Wind Energy Economics
Michael Milligan, National Renewable Energy Laboratory
Introduction Economic evaluations of wind plants include detailed estimates of costs and benefits. A number of factors influence the economics of a wind plant: the characteristics of the wind resource, the size of the project, the financing methods and firm structure, and unique requirements such as interconnection with the grid or special siting (offshore wind farms, for example). The cost of wind turbine hardware, including the interface to the transmission system, can usually be accurately estimated. However, disagreements can occur over how to correctly allocate the cost of new transmission and other joint-use facilities, whether to use accounting or economic costs (or benefits), and which method to use to determine potential operating cost impacts of wind plants. A number of assumptions must be made in a cost-benefit analysis, such as how to discount future revenue/costs to the present; how to estimate the future rate of inflation; and how to calculate the risks, both positive and negative, that are influenced by wind power plants. The economics of a wind power plant can also be affected by power market structure. For example, some power pool operating rules impose high penalties on generators that can’t be accurately scheduled. Penalties that are intended to be punitive can be high, significantly eroding the economic viability of the wind plant. The impact of penalties that are cost-based is not so severe. In California, the Independent System Operator has a special tariff for wind plants that elect to participate in the program. In return for paying a small forecasting fee, hourly imbalances (the difference between actual generation and predicted generation) are netted over the month and charged a weighted average price. This practice has also been proposed by the Federal Energy Regulatory Commission in its Standard Market Design.
Costs Over the past several years, the cost of wind energy has declined dramatically. Figure 1 illustrates this decline. The cost of energy (COE) is a function of the technology, quality of the wind site, and financing structure of the wind plant owner. Some economies of scale are also involved in the construction process. For example, obtaining permitting, developing infrastructure such as site access, and providing cranes to erect the turbines involve relatively high fixed costs, regardless of the size of the project. Larger projects can therefore benefit because these costs are spread among more turbines (and therefore, more energy production). If joint-use facilities or other cost allocations among different plants are not involved, assessing accounting costs is often straightforward. The primary costs of wind plants are fixed costs that are incurred during project development. The major cost components include land (lease or purchase), the rotor assembly (including hub), tower, generator, power electronics, controls and instrumentation, drive train components, and yaw system. Land costs often include an upfront payment of $1,000-$3,000, and annual landowner lease payments are typically between $1,500 and $2,000 per turbine. Because wind power doesn’t use fuel, the primary ongoing costs are operation and maintenance expenses. To integrate wind power plants into the electrical supply, the additional ancillary services may be required (regulation and load-following services) that can be provided other power plants to compensate for wind’s volatility.1 Obtaining transmission access can also involve a cost, although this is highly dependent on the power purchase agreement, transmission line loading, ownership of the line, operational jurisdiction of the transmission system, and other financial characteristics of the project. In many cases, transmission use is assessed with a two-part rate based on capacity and energy. If transmission rates are based on locational marginal pricing (LMP) on a congested system, significant variations in rates at different times and locations can occur. Once cost estimates have been established, they must be spread over the estimated life of the project (usually 20 years). Based on estimates of annual wind energy production, average energy cost can be calculated. So that the real cost of wind can be estimated in current dollars, estimates of future inflation must be established, along with an estimated discount rate to discount future costs to the present. The project cost will normally be quite sensitive to these assumptions, so it is often useful to vary the parameters so that their influence on project economics can be assessed. Rotor (17.28%) BOS (29.50%) Land (0.15%) Tower (13.10%) Drive train, nacelle (39.24% Control, safety (0.73%)
Costs are also highly dependent on the method of financing (mix of debt/equity) and whether the project owner is an investor owned utility (IOU), rural electric cooperative (REC), or non-utility generator (NUG).2 In addition to the different interest rates that each of these entities would pay, only IOUs and private NUGs qualify for the Federal Production Tax Credit (PTC), whereas RECs qualify for the Renewable Energy Production Incentive (REPI). Wiser and Kahn find significant differences in financing costs that arise from these alternative arrangements. Figure 4 illustrates the range of possible costs for different financing arrangements. The graph also illustrates the important impact of the size of the project on average energy cost. For small projects, it is not possible to capture various economies of scale related to the cost of permitting, construction, and grid connection.
Economic costs include accounting cost, plus any additional costs that may not be taken into account by the market. For wind farms, these costs are typically believed to be small and difficult to measure. They could include the negative visual impact of a wind farm or increased traffic during the construction of the wind plant.
Benefits Perhaps one of the most obvious benefits of wind is that it reduces the need to use conventional fuels for power generation. Accurately determining the dollar value of this fuel saving can be difficult, particularly given the varying level of restructuring of power markets in the United States. In regulated markets, the value of fuel saving can be estimated by running an electricity production simulation model to determine which power plants’ operation would be curtailed by the wind plant and by how much. Different regions have different fuel mixes and different operating characteristics, so the value of this fuel offset can vary significantly across the country. In restructured markets, a similar type of model can be used after adapting it to the local market conditions. The economic incidence3 of these benefits will also vary widely. For example, an IOU that uses large amounts of wind will save on its fuel bill, whereas in a restructured market, an NUG with a conventional plant may reduce its output (and therefore sales and profits) because a wind NUG could bid a lower cost of energy for some hours of the year. One significant example of the difference between accounting cost and economic cost is the environmental damage caused by many conventional power sources. Because pollution costs are not incurred directly by power generators, companies don’t have an incentive to reduce pollution unless specific regulatory agencies require it. Specific estimates of the monetary value of pollution are complex to evaluate. However, plausible ranges can be established, such as those developed in Minnesota.4 Wind power plants can reduce fuel usage by conventional power generation, which will in turn reduce emissions of NO2, SO2, and other pollutants, depending on the fuel involved. The economic benefit of the emission reduction induced by the wind plant can be estimated using a range of monetary values for the various pollutants. A conventional generator consumes large amounts of fuel over its lifetime, which can be 20-30 years or more. During that time, significant fuel price increases over and above the rate of inflation can occur. For example, in February 2003, natural gas prices on the New York Mercantile Exchange increased from $6.60/MBTU to $10.90/MBTU, a 65% increase. To help guard against the risk of fuel price volatility, various risk-mitigation strategies are pursued that provide a hedge against possible rising fuel costs. This hedging activity incurs a real cost, and this cost is normally excluded from the analysis of conventional generation costs. Because wind plants don’t consume fuel, there is no risk of fuel price increases; therefore, there is no need to pursue the associated hedging activities. The hedging value provided by wind plants has been estimated to be approximately $0.005/kWh.5 Wind power plants can provide an economic stimulus to the local economy. The range of impacts depends on a number of factors, including the size and characteristics of the local economy, sources of capital, ownership of the plant, and the size of the wind plant. Much of the economic impact occurs during the construction period of the wind plant. In rural areas, it is common for farmers to receive lease payments for wind turbines that are located on the farmland. Significant tax revenues can also be generated by the wind plant, depending on the local tax structure and the size of economic development incentives that are granted to the developer. In addition to offsetting the fuel used by conventional power plants, wind plants can reduce the need to build new conventional generation, which is called capacity credit. Capacity credit can be assessed using detailed power production simulation models. Because wind plants don’t provide constant power output, the capacity value of a wind plant is some fraction of its rated capacity, and it can range from 20%-40% of rated capacity (percentage values outside of this range are also possible). One of the key determinates of the capacity value is the quality of the wind resource and its temporal match with the electricity demand.
Other Issues Evaluating the economics of a wind power plant is a reasonably complicated undertaking and is subject to a number of important assumptions. When comparing the economics of a wind plant with the economics of another technology, it is important to compare “apples to apples.” For example, comparing the cost of a new wind plant to the cost of existing generation is not valid because most old power plants have fuel contracts that were locked in at low prices, and new gas or coal plants will not be able to duplicate those contracts. When new generation is built, regardless of the technology, additional transmission capacity is often required. This is particularly true in the western regions of the United States. Allocating transmission costs to specific generators is a complex process because new transmission can provide other benefits and because transmission is an example of a joint use facility. Small assumptions can lead to differing cost allocations. The specific conventional fuel reduction benefits of a wind plant will also depend heavily on the local fuel mix. This extends to emission reduction benefits as well. Because wind is an intermittent power source, this variability can impose additional costs on the system relative to a conventional power plant. This variability must be analyzed in the context of the entire power system, which already has significant variability. Wind forecasting technology can help reduce the impact of wind’s variability on the system.
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