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Title: Methodology for Costs Calculator Content: This note sets out the methodology we are using to include costs to the 2050 Calculator. h1 Summary The 2050 Costs Calculator includes costs for all activities associated with greenhouse gas emissions. This includes fossil fuel combustion, international aviation and shipping, industrial processes, agriculture and waste, land use, land use change and forestry (LULUCF). There are 130 technologies in the 2050 Costs Calculator and *capital, operating expenditure and fuel costs* are included for each of these to 2050. The 2050 Calculator excludes welfare costs. The 2050 Costs Calculator has the following cost information for each technology and fuel in 2050: * Since there is considerable uncertainty about costs in forty years’ time the Calculator uses a *costs range* designed to be sufficiently wide as to capture the views of all credible experts. In particular: ** The *lower cost* estimate for 2050 is the most optimistic assessment of future technology costs published by a credible evidence source. It assumes both technological progress to drive costs down over time and sufficient availability of skilled staff and materials to build and operate it. ** The *upper cost* estimate for 2050 is the most pessimistic view, assuming minimal technological progress over the next 40 years. In practice this usually means assuming that technology costs remain frozen at today’s prices. * *Default point estimate* – this is a point within the high/low range consistent with the latest cost assumptions from MARKAL. It assumes the DECC central fossil fuel price assumption and 7% finance costs for all technologies. The cost estimates in the 2050 Costs Calculator are drawn from a *wide range of credible, published sources*. Sources include economic and energy models (MARKAL and ESME), 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 existed published assumptions. Critically, the 2050 Costs Calculator has *no inbuilt cost-optimisation* function: all choices are left up to the user. The 2050 Costs Calculator is particularly well suited to answering questions such as: * What is the cost of pathway X relative to pathway Y? * What are the biggest component costs of pathway X? * How could the cost of pathway X change if, say, fossil fuel prices are high and the cost of, say, renewables are as low as credible experts believe is possible? h2 Caveats 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 the 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 presented exclude energy security impacts, costs arising from the damaging impacts of climate change, welfare costs and wider macroeconomic impacts.* The damage costs of climate change could be particularly significant – up to 20% of GDP. Other welfare costs excluded from the analysis include costs associated with living in cooler buildings, travelling less, changes to landscape, air and noise pollution. The Calculator does not take into account taxes or subsidies, R&D costs, administrative costs associated with delivering policies, or wider macroeconomic costs. # *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. h1 Contents This paper sets out the methodology used to calculate capital, operating costs and fuel costs and how they are aggregated into the 2050 Calculator. Specific questions are set out at the end. Structure of paper: * Background * Scope: technology and fuel costs only * Costs expressed as a range * Costs are exogenous * Total and incremental costs * Defining the counterfactual * Discounting * Financing * What this analysis should/not be used for * Questions * General comments h1 Background The 2050 Costs Calculator released today builds on the original 2050 Calculator first released in July 2010. This tool enabled the public to join in an informed debate on the future of the UK’s energy system, and to support policymakers in making the best choices for the long-term. The Calculator is an engineering model based on physical and technical potential which allows users to consider the implications of the pathway for energy security, land use, electricity demand and other wider impacts. Following a Call for Evidence, the Government committed to add costs to the 2050 Calculator to allow users to also compare pathways on this basis. Government has been working to develop the analysis needed to update the Calculator, consulting with experts in industry and academia to develop the strongest evidence base available. h1 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 2007 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 these technologies, the cost includes: * Investment costs * Fixed operating costs * Variable operating cost where these costs are material * Fuel costs * Infrastructure/system/network costs (such as electricity grid, transport network and charging points for vehicles) * Cost of decommissioning a nuclear plant, storing nuclear waste, and storing carbon from CCS plants. These costs are incurred beyond 2050 but we include them in our annualised costs prior to 2050. * Finance costs (i.e interest payments on loans for expensive capital investments). It does not include: * The cost of Greenhouse gases, either as a damage cost to the environment or the price of carbon in the traded sector. * Costs of existing infrastructure - we only include the costs of technology installed or purchased from 2010 onwards. * Welfare loss arising from behaviour change (e.g. inconvenience of living in buildings with less comfortable temperatures, loss of landscape aesthetics