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Costs methodology for 2050 Calculator

This note sets out the methodology we are using to include costs to the 2050 Calculator.

Summary

The 2050 Calculator includes costs for all activities associated with greenhouse gas emissions. This includes fossil fuel combustion, industrial processes, agriculture and waste, land use, land use change and forestry (LULUCF). International aviation and shipping emissions are also included in the 2050 Calculator for complete coverage of all sectors. [1]

There are 130 technologies in the 2050 Costs Calculator and capital, operating expenditure and fuel costs are included for each of these to 2050. These cost estimates cover the whole of the energy system (everything from: power stations and industrial processes; to cars, planes and trains and the fuel they use; to gas boilers and cavity wall insulation). These costs should not be confused with the bills households pay for their electricity and heating.

The 2050 Costs Calculator has the following cost information for each technology and fuel in 2050:

  • Default point estimate – consistent with MARKAL.
  • High/low costs range - designed to reflect the highest/lowest that credible experts believe costs could be in 2050.

The cost estimates in the 2050 Costs Calculator are drawn from a wide range of credible, published sources. Sources include economic and energy models (in particular MARKAL[2]), sectoral analysis (Parsons Brinckerhoff, Mott MacDonald, AEA, NERA), UK Government Departments, independent analytical bodies such as the Committee on Climate Change and wherever possible the real world cost of technologies as reported by financial bodies or the media. The 2050 Calculator includes no new evidence about costs, it simply brings together existing published assumptions.

There are a number of important caveats to bear in mind when interpreting results from the 2050 Calculator; these are set out below.

Introduction

This paper sets out the methodology used to calculate capital, operating costs and fuel costs in the 2050 Calculator.

The 2050 Costs Calculator released today updates the 2050 Calculator as published in July 2010 and March 2011. The 2050 Calculator now includes information on capital, operating and fuel costs and air quality impacts. It also has updated trajectories for international aviation and shipping and waste.

Scope: Technology and fuel costs only

The Calculator will capture the technology and fuel costs associated with supplying and using energy and producing emissions between 2010 and 2050. Specifically:-

  • On the energy supply side, this includes power stations, primary energy sources (fossil fuels, uranium and biomass) and transmission networks.
  • On the energy demand side, this includes energy users (heating systems, cars and industrial plants) and demand reducing equipment such as insulation.

For each of the c. 130 technologies in the 2050 Calculator, we include capital, operating costs and fuel costs.

Default costs

The 2050 Calculator uses default cost assumptions which are consistent with the latest version of the MARKAL model. These default assumptions do not necessarily reflect the Government's views about future costs.

MARKAL cost assumptions have been used for those technologies where the mapping between MARKAL and the Calculator is fairly straight forward; this is c. half the technologies in the Calculator. We have MARKAL assumptions for: power sector technologies, cars, freight, heat insulation, bioenergy and hydrogen production costs. We used the latest version of MARKAL (version 3.26, the underlying assumptions for which were published in Spring this year).

For those sectors where it is more problematic to map from MARKAL to the Costs Calculator (such as heat and industry) and for sectors which MARKAL does not cover (agriculture and waste), we have used a 35th centile assumption.

In a small number of cases, we did not use the MARKAL estimate or the 35th centile. This was the case for international aviation and shipping (2010-2050 costs) and electric cars (2010 cost).

To see a list of which costs are from MARKAL and which are not view the sources of default costs page.

Finance costs are set at 7% default. For more details on finance costs, see: finance costs methodology.

Fossil fuel prices for 2050 will default to the DECC central projection for 2030 ($130/barrel).

High / low costs range

In the "test assumptions" page in the web tool, the user is able to explore the effect of making more optimistic or pessimistic assumptions about future costs.

Future fuel and technology costs are highly uncertain. The following are just a few factors which could cause future technology costs to be lower or higher:

  • The climate change policy of other countries. Lots of long term, predictable climate initiatives internationally could have a big effect on RDD&D expenditure globally which could bring down technology costs.
  • Success of scientists and engineers in discovering better, cheaper low carbon technology solutions.
  • Technology roll out in other countries. This could push prices up (e.g. if it results in a shortage of, say, CCS engineers), or push prices down (if learning by doing reduces unit costs). The UK is not a very large market and so could be a price taker for many technologies.
  • Technology roll out in the UK. For example, the marginal cost of land used for wind turbines will increase as the roll out of wind increases. Alternatively, marginal cost of installing charging points for electric vehicles may decline as the number of electric vehicles in circulation increases through learning by doing / economies of scale.

