Economic tools can help analyze the costs and benefits of renewable energy options over time, but have limitations. Storage solutions are needed to overcome the intermittency of renewables. Transitions to new energy systems take decades as new technologies diffuse. External environmental costs are not fully captured in traditional economic analysis of energy options. Policy mixes that include regulations, incentives and disincentives can promote transitions to more sustainable energy systems.

1. Economic tools and the choice of
energy options
with specific reference to Renewable Energy options
Lecture at Sustainability Institute, 25 July 2012
by
Martin de Wit

2. Questions
• How do we solve the tension between
affordable and sustainable energy?
• How do we solve the choice between
renewable energy systems and increased
efficiencies of conventional energy systems?
• Do these tensions and choices matter for
human wellbeing?

3. Definitions of economics
• The social science that deals with the
production, distribution, and consumption of
goods and services and with the theory and
management of economies or economic
systems (freedictionary)
• A social science that studies how
individuals, governments, firms and
nations make choices on allocating scarce
resources to satisfy unlimited wants
(Investopedia)

4. Some basic concepts in economics
• Microeconomics:
– Behaviour of economic agents
(actors, decisionmakers): maximising utility
• Macroeconomics:
– How entire economies operate
• Opportunity costs
• Property rights
• Market value
De Wit Sustainable Options (Pty) Ltd 4

5. Simple economic model
Source: Wikipedia

6. A more
complex
economy

7. Cost-benefit
• Pleasure-pain (Bentham)
• Cost-benefit analysis (CBA):
– Benefit-cost analysis (BCA), also known as cost-benefit
analysis, aims to inform the decision-making process
with specific types of information, namely measures in
monetary terms of willingness to pay for a change by
those who will benefit from it, and the willingness to
accept the change by those who will lose from it.
(Evans School Public Affairs)
– Money as common metric

8. Economic appraisal tools
• Net present value (NPV)
– Present value of all benefits > present value of all
costs or NPV>0
• Benefit Cost Ratio (BCR)
– PV of benefits / PV of costs
– BCR >1
• Internal rate of return (IRR)
– Rate at which PV of benefits equals PV of costs
– IRR > ‘hurdle rate’
De Wit Sustainable Options (Pty) Ltd 8

9. Results of economic evaluation on
energy options
• NBER 2009 (Geofrey Heal):
– main renewables face a major problem because of their
intermittency (the wind doesn’t always blow nor the sun
always shine) and that this has not been adequately
factored into discussions of their potential.
– Without new storage technologies that can overcome this
intermittency, much of the decarbonization of the economy
will have to come from nuclear, carbon capture and
storage (CCS) and energy efficiency (geothermal and
biofuels can make small contributions).
– Nuclear and CCS are not without their problems. New
energy storage technologies could greatly increase the role
of renewables, but none are currently in sight.

10. Results of economic evaluation RE in Africa
• World Bank (Deichmann et al 2010) tested the conventional view that
renewable power remains too costly for large-scale applications in
countries where poverty alleviation is the primary objective.
– for a majority of households, decentralized power supply is unlikely to be
cheaper than grid supplies any time soon
– Levelized costs for wind energy are very low, but wind potential is limited to a
relatively small share of each country.
– Solar PV would cover less than ten percent of all households under realistic
technical change scenarios over the next 20 years.
– And electricity generated with biodiesel generators—as well as conventional
diesel—tends to be more expensive than grid supplied power for most areas.
– Furthermore, where decentralized electricity generation is not already
cheaper today or, after considering likely cost reductions, over the next 20
years, carbon taxes or equivalent premiums for renewable investments are
unlikely to make the difference under realistic rates per emitted ton of CO2
avoided.
– All things considered, our evidence suggests that the economics of
decentralized renewable power may be compelling for large regions of rural
Africa.

11. Summary of results
• Energy storage solutions needed to make RE
more viable
– Nuclear, CCS and energy efficiency important in
de-carbonization of economy
• Costs and benefits over time and spatially play
important role in roll-out of RE
• Role of decentralised RE applications

12. Limitations and new developments
• Opportunity costs of using non-renewable
resources (resource economics)
• Environmental costs of energy transformation
not counted (environmental economics)
• Thermodynamics and natural limits (ecological
economics)
• Transitions (evolutionary and institutional
economics)

13. Resource Economics
• Apart from finite availability, many other important
factors including exploration, capital investment, and
heterogeneous reserve quality are important for the
economics of energy depletion and development
(Krautkraemer&Toman)
• Discovery of new deposits and technological
progress, which lower the costs of extraction and
processing, have greatly mitigated the impacts of finite
availability on costs and supply of depletable fossil fuel
resources.
• When the marginal cost of using a traditional fuel type
exceeds the marginal costs of alternative fuel options, a
transition from traditional fuels to alternatives
occurs, assuming that the alternatives provide the same
energy services as traditional fuels.