from wind farms, potential inconvenience of taking public transport rather than car, less international flights) * Public safety risks (perceived or actual) associated with incumbent technologies e.g. oil extraction, or new low carbon technologies e.g. nuclear or CCS. * R&D costs. * Opportunity cost. The opportunity cost within sectors due to economic activity to produce low carbon technologies rather than alternative activity, such as investment in renewable power research compared to other profitable R&D. There is also the opportunity cost of existing assets. For example, the opportunity cost of agriculture producing bio-crops rather than a more profitable use of land will not be captured. * Non-market costs such as greater air pollution and noise. * Macro-economic costs. We will not quantify what the pathways mean for adjustments in the wider macro economy, or for its resilience to shocks such as oil and gas price spikes, that have in the past caused recessions, business failures and job losses. * Costs of achieving technology deployment - Administrative costs of adhering to regulations or taxation such as fuel duty or VAT or government subsidies. See the missing costs page for more detail. h1 Costs expressed as a range Future fuel and technology costs are highly uncertain. The following are just a few high-level 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 R&D expenditure globally which could bring down technology costs * 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 capturing all the above factors. h2 The high and low ranges High and low costs are defined as follows: * *The lower cost estimate for 2050 is an optimistic assessment of future technology costs, assuming technological progress drives costs down over time. It is the lowest that credible experts can foresee the cost falling to, for example assuming technology breakthroughs and availability of the skilled staff and materials required to build and operate it. This could arise through well designed climate policy in the UK and other countries.* * *The upper cost estimate for 2050 is a pessimistic view, assuming minimal technological progress over the next 40 years. The upper estimate is the highest that credible experts can foresee the costs being and usually assumes that technology costs remain frozen at today’s prices. This could happen if the UK and rest of the world implemented badly designed climate policy or none at all.* In reality, we know that costs are likely to look like chart 1: falling over time with a fan of uncertainty. In some cases, the "high" cost estimate could even stay the same or rise (e.g. gas power stations and off shore wind costs have increased in recent years driven by various factors including regulatory costs and materials prices). Where we have high/low data for various years similar to chart 1, we have used it. Insert chart 1 But for many sectors, data availability is very limited. In these cases, we will represent the range as in chart 3. The 2050 "high" estimate is the technology price today. The 2050 "low" estimate is the lowest available estimate (which in all cases is an estimate of technology costs from economic models, sectoral studies, etc for 2050). Question for stakeholders: we have assumed that the low cost estimate declines linearly between 2007 and 2050. Do you have any views on whether there is a better simple methodology we could use to sketch out the trajectory between 2007 and 2050? Insert chart 3 h1 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: # 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. # 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 will 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. h1 Total and incremental costs We will capture the total cost of each technology in the Calculator. For example, the transport cost will include the total cost of new cars purchased (rather than the incremental cost of an energy efficient car). However for a small number of technologies we have only included the incremental costs. e.g. For new buildings, we have only included the incremental cost of "greener" buildings over and above the cost of conventional buildings. This is because estimating house prices out over the next forty years would be too difficult. For a given pathway, the Calculator will be able to add together these individual technology costs to work out the total cost. This total cost will capture the cost of heating homes and businesses, producing electricity, travelling, fossil fuels, biomass and reducing emissions in agriculture and industry over the period 2007 to 2050. By comparing the total costs of two pathways, we will be able to work out incremental cost. The method we propose to use to calculate incremental cost is set out in the incremental cost page. h1 Defining the counterfactual Given that the costs in the Calculator will be total costs, rather than incremental costs, we need a counterfactual to compare the costs of any pathway against. Even if we will give users the option to pick a preferred counterfactual, we need to decide what option we will give them by default. The simplest, easiest to understand counterfactual is to assume minimal effort across all sectors. This is generated by selecting effort level 1 (minimum) for all sectors in the Calculator. However we should bear in mind the following about this "All Level 1s" pathway: * It does not reflect the effect of existing or planned policy. * It does not meet the 80% 2050 target. * It makes unrealistic assumptions about energy imports. The pathway would have a strong dependence on natural gas, comprising nearly 2/3rds of primary energy demand in 2050 with the majority imported (90% including oil). * It is not least cost - for example, there is no use of behavioural change to reduce energy demand and emissions. All level 1s will form our best guess counter-factual, however for the webtool we intend that users will have to choose a counterfactual to compare costs with. h1 Discounting The Calculator will have functionality to show costs in undiscounted or discounted form. If we wish to discount costs (for example, to present a Net Present Value), we could use the HMG Green Book suggestion of 3.5%. However the 3.5% rate takes account of catastrophe risk and pure time preference and there are arguments against accounting for this in climate change appraisal (as set out in Stern Review). So alternatively we could use a lower discount rate which did not account for these elements. Question for stakeholders: do you think we should use 3.5% or a lower discount rate? h1 Financing Expensive capital infrastructure such as power stations have to be paid for, by someone, at the time of construction but last for many years. The Calculator will have functionality to present costs in the following ways:- h2 Cash Flow Investment costs occur at the year of deployment. The cash flow profile will show the lumpy nature of capital investments. h2 Financing Costs (amortised capital) This would involve spreading the cost of capital over a typical loan period with an associated interest rate. Both will be defined by assumptions on where the investment will be funded from and the risk premium we could expect from the technology. For example, the interest rate is likely to be progressively higher using the following sources of finance: government (general taxation), government (bonds), green investment bank, private finance. For simplicity, we would like to use the same interest rate for all technologies - we are thinking of using a real interest rate of 10%[originally proposed 6.5%, but have had suggestions that 10% is a more reasonable 'high' level. We are planning to express finance costs as a range, so this just sets a rough upper bound for the average from now to 2050]. Question for stakeholders: what loan period are appropriate for different technologies? What interest rate would be appropriate to use for all technologies? Keeping it simple: Cat 1 20 years - "regulated" infrastructure, e.g. networks Cat 2 10 years - other infrastructure, e.g. power stations Cat 3 5 years - consumer purchases, e.g. heat pumps However, if the assets are eligible for support (e.g. subsidies such RHI, FiT, carbon floor price) against which loans can be securitised then the loan period could be extended, e.g. from Cat 2 to 1 or 3 to 2. h1 What this analysis should/not be used for The Calculator indicates: * How costs and cost uncertainty varies by sector, technology and pathway * How costs are split by capital, operating and fuel costs by technology and sector Beyond the scope of the model: * Testing out different policy or global scenarios. For example: ** Effect of high roll out of nuclear globally on nuclear costs in the UK ** Effect of high levels of R&D globally ** Effect of different levels of technology roll out in the UK on costs. e.g. Effect of "big bang" roll out of electric vehicles compared to a gradual scale up. * Analysis of the drivers of technology costs and the effects on price * Household bill impacts or any analysis of who pays * Appraisal of policy options. h1 Questions for stakeholders # *Finance costs*: what loan periods are appropriate for different technologies? What interest rate would be appropriate to use for all technologies? # *Discount rate*: we could 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, part of the 3.5% reflects catastrophe risk and pure time preference. There is a debate to be had on whether we should discount for these elements; excluding them would reduce the discount rate. # *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? # *Lower end of costs range*: for simplicity, for each technology we have assumed the low cost estimate is constant between 2007 and 2050 (see graph 2). But it would be more realistic to make this cost decline over time (see graph 3). Views on how to do this would be helpful. # *Incremental costs*: there are three possible ways of working out the total cost of one pathway over and above another pathway, as set out in the incremental costs page. We propose to use a method that compares the best case for a scenario against the worst case of the counterfactual. Your views on whether this is sensible would be helpful. # *Data on lumpy costs in CCS, international geosequestration, nuclear decommissioning and waste and industry.* Wherever possible, we seek to record capital costs as lumpy investments. But for the above named technologies we have not been able to do this because the costs data has been expressed as a function of energy output. Any data to correct this would be appreciated. h1 General comments Please add any general comments or responses to above questions in here: Mike Childs of Friends of the Earth has some general issues around methodology . Mike Knowles (Knowlesmichael2 ), member of IMech, has some comments around the impact of recent government policies on investment costs for renewables. See page: Mike Knowles' comments on investment and government involvement in renewable power generation . User: Sophie Hartfield Picture updated at: Signed off by: Sophie Hartfield Signed off at: 2011-08-10 10:58:10 UTC |