Our cost range is a simple way of attempting to capture all the above factors.

The high and low ranges

The cost range for 2050 represents the highest / lowest that credible experts can foresee costs being. Specifically:

  • Low cost estimate – costs are the lowest that credible published studies suggest they could be by 2050, for example assuming technology breakthroughs and low cost material and labour.
  • High cost estimate – costs in 2050 are frozen at today’s levels (or even higher if credible published evidence suggests this could be the case). This assumes no technological breakthroughs over the next forty years and high labour and material costs.

Figure 1 illustrates what the high/low costs range and default costs could look like.

We have not used a point estimate for 2010; this reflects the reality that the same technology is currently sold in the market for a range of prices.

Where there is evidence to suggest it, the 2050 "high" cost estimate is higher than costs today. For example, the 2050 high cost for nuclear is £4.5bn/GW (compared to a typical rate today of £2.1bn/GW).

Figure 1: Picture illustrating high low and default costs

There are three advantages to this simple methodology for defining high/low costs:

  • Simple – this is analytically simple and easy to understand. It is objective because technology costs today are a verifiable fact.
  • Avoids false confidence – there is genuine uncertainty about whether scientists will achieve the technology breakthroughs necessary to bring down the costs of specific technologies. We should not presume that the cost of any technology will fall as a matter of course e.g. history shows that nuclear power costs have actually risen over the last forty years.
  • Consistent with 2050 Calculator trajectory methodology – the technology trajectories reflect all credible views on the role of technologies. Similarly, our high/low range reflects all credible views on possible future costs.

Costs are exogenous

The high/low costs we use for each technology will be the same regardless of which pathway the user selects. In other words, costs are treated as exogenous to the model, not endogenous.

We will do this for two reasons:

  1. To keep the simplicity of the Calculator. If we made the Calculator capable of modelling learning rates then it would be a less transparent, simple and accessible tool.
  2. The UK is likely to be a price taker in many technologies. It would arguably be spurious accuracy because levels of technology R&D and roll out in other countries will arguably have more of an impact on the UK than our own choices (i.e. the UK is a price taker).

Although costs are exogenous, we do make a provision for minimal technological improvement over time. For most technologies, we assume incremental improvements in energy efficiency over time. So although the high, low cost estimates appear constant over time, on a like for like comparison prices are actually falling slightly.

Discounting

Click here for details of: discount rate methodology.

Financing

Click here for: finance costs methodology.

Incremental costs

Click here for: incremental costs methodology.

Comparator pathway

The user can select to view the costs of their pathway relative to any pathway. But as a default, the Calculator shows costs relative to not tackling climate change. Click here to see more infomation on this pathway: All Level 1s

Important caveats and limitations of the analysis

There are a number of important caveats to bear in mind when interpreting results from the 2050 Costs Calculator:-

