Energy economics in an era of carbon pricing

How much does low carbon electricity cost? What carbon price is needed to make it economical, and how does that price compare with the true external costs of carbon emissions?

I’ve looked at the carbon emissions from several electricity generating technologies in an earlier post, now I’ll take a look at the costs of low carbon electricity.

What Are the External Costs of Carbon Emissions?

The cheapest electricity in the UK comes from fossil fuels. That’s because fossil-fuel power stations do not bear the external costs of their CO₂ emissions. Their carbon emissions and consequent global warming carry an economic cost, but that cost is borne by third parties, not by the polluter. There are several ways to correct such “negative externalities” of a market activity. When it’s done through taxation, for example, it’s called a “Pigovian tax”.

The first step towards charging for the external costs of carbon emissions is to quantify those costs. One of the most rigorous economic analyses of this question was performed by the UK Stern Review of the Economics of Climate Change ^[1]. This is its key conclusion on emissions costs:

Preliminary calculations adopting the approach to valuation taken in this Review suggest that the social cost of carbon today, if we remain on a BAU [business-as-usual] trajectory, is of the order of $85 per tonne of CO₂ [£155/tC] – higher than typical numbers in the literature, largely because we treat risk explicitly and incorporate recent evidence on the risks, but nevertheless well within the range of published estimates. This number is well above marginal abatement costs in many sectors.

Stern Review Executive Summary, (page xvi) ^[1]

This value, £155 per tonne of carbon, is probably the best estimate currently available of the social cost of carbon emissions.

Impact On Electricity Costs

What is the outcome on electricity costs if we apply this carbon price to electricity generation?

A carbon price can be established through tax, trading or regulation. I won’t go into the detail of the pricing mechanism here, I’ll simply look at the effect of applying Stern’s estimate of carbon cost to the UK electricity market. As a part of the Stern Review, Prof. Dennis Anderson produced a study that addressed this very point ^[2]. He calculated the effects of a carbon price on the relative costs of fossil fuel and low carbon technologies. Prof. Anderson is Emeritus Professor of Energy and Environmental Studies at Imperial College. Anderson produced a further updated report for the Institute for Public Policy Research ^[3] in 2007. I’ve used the numbers from that more recent report here.

Table 1 presents data from Anderson’s IPPR report. The table compares several low carbon technologies against the lowest cost “marker” technology for electricity generation in the UK. Three carbon prices are considered; zero, £100 per tonne of carbon, and £200 per tonne of carbon. These values bracket Stern’s estimate for the actual external cost of carbon emissions, and this is also the carbon price range than policy discussions are focussed on.

The “marker” technology is the cheapest present-day option. This is what the low carbon option is competing against. The marker technology for distributed photovoltaic and decentralised Combined Heat and Power (dCHP) is grid electricity. The marker technology for the other low carbon technologies, which supply power to the grid, is coal or natural gas combined cycle (NGCC). Prices in the medium term (up to 20 years) and long term (over 20 years) are evaluated. The “longer term” prices factor in the opportunities for technological innovation over a longer period.

Table 1.  Relative Costs of Low Carbon and Fossil Fuel Technologies, and the Effects of a Carbon Price at £100/tC and £200/tC

	Carbon price	Electricity price (a)
		Medium term	Longer term
	£/tC	p/kWeh	p/kWeh
Marker technologies
Natural gas or coal; (b)	0	3.2	2.6
Natural gas or coal;	100	4.6	4.2
Natural gas or coal;	200	5.6	5.1
Grid electricity;	0	8.0	8.0
Grid electricity;	100	9.7	9.7
Grid electricity;	200	11.4	11.4
Low carbon technologies
Electricity from gas with CCS (c)		5.2	4.8
Electricity from coal with CCS (c)		5.2	4.8
Nuclear power (c)		3.9	3.5
Electricity from energy crops (c)		6.4	4.8
Electricity from organic wastes (c)		6.9	4.1
Onshore wind (c)		4.4	3.9
Offshore wind (c)		8.2	6.0
PV for distributed generation (d)		42.1	24.0
Decentralised CHP (d) (e)		24.2	8.8
Data are from the IPPR study [3]; Carbon prices are in UK pounds per tonne of carbon; Electricity prices are in pence per kilowatt-hour of electricity; The table assumes an oil price of $50/barrel; The table assumes a gas price of £4/GJ. CCS means Carbon Capture and Storage;  CHP means Combined Heat and Power; Notes: (a)  “Medium term” is up to 20 years;  “Longer term” is over 20 years; (b)  The figures for natural gas assume combined cycle operation; (c)  The “marker” technology for this low carbon technology is coal or natural gas; (d)  The “marker” technology for this low carbon technology is grid electricity; (e)  Decentralised CHP uses hydrogen obtained from natural gas or coal with CCS; Low carbon technologies with a price lower than their marker at £100/tC are highlighted.

Some Conclusions

Now, what do the numbers show? Let’s start with the caveats. The cost estimates for the low carbon technologies are only accurate to about 25%–30%. The estimates assume an oil price of $50/barrel, but the price of oil has now risen to over $100/barrel. Higher fossil fuel prices favour the low carbon options. Also, technology advances in solar photovoltaics, as discussed in a previous post, mean that PV costs may drop more quickly than projected in this model.

Dungeness B nuclear power station (British Energy)

I’ve highlighted the most cost-effective low carbon technologies in Table 1. These have a price that is lower than their respective “marker” technologies when a carbon price of £100/tC is applied. They are the overwhelmingly cost-effective technologies when the true external costs of carbon emissions are factored in. Some clear points emerge from the data in Table 1:

• From Anderson’s IPPR report, “There is not a single low carbon technology for supplying energy for which the expected costs are lower than those of the fossil fuel or ‘marker’ technologies.”  This is the key rationale for a carbon pricing policy.
• With carbon emissions costs factored in, the lowest cost electricity is from nuclear energy and on-shore wind.
• In the longer term, electricity from organic wastes and dCHP also become cheaper than their “markers”, even at a low carbon price of £100/tC.
• At a higher carbon price of £200/tC, all the low carbon technologies except off-shore wind and distributed PV beat their “markers” on timescales beyond twenty years (but see the comment about PV above).

References

1. STERN REVIEW: The Economics of Climate Change, N. Stern, Executive Summary (2006)  (WebCite cache)
2. Costs and Finance of Abating Carbon Emissions in the Energy Sector, D. Anderson, Supporting Research commissioned as part of the Stern Review (2006)  (WebCite cache)
3. Policies for a Low Carbon UK Energy System – Findings of a Study For IPPR, D. Anderson, Institute for Public Policy Research (2007)  (table 6, p.26; table 9, p.34)  (WebCite cache)