Title: Methodology for Costs Calculator Content: This note sets out the methodology we are using to include costs to the 2050 Calculator. h1 Summary The 2050 Costs 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. However, it should be noted that these 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. There are 130 technologies in the 2050 Costs Calculator and *capital, operating expenditure and fuel costs* are included for each of these to 2050. The 2050 Calculator excludes welfare costs. The 2050 Costs Calculator has the following cost information for each technology and fuel in 2050: * Since there is considerable uncertainty about costs in forty years’ time the Calculator uses a *costs range* (other than for international emissions) designed to be sufficiently wide as to capture the views of all credible experts. In particular: ** The *lower cost* estimate for 2050 is the most optimistic assessment of future technology costs published by a credible evidence source. It assumes both technological progress to drive costs down over time and sufficient availability of skilled staff and materials to build and operate it. ** The *upper cost* estimate for 2050 is the most pessimistic view, assuming minimal technological progress over the next 40 years. In practice this usually means assuming that technology costs remain frozen at today’s prices. * *Default point estimate* – this is a point within the high/low range consistent with the latest cost assumptions from MARKAL. It assumes the DECC central fossil fuel price assumption and 7% finance costs for all technologies. The cost estimates in the 2050 Costs Calculator are drawn from a *wide range of credible, published sources*. Sources include economic and energy models (MARKAL and ESME), 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 existed published assumptions. Critically, the 2050 Costs Calculator has *no inbuilt cost-optimisation* function: all choices are left up to the user. The 2050 Costs Calculator is particularly well suited to answering questions such as: * What is the cost of pathway X relative to pathway Y? * What are the biggest component costs of pathway X? h2 Caveats 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 the 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 presented exclude energy security impacts, costs arising from the damaging impacts of climate change, welfare costs and wider macroeconomic impacts.* The damage costs of climate change could be particularly significant – up to 20% of GDP. Other welfare costs excluded from the analysis include costs associated with living in cooler buildings, travelling less, changes to landscape, air and noise pollution. The Calculator does not take into account taxes or subsidies, R&D costs, administrative costs associated with delivering policies, or wider macroeconomic costs. # *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 (on the bases set out in the relevant sections) to enable the user to consider emissions across all sectors. However, it should be noted that pathways that meet the UK’s 2050 target will differ from pathways in the calculator that include international aviation and shipping emissions and achieve an 80% reduction in all emissions on 1990 levels. h1 Contents This paper sets out the methodology used to calculate capital, operating costs and fuel costs and how they are aggregated into the 2050 Calculator. Specific questions are set out at the end. Structure of paper: * Background * Scope: technology and fuel costs only * Costs expressed as a range * Costs are exogenous * Total and incremental costs * Defining the counterfactual * Discounting * Financing * What this analysis should/not be used for * Questions * General comments h1 Background The 2050 Costs Calculator released today builds on the original 2050 Calculator first released in July 2010. This tool enabled the public to join in an informed debate on the future of the UK’s energy system, and to support policymakers in making the best choices for the long-term. The Calculator is an engineering model based on physical and technical potential which allows users to consider the implications of the pathway for energy security, land use, electricity demand and other wider impacts. Following a Call for Evidence, the Government committed to add costs to the 2050 Calculator to allow users to also compare pathways on this basis. Government has been working to develop the analysis needed to update the Calculator, consulting with experts in industry and academia to develop the strongest evidence base available. h1 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 2007 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 these technologies, the cost includes: * Investment costs * Fixed operating costs * Variable operating cost where these costs are material * Fuel costs * Infrastructure/system/network costs (such as electricity grid, transport network and charging points for vehicles) * Cost of decommissioning a nuclear plant, storing nuclear waste, and storing carbon from CCS plants. These costs are incurred beyond 2050 but we include them in our annualised costs prior to 2050. * Finance costs (i.e interest payments on loans for expensive capital investments). It does not include: * The cost of Greenhouse gases, either as a damage cost to the environment or the price of carbon in the traded sector. * Costs of existing infrastructure - we only include the costs of technology installed or purchased from 2010 onwards. * Welfare loss arising from behaviour change (e.g. inconvenience of living in buildings with less comfortable