  • Not impact on energy bills. Results from the 2050 Costs Calculator are presented as £/person/year, but this should not be interpreted as the effect on energy bills. The impact on energy bills of, say, building more wind turbines will depend on how policy is designed and implemented (e.g. via tax, subsidy, regulation, etc). Taxes and subsidies are not captured in the 2050 Costs Calculator so we cannot use the tool to examine these effects. The Government uses other, more sophisticated models to examine the effect of specific policy interventions on electricity and energy prices.
  • Pathway costs should be understood relative to other pathways. The total cost of pathways is presented in the 2050 Costs Calculator but for these to be meaningful they should be compared to the costs of another pathway. This is because there is no “zero cost” option (unless the UK were to stop using energy altogether).
  • The costs exclude important benefits associated with the move to a low carbon economy. Specifically:
  • avoided damage costs associated with climate change. The Stern Review (2006) calculated these at up to 20% of global GDP annually
  • energy security benefits
  • wider resource efficiency savings. [3]
  • Estimates exclude important costs associated with the move to a low carbon economy. Specifically:
  • welfare costs such as inconvenience of living in buildings with less comfortable temperatures and potential inconvenience of travelling less
  • wider macroeconomic costs
  • R&D costs
  • the cost of most existing infrastructure (e.g. the capital and finance costs associated with existing power stations)
  • the policy costs associated with regulating and enforcing future policy
  • opportunity cost (e.g. the opportunity cost of investing in low carbon technologies rather than, say, better schools or hospitals, is not captured)
  • public safety risks (perceived or actual) associated with incumbent technologies e.g. oil extraction, nuclear, CCS
  • costs associated with embedded emissions. The 2050 Calculator does not include embedded emissions because it is designed to reflect the UK's 2050 target and embedded emissions are not included in this. [4]
  • Long term, not short term analysis. The Calculator is best suited to long term analysis of the energy system in 2050 rather than policy implications over the 2010s and 2020s.
  • User driven model, not market based. The 2050 Costs Calculator costs the combination of technologies chosen by the user . Consequently it does not take into account price interactions between supply and demand. For example, if the cost of, say, electricity generation increases then the Calculator does not capture any elasticity of demand response from the electricity user. Cost optimising models better handle such price responses.
  • Costs are exogenous. Technology costs do not vary depending on the level of technology roll out. However if the user has beliefs about how they would expect the unit costs of particular technologies to change in their pathway, they can sensitivity test the effect of varying these assumptions.
  • International aviation and shipping emissions are not currently included in the UK’s 2050 target because of the lack of an internationally agreed methodology for assigning these international emissions to individual countries. They have been included in the Calculator to enable the user to consider emissions across all sectors. The Government will take a decision on whether international aviation and shipping emissions should be included in the 2050 target next year (2012).

The 2050 Calculator should be used to answer questions such as:

  • What are the capital, operating and fuel costs of pathway X relative to pathway Y?
  • What are the biggest component costs of pathway X?
  • How might the capital, operating and fuel costs of pathway X change when, say, renewables costs are as cheap as credible experts believe possible, and nuclear costs are expensive?

But it should not be used to answer questions such as:

  • What is the effect on energy demand of, say, switching to more expensive forms of electricity generation? (Because the 2050 Calculator does not have a price feedback.)
  • What is the impact of policy X on energy bills? (Because the 2050 Calculator cannot say what the impact on an electricity or heating bill will be - this is mostly because we would need to make an assumption about the policy used to implement this change.)
  • What is the expected cost of policy X over the next 10-20 years? (The Calculator is best suited to 2050 analysis, not short/medium term analysis.)
  • What are the wider macroeconomic costs or welfare costs of policy X? (These impacts are excluded from the Calculator.)
  • What’s the optimal, least cost means of reducing emissions by 80%? (The Calculator cannot automatically work this out but the user can work out least cost pathways for themselves.)

Questions for stakeholders

  1. Finance costs: as a default, we hve assumed finance costs are 7% for all technologies; is it too simplistic to use the same interest rate for all technologies? See finance costs methodology. Do you have any evidence for what interest rates and loan periods are used to finance technology capital costs today?
  2. Discount rate: we currently use a discount rate of 3.5% for the first 30 years and 3% for the remainder of the appraisal period (in line with HMG Green Book guidance). However, we could use a Stern-adjusted lower discount rate. See: discount rate methodology. What do you think?
  3. Upper end of costs range: our upper estimate of technology costs in 2050 is technology prices today. We judge that this is the highest that credible experts can foresee the costs being in 2050. Do you have any views on whether this is a sensible definition of the upper estimate for all technologies?
 
  1. Note: international aviation and shipping emissions are currently not included in the UK's 2050 target, primarily because of the lack of an internationally agreed methodology for assigning these international emissions to individual countries. But these emissions have been included in the 2050 Calculator to ensure complete coverage of all sectors.
  2. see http://www.ukerc.ac.uk/support/tiki-index.php?page=ES_MARKAL_Documentation_2010
  3. Stern et al point out the wider benefits not captured by economic models such as MARKAL and the 2050 Calculator. See: Stern et al (2011) The Basic Economics of Low-Carbon Growth in the UK, policy brief, Grantham Research Institute on Climate Change and the Environment and the Centre for Climate Change Economics and Policy. http://www2.lse.ac.uk/GranthamInstitute/publications/Policy/docs/PB_economics-low-carbon-growth_Jun11.pdf.
  4. Note: international aviation and shipping are not included in the UK's 2050 target but they are included in the 2050 Calculator until the Government makes its final decision on whether or not to include them in the 2050 target.