, Renewable Energy World, March/April 2003 Reproduced with kind permission by Dr. Awerbuch

But, what about long-term contracts?


Even assuming 30-year fuel purchase contracts at no cost raises the cost of electricity estimates considerably.
Coal boiler Coal IGCC Gas CC Gas GT

Risk-adjusted cost of electricity

Nuclear

Risk-adjusted cost of electricity estimates assuming that projected fuel costs can be assured by long-term contracts (30years) at no cost
Source: Shimon Awerbuch, Renewable Energy World, March/April 2003 Reproduced with kind permission by Dr. Awerbuch

A primer of Portfolio Theory

The Portfolio Effect

Investing in a suitable portfolio of two risky assets is less risky than investing in any of the two assets alone

Correlation coefficient =0.6

Source: S. Awerbuch, M. Berger, Applying portfolio theory to EU electricity planning and policy making, International Energy Agency, EET/2003/03, February 2003 Reproduced with kind permission by Dr. Awerbuch

Combining a risky portfolio with a riskless asset


Adding a riskless asset reduces the combined portfolio risk at any level of return (below M) or, conversely, increases the portfolio return at a given risk level, even though the stand-alone return of the riskless asset is low.
Given risk level

A primer of Portfolio Theory

Given level of return

Source: S. Awerbuch, M. Berger, Applying portfolio theory to EU electricity planning and policy making, International Energy Agency, EET/2003/03, February 2003 (slightly modified) Reproduced with kind permission from Dr. Awerbuch

Efficient Frontier and Sharpe Ratio


Anual return on investment [%]
Efficient frontier (Markovitz) Security

Portfolio theory

r (x)

Efficient security Arbitrary securities

Rf

S x

r x R f

s (x)

Risk (standard deviation) [%]

s x

Sharpe Ratio

Building an risk-efficient generation portfolio for the

US (coal+gas+renewables)

Risk and "Return" for Three-Technology US Generating Portfolio


Assumed Cost for Riskless Renewable: $.12/kWh
18%
M: Optimum Coal-Gas Mix (72% - 28% ) K: 6% Renewables K M
Coal-Gas Capacity Mix: 65% - 35% A

Note: In order to apply the language of portfolio theory the reciprocal electricity cost is defined as the return.

60% Gas

"Return" (kWh per Cent)

16%

Return of a minimal risk coal-gas portfolio (77%coal, 23%gas)

14%
Coal-Gas Generation Mix: 77% - 23%

12%

B: 100% COAL

10%
F

H: 50% Renewables + 50% M

8% 0.00

100% Renewable

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

RISK: Portfolio Standard Deviation


Source: S. Awerbuch, "Getting It Right: The Real Cost Impacts of a Renewables Portfolio Standard," Public Utilities Fortnightly, February 15, 2000.

Even at US$0.12/kWh the renewable energy technology reduces the portfolio while maintaining the portfolio return.

A portfolio with 6% renewables (and 68% coal, 26% gas) is less risky at the same return

Risk of 77% coal/23% gas portfolio Graph reproduced with kind permission from Dr. Awerbuch

Building an risk-efficient generation portfolio

for the
0.27 0.26 0.25 0.24 0.23 0.22 0.21 0.20 0.19 0.18

Mexico (preliminary)

Portfo lio RE TURN [kWh/cent]

RIS K: Portf olio Stand ard Deviation

Taken from a draft by Dr. Awerbuch (with kind permission)

Mexican generation portfolios


Neither the current generating mix nor the expected business as usual mix expected in 2010 (resulting mainly from massive additions of generation capacity based on natural gas) are efficient in the sense that they lie well below and to the right of the efficient frontier. The addition of renewable energy technologies may improve portfolio efficiency considerably, although some portfolios may not be technically feasible at present.

Strategies: Meeting new electricity


demand by additions of central power plants
Utility management

Planning staff

Contracters

Large power plant (500-1000MWe)

US$ 800-1,200 kWe

demand by energy efficiency projects


Government
Energy efficiency codes Technical guidelines and assistance
Funds

Strategies: Meeting new electricity

Energy efficiency projects at industry/government/buildings/transport


Funds from private investors and institutions

Consultants (ESCOs)

Freed generating capacity (Nega-Watts*)

US$ 100-300

Energy efficiency projects require a substantially lower investment/kW but involve many actors and therefore require efficient societal efforts. Code enforcement is as important as the design of a true market for energy efficiency projects.

kWe

*Term coined by Amory Lovins

Renewable energy technologies


Readily available alternatives

Landfill gas: Mostly conventional technology, helps address waste issues

Wind: Mature technology, very fast growing markets


Vrnamo gasification plant (Sweden)

Biomass pellets

Solar hot water: Robust and cheap technology

Biomass: Gasification/ direct combustion: Technologies for fuel handling/conditionning available

Conclusions
Natural gas is a fuel with high price volatility (at least in North America) and therefore should be considered a risky cost-stream. Substantially higher natural gas prices can be anticipated from the few resource additions during the past four decades and the current dash for gas. Traditional discounting for cost of electricity (COE) estimates heavily discriminate renewable energy technologies (RETs), but when adjusted for risk RETs look much more favorable. Portfolio theory applied to COE estimates shows that the addition of small, readily available portions of RET capacity reduce the overall (portfolio) risk, while maintaining the COE.

Thank you!
oprobst@itesm.mx