temperatures, loss of landscape aesthetics from wind farms, potential inconvenience of taking public transport rather than car, less international flights) * Public safety risks (perceived or actual) associated with incumbent technologies e.g. oil extraction, or new low carbon technologies e.g. nuclear or CCS. * R&D costs. * Opportunity cost. The opportunity cost within sectors due to economic activity to produce low carbon technologies rather than alternative activity, such as investment in renewable power research compared to other profitable R&D. There is also the opportunity cost of existing assets. For example, the opportunity cost of agriculture producing bio-crops rather than a more profitable use of land will not be captured. * Non-market costs such as greater air pollution and noise. * Macro-economic costs. We will not quantify what the pathways mean for adjustments in the wider macro economy, or for its resilience to shocks such as oil and gas price spikes, that have in the past caused recessions, business failures and job losses. * Costs of achieving technology deployment - Administrative costs of adhering to regulations or taxation such as fuel duty or VAT or government subsidies. See the missing costs page for more detail. h1 Costs expressed as a range Future fuel and technology costs are highly uncertain. The following are just a few high-level 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 R&D expenditure globally which could bring down technology costs * 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. h2 The high and low ranges High and low costs are defined as follows: * *The lower cost estimate for 2050 is an optimistic assessment of future technology costs, assuming technological progress drives costs down over time. It is the lowest that credible experts can foresee the cost falling to, for example assuming technology breakthroughs and availability of the skilled staff and materials required to build and operate it. This could arise through well designed climate policy in the UK and other countries.* * *The upper cost estimate for 2050 is a pessimistic view, assuming minimal technological progress over the next 40 years. The upper estimate is the highest that credible experts can foresee the costs being and usually assumes that technology costs remain frozen at today’s prices. This could happen if the UK and rest of the world implemented badly designed climate policy or none at all.* In reality, we know that costs are likely to look like chart 1: falling over time with a fan of uncertainty. In some cases, the "high" cost estimate could even stay the same or rise (e.g. gas power stations and off shore wind costs have increased in recent years driven by various factors including regulatory costs and materials prices). Where we have high/low data for various years similar to chart 1, we have used it. Insert chart 1 But for many sectors, data availability is very limited. In these cases, we will represent the range as in chart 3. The 2050 "high" estimate is the technology price today. The 2050 "low" estimate is the lowest available estimate (which in all cases is an estimate of technology costs from economic models, sectoral studies, etc for 2050). Question for stakeholders: we have assumed that the low cost estimate declines linearly between 2007 and 2050. Do you have any views on whether there is a better simple methodology we could use to sketch out the trajectory between 2007 and 2050? Insert chart 3 h1 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: # 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. # 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 will 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. h1 Total and incremental costs We will capture the total cost of each technology in the Calculator. For example, the transport cost will include the total cost of new cars purchased (rather than the incremental cost of an energy efficient car). However, for a small number of technologies we have only included the incremental costs. e.g. For new buildings, we have only included the incremental cost of "greener" buildings over and above the cost of conventional buildings. This is because estimating house prices out over the next forty years would be too difficult. For a given pathway, the Calculator will be able to add together these individual technology costs to work out the total cost. This total cost will capture the cost of heating homes and businesses, producing electricity, travelling, fossil fuels, biomass and reducing emissions in agriculture and industry over the period 2007 to 2050. By comparing the total costs of two pathways, we will be able to work out incremental cost. The method we propose to use to calculate incremental cost is set out in the incremental cost page. h1 Defining the counterfactual Given that the costs in the Calculator will be total costs, rather than incremental costs, we need a counterfactual to compare the costs of any pathway against. Even if we will give users the option to pick a preferred counterfactual, we need to decide what option we will give them by default. The simplest, easiest to understand counterfactual is to assume minimal effort across all sectors. This is generated by selecting effort level 1 (minimum) for all sectors in the Calculator. However we should bear in mind the following about this "All Level 1s" pathway: * It does not necessarily reflect the effect of existing or planned policy. * It does not meet the 80% 2050 target. * It makes unrealistic assumptions about energy imports. The pathway