14. Physical Scarcity? Case of oil
There is increasing evidence that the physical scarcity of fossil fuels is a
serious possibility – stagnant or declining production

15. Oil Reserves (I)
180 000
Oil Proved Reserves, million tonnes
160 000
140 000
120 000
100 000
80 000
60 000
40 000
20 000
-
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Sources: Gap Minder, Wikipedia

16. Oil Production Costs
Source: The Oil Drum (2010)

17. Oil Prices
Rising demand, stagnant production, and rising prices may signal
physical scarcity impacts on the marginal cost of production

18. Environmental economics
• Rise of environmental economics
– market failures and external costs, the costs of
pollution, pollution abatement, economics of regulation in
normative framework of efficiency
• The environment provides many services to mankind.
In general, one can distinguish between three
important economic functions:
– supply of raw materials and energy inputs in the economic
process;
– assimilation of emitted waste of the economic process, i.e
the ‘sink’ function; and
– provision of general life support.

20. Ecological economics (I)
• Field born out of the limited
interpretation of ecology as
presented in environmental
and resource economics (Van
den Bergh, 2001).
• Baumgärtner et al.
(2008:385), ‘the subject matter
of EE [ecological economics] is
the relationship between the
economic and the ecological
system, and its underlying
central aim is to provide
knowledge for a sustainable
management of this
relationship.’

21. Ecological Economics (II)
• According to Costanza (2009), ecological
economics has the following ideals:
– ‘Ecological economics is a transdisciplinary field that
seeks to integrate the study of humans and the rest of
nature as the basis for the creation of a sustainable
and desirable future.
– It seeks to dissolve the barriers between the
traditional disciplines and achieve a true consilience of
all the sciences and humanities...[allowing]
– to build a world that is both sustainable and desirable
and that recognizes our fundamental partnership with
the rest of nature.’

22. Ecological Economics - principles
• Roots in systems ecology
• Economy as subsystem
– thermodynamically closed system
– Economic models cannot violate biophysical principles
• Ecological limits and thresholds (e.g. planetary
boundaries)
– Limits in substitution of natural resources and
environment – thermodynamics, material and energy
inputs in human needs, essential natural capital
• Normative framework of efficiency, justice and
sustainability

23. Newer developments in economics
• More empirical economists study the behavior of
institutions and individuals, rather than
continuing to model abstract utility functions
(Sagoff 2011. The rise and fall of ecological
economics)
– Behavioural and institutional focus
• WTP (adjusted utility) and CBA in itself are
challenged as having little effect on public policy
– Evaluation tools and techniques are in development

24. Energy Transitions
Take Time
• Previous energy
transitions were made
in a MINIMUM of 30
years for diffusion to
dominance
• Previous energy
transitions were made
because the new
technology was
perceived to be better
and cheaper.
• Consumers consumed
more energy after the
transition than before.
Fouquet, R. 2010. “The slow search for solutions: Lessons from historical energy transitions by sector and service.”Energy
Policy. vol. 38, pp. 6586-6596.

25. U.S. Oil Prices and Recessions
The economic importance of oil
far surpasses its cost share
http://netenergy.theoildrum.com/node/5304

26. Oil Prices and Energy
Transitions
200
cline
e
1996
EROI D
180
Linear
160
140
PE,t [2010$/barrel]
120 2010
100
2008
80
Today ecl
ine
D
2007 R OI
al E
60 n
2009 ne
E xpo
40
20
0
1940
1950
1960
1970
1980
1990
2000
2010
2020
2030
2040

27. Impacts on evaluation of energy
systems?
• Recessions or transitions are both possibilities
• Supply, cost and price of alternatives to
conventional fossil fuels – heavy oils, natural
gas – also matter
• RE solutions operate in broader energy and
world economy context
• Economic tools may help in estimation costs
and benefits, little guidance in predicting
smooth or abrupt transitions

28. Policy instruments
Policy Types Information Incentives Disincentives Regulations
Examples promoting grants, subsidies carbon taxes targets and
(FIT), tax quotas
exemptions/rebate
s, consumer
rebates, low-
interest loans,
mortgage rate
reduction

29. Economic tools: Adding value to RE
debate?
• How do we solve the tension between affordable and sustainable
energy?
– CBA, but add time and space. Limitations on predictions. Understand
why limited impact on public policy
– No vested interests either in conventional or RE energy domains;
economics of non-conventional oils, natural gas and nuclear to better
understand and guide transitions
• How do we solve the choice between renewable energy systems
and increased efficiencies of conventional energy systems?
– Include analysis of transitions, include behaviour of institutions and
people. Get sense of quantum on efficiency gains.
• Do these tensions and choices matter for human wellbeing?
– External costs need to be included
– Most end-users interested in affordable electricity, transport