[MUSIC] We are moving more and more towards the technological part of the course. And this therefore requires that we take a hard look at the cost of energy and in particular the cost of electricity because electricity is the fastest growing final form of energy. And in this session we're going to understand the interplay between firm dispatchable and intermittent energy sources. We're going to introduce the concept of levelized cost of energy and most important, we're going to see how different ways of producing energy have to interact in a constructive way in order to get the most efficient outcome. Now, we need some terminology and we start from a simple definition base load, base load on an electricity grid is the minimum level of demand on the electricity grid over a span of time. Because you can think about it, there's a certain base load plant commits to produce to put into the grid a minimum amount of energy over time. And how can this base load demand be met, how can the supply be produced? By one unvarying power plants, which means plants that always produce when they're up and running roughly the same amount of energy. Examples are coal or nuclear plant at the opposite end, you have intermittent, intermittent, could be wind and solar and as the name suggests, the energy production only occurs when there is wind, when there is sun and therefore it is intermittent. And in order to make up for the shortfall in the intermittent you have a dispatchable generation, dispatchable is a blanket term that covers a series of way of producing energy. The quickest way to think about, the simplest way to think about it, even if it is not the most prominent where you're producing the special energy, think about it as a battery. So when the wind is not blowing, you switch on the battery in reality there are much more efficient ways for instance, pumped storage when energy is not required. I can pump water upstream and then it can be activated, can be released down, move the turbine etcetera when it is required and it is surprisingly fast to be switched on. Hydro electric pump storage is very, very fast in ways there is a storage plant that can be ramped up in 16 seconds. But the key feature is that the interplay between the three sources, unvarying dispatchable and intermittent is extremely important. The second important concept to introduce is the levelized cost of energy. Case levelized cost of energy calculations are based on the average lifetime cost approach. Using the discounted cash flow method, we will have a lot to say about discounting future cash flows. When we look at the economics of climate change for the moment, let's just keep in the back of our mind that whenever I have costs and benefits in the future, I have to discount them back to today. And standard calculations of levelized cost of energy typically use three discount rate, which is 3%,7% and 10%. The calculation of the levelized cost of energy is based on combining the present value or rather equating the present value of a discounted revenues and the present value of the discounted costs. I mentioned that there are three standard discount rate and there is a general feature about the levelized cost of energy. The levelized cost of energy is these calculations are to a very large extent standardized. They use a combination of generic, country specific and technology specific assumptions for the various technical and economic parameters and the parameters are agreed by the expert group on the cost of generating electricity. And one of the key choices made by this group is, as I said, the choice of a discount factor. So how does it work? As I said, the idea is to equate required benefits and costs and the required benefits as written as you can see in this equation here, you have sum over. I have P is the constant lifetime remuneration required by the supplier of electricity per unit energy provided. MWh is a constant amount of electricity produced, expressed in megawatt hours and r is the all important discount rate. So these are my required benefits expressed in terms of lifetime remuneration assumed constant for the supplier of the electricity. I have to equate this to the costs and the costs given by the summation of the capital costs kappa, the operational maintenance costs OM, the fuel costs and the carbon costs which have an obvious meaning. The decommissioning costs that could be very important for instance for the nuclear energy. And all of these occur at different points in time and therefore all of these are discounted by an appropriate discount factor. And as I said, we're going to equate costs and benefits and in the previous slides we saw that the remuneration for the producer is constant. Therefore I can take the remuneration out and I can solve for the remuneration as shown in equation three. So the remuneration required which is assumed to be constant and which has been taken out of estimation is given by the ratio. Or what is the numerator which are the costs and the denominators which are the benefits without the compensation. This quantity, this P is the levelized cost of energy. What does it mean? Well, the levelized cost of energy, answers the question, what compensation should I demand, I am the producer. What compensation should I demand for investing in a given energy producing initiatives in a competitive market without rents ,this should equal the cost to providing one unit of output. It is the constant price of electricity for which the NPV is exactly equal to zero. So the higher the levelized cost of energy, the more the technology is expensive and attractive. So the higher the levelized cost of energy, the more the producer would have to be incentivized in order to produce that type of energy. I want a levelized cost of energy as low as possible. We will look at this in detail in future sessions, but the discount factor plays a key role in arriving at the conclusion of which type of energy is more attractive. Clearly, we use these rather standardized calculations in order to compare am I better off making a capital investment in a nuclear power plant, a wind power station, a gas station, a solar state, solar panel farm, etc. Since most of the benