Why Wind is Not Coal: On the Economics of Electricity

35 Pages Posted: 26 Apr 2014

See all articles by Lion Hirth

Lion Hirth

Neon Neue Energieökonomik GmbH; Hertie School of Governance

Falko Ueckerdt

Potsdam Institute for Climate Impact Research

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK); Mercator Research Institute on Global Commons and Climate Change (MCC); Technische Universität Berlin (TU Berlin)

Date Written: April 24, 2014

Abstract

The economics of electricity is shaped by its physics. A well known example is the non-storability of electricity that causes its price to fluctuate widely. More generally, physical constraints cause electricity to be a heterogeneous good along three dimensions - time, space, and lead-time. Consequently, different generation technologies, such as coal and wind power, produce different economic goods that have a different marginal economic value. Welfare maximization or competitiveness analyses that ignore heterogeneity deliver biased estimates. This paper provides an analytical welfare-economic framework that accounts for heterogeneity for unbiased assessments of power generators. The framework offers a rigorous interpretation of commonly used cost indicators such as ‘levelized electricity costs’ and ‘grid parity’. Heterogeneity is relevant for all generators, but especially for variable renewables such as wind and solar power. We propose a definition of ‘variability’, derive the opportunity costs of variability, and link that concept to the ‘integration cost’ literature. A literature review shows that variability can reduce the value of wind power by 20-50%. Thus it is crucial that economic analysis accounts for the physics of electricity.

Keywords: Power Generation, Electricity Sector, Integrated Assessment Modeling, Variable Renewables, Integration Costs, Welfare Economics, Power Economics, Levelized Electricity Cost, Grid Parity

JEL Classification: Q42, D61, C61

Suggested Citation

Hirth, Lion and Ueckerdt, Falko and Edenhofer, Ottmar, Why Wind is Not Coal: On the Economics of Electricity (April 24, 2014). FEEM Working Paper No. 39.2014. Available at SSRN: https://ssrn.com/abstract=2428788 or http://dx.doi.org/10.2139/ssrn.2428788

Lion Hirth (Contact Author)

Neon Neue Energieökonomik GmbH ( email )

Karl-Marx-Platz 12
12043
Berlin, 12043
Germany

HOME PAGE: http://www.neon-energie.de

Hertie School of Governance ( email )

Friedrichstraße 180
Berlin, 10117
Germany

Falko Ueckerdt

Potsdam Institute for Climate Impact Research ( email )

Telegraphenberg
Potsdam, Brandenburg 14412
Germany

HOME PAGE: http://www.pik-potsdam.de/pik-frontpage?set_language=en

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK) ( email )

P.O. Box 601203
14412 Potsdam, Brandenburg
Germany

Mercator Research Institute on Global Commons and Climate Change (MCC)

Torgauer Straße 12-15
Berlin, 10829
Germany

Technische Universität Berlin (TU Berlin)

Straße des 17
Juni 135
Berlin, 10623
Germany

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