Cost Benefit Analysis in the context of the Energy Infrastructure Package

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Cost Benefit Analysis (CBA) has proven to be a useful tool to support the economic appraisal of important projects in many sectors. Recently, a single CBA method has been proposed at EU level to evaluate and compare electricity transmission and storage projects from different countries, which is unprecedented anywhere in the world.

The European Commission estimates that about €200 billion needs to be invested in electricity and gas infrastructure in order to achieve the 2020 energy and climate objectives. There is a risk that almost half of this expected investment will be too late or not at all. The Energy Infrastructure Package therefore establishes a process to identify Projects of Common Interest whose development will be accelerated. Projects of Common Interest will be selected based on a Cost Benefit Analysis method.

In a recent THINK report for the European Commission (DG Energy), we conclude that the Cost Benefit Analysis method that has been proposed by the European Network of Transmission System Operators for Electricity (ENTSO-E) at the end of 2012 is an important step in the right direction, but it is still possible to improve.

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Cost Benefit Analysis in the context of the Energy Infrastructure Package

  1. 1. Cost Benefit Analysisin the context of the Energy Infrastructure Package The Institute of International and European Affairs February 26, 2013, Dublin Leonardo Meeus
  2. 2. Cost Benefit Analysis Introduction WHY A PACKAGE? • €200 billion needs to be invested in electricity and gas infrastructure in order to achieve the 2020 energy and climate objectives • Risk that almost half of this investment will be too late or not at all WHY CBA IN THIS PACKAGE? • Projects of Common Interest • Cost allocation, investment incentives WHY A THINK REPORT ON THIS TOPIC? • Single CBA method will be developed for electricity infrastructure projects • ENTSO-E proposed a draft CBA method at the end of 2012 • Conclusion: this proposal is an important step in the right direction, but improvements could still be made, as proposed in our reportwww.florence-school.eu 2
  3. 3. Cost Benefit Analysis Report outline 1. Scope of the analysis – Project definition – Baseline definition – Effect mapping – Distributional effects 2. Calculation of net benefit OF – Monetization – Inter-temporal discounting of costs and benefits – Uncertainty 3. Ranking projectswww.florence-school.eu 3
  4. 4. Cost Benefit Analysis Report outline 1. Scope of the analysis – Project definition – Baseline definition – Effect mapping – Distributional effects 2. Calculation of net benefit OF – Monetization – Inter-temporal discounting of costs and benefits – Uncertainty 3. Ranking projectswww.florence-school.eu 4
  5. 5. Cost Benefit Analysis 1. Scope of the analysis ENTSO-E draft proposal Distinguishes between effects to be • Monetized: “total project expenditures”, “social-economic welfare” and “variation in losses” • Quantified as additional indicators: “Social and environmental sensibility”, “security of supply”, “RES integration”, “variation in CO2 emissions”, technical resilience” and “robustness” Comments Ranking projects based on these effects • Implies an implicit monetization of effects that have not been monetized explicitly • Which is less transparent than monetizing all relevant effects Recommendations • CBA should concentrate on a reduced list of effects and those should be monetized • Ranking should be primarily based on the monetized net benefitwww.florence-school.eu 5
  6. 6. Cost Benefit Analysis 1. Scope of the analysis MACROECONOMIC EFFECTS EXTERNALITIES POWER SYSTEMwww.florence-school.eu 6
  7. 7. Cost Benefit Analysis 1. Scope of the analysiswww.florence-school.eu 7
  8. 8. Cost Benefit Analysis 1. Scope of the analysis Effects we can disregard • (1) Macroeconomic effects are relatively similar for most projects • (2) CO2 effect is internalized in the production cost savings by the carbon price • (3) Renewable energy effect is also internalized by the renewable energy target Effects we can disregard for most, but not all, projects • (1) Local environmental and social costs are partly internalized in the infrastructure costs by EU Environmental Impact Regulations (except for visual impact) • (2) Early deployment benefits are partly covered by EU innovation support (except for exceptionally innovative projects) • (3) Other market benefits are usually relatively small (except for isolated areas)www.florence-school.eu 8
  9. 9. Cost Benefit Analysis 1. Scope of the analysiswww.florence-school.eu 9
  10. 10. Cost Benefit Analysis Report outline 1. Scope of the analysis – Project definition – Baseline definition – Effect mapping – Distributional effects 2. Calculation of net benefit OF – Monetization (includes which model to use) – Inter-temporal discounting of costs and benefits – Uncertainty 3. Ranking projectswww.florence-school.eu 10
  11. 11. Cost Benefit Analysis 2. Calculation of net benefit ENTSO-E draft proposal • The draft ENTSO-E proposal leaves certain modeling choices to the Regional Groups, while also providing some model specifications Comments • It will be important to coordinate modeling choices by Regional Groups with the data validation process of the baseline • Value of lost load should be established to allow for the monetization of consumer surplus Recommendations • The model used to monetize the production cost savings and gross consumer surplus needs to be explicitly stated • Value of lost load should be established following CEER guidelines, or an intermediate solution could be that a value is agreed upon as part of the data validation process for the baselinewww.florence-school.eu 11
  12. 12. Cost Benefit Analysis 2. Calculation of net benefit ENTSO-E draft proposal • The proposal already refers to the use of multiple scenarios and the use of sensitivity analysis to deal with uncertainty, but not yet a stochastic approach Comments • Stochastic approach has already been implemented by several TSOs in Europe for electricity infrastructure projects (including Eirgrid) Recommendations • Stochastic approach consistent with the Energy Roadmap 2050 should be used to address uncertainty • Ranking should then be based on the mean value of the resulting net benefit distribution, with adjustments for projects that have a significantly different risk profilewww.florence-school.eu 12
  13. 13. Cost Benefit Analysis Recommendations Scope of the analysis • (1) project interaction must be taken into account in the project and baseline definition • (2) data consistency and quality should be ensured • (3) the conventional time horizon is 20-25 years • (4) CBA should concentrate on a reduced list of effects and those should be monetized • (5) distributional concerns should not be addressed in the calculation of net benefits Calculation net benefit • (6) infrastructure costs need to be disaggregated • (7) the model used to monetize the production cost savings and gross consumer surplus needs to be explicitly stated • (8) a common discount factor should be used for all projects • (9) a stochastic approach consistent with the Energy Roadmap 2050 should be used to address uncertainty Ranking projects • (10) the ranking should be primarily based on the monetized net benefitwww.florence-school.eu 13
  14. 14. Thanks for your attention http://think.eui.eu; leonardo.meeus@eui.euwww.florence-school.eu 14

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