would have a strong dependence on natural gas, comprising nearly 2/3rds of primary energy demand in 2050 with the majority imported (90% including oil). * It is not least cost - for example, there is no use of behavioural change to reduce energy demand and emissions. All level 1s will form our best guess counter-factual, however for the webtool we intend that users will have to choose a counterfactual to compare costs with. h1 Discounting The Calculator will have functionality to show costs in undiscounted or discounted form. If we wish to discount costs (for example, to present a Net Present Value), we could use the HMG Green Book suggestion of 3.5%. However the 3.5% rate takes account of catastrophe risk and pure time preference and there are arguments against accounting for this in climate change appraisal (as set out in Stern Review). So alternatively we could use a lower discount rate which did not account for these elements. Question for stakeholders: do you think we should use 3.5% or a lower discount rate? h1 Financing Expensive capital infrastructure such as power stations have to be paid for, by someone, at the time of construction but last for many years. The Calculator will have functionality to present costs in the following ways:- h2 Cash Flow Investment costs occur at the year of deployment. The cash flow profile will show the lumpy nature of capital investments. h2 Financing Costs (amortised capital) This would involve spreading the cost of capital over a typical loan period with an associated interest rate. Both will be defined by assumptions on where the investment will be funded from and the risk premium we could expect from the technology. For example, the interest rate is likely to be progressively higher using the following sources of finance: government (general taxation), government (bonds), green investment bank, private finance. For simplicity, we would like to use the same interest rate for all technologies - we are thinking of using a real interest rate of 10%[originally proposed 6.5%, but have had suggestions that 10% is a more reasonable 'high' level. We are planning to express finance costs as a range, so this just sets a rough upper bound for the average from now to 2050]. Question for stakeholders: what loan period are appropriate for different technologies? What interest rate would be appropriate to use for all technologies? Keeping it simple: Cat 1 20 years - "regulated" infrastructure, e.g. networks Cat 2 10 years - other infrastructure, e.g. power stations Cat 3 5 years - consumer purchases, e.g. heat pumps However, if the assets are eligible for support (e.g. subsidies such RHI, FiT, carbon floor price) against which loans can be securitised then the loan period could be extended, e.g. from Cat 2 to 1 or 3 to 2. h1 What this analysis should/not be used for The Calculator indicates: * How costs and cost uncertainty varies by sector, technology and pathway * How costs are split by capital, operating and fuel costs by technology and sector Beyond the scope of the model: * Testing out different policy or global scenarios. For example: ** Effect of high roll out of nuclear globally on nuclear costs in the UK ** Effect of high levels of R&D globally ** Effect of different levels of technology roll out in the UK on costs. e.g. Effect of "big bang" roll out of electric vehicles compared to a gradual scale up. * Analysis of the drivers of technology costs and the effects on price * Household bill impacts or any analysis of who pays * Appraisal of policy options. h1 Questions for stakeholders # *Finance costs*: what loan periods are appropriate for different technologies? What interest rate would be appropriate to use for all technologies? # *Discount rate*: we could 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, part of the 3.5% reflects catastrophe risk and pure time preference. There is a debate to be had on whether we should discount for these elements; excluding them would reduce the discount rate. # *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? # *Lower end of costs range*: for simplicity, for each technology we have assumed the low cost estimate is constant between 2007 and 2050 (see graph 2). But it would be more realistic to make this cost decline over time (see graph 3). Views on how to do this would be helpful. # *Incremental costs*: there are three possible ways of working out the total cost of one pathway over and above another pathway, as set out in the incremental costs page. We propose to use a method that compares the best case for a scenario against the worst case of the counterfactual. Your views on whether this is sensible would be helpful. # *Data on lumpy costs in CCS, international geosequestration, nuclear decommissioning and waste and industry.* Wherever possible, we seek to record capital costs as lumpy investments. But for the above named technologies we have not been able to do this because the costs data has been expressed as a function of energy output. Any data to correct this would be appreciated. h1 General comments Please add any general comments or responses to above questions in here: Mike Childs of Friends of the Earth has some general issues around methodology . Mike Knowles (Knowlesmichael2 ), member of IMech, has some comments around the impact of recent government policies on investment costs for renewables. See page: Mike Knowles' comments on investment and government involvement in renewable power generation . User: Richard Clarkson Picture updated at: Signed off by: Sophie Hartfield Signed off at: 2011-08-10 10:58:10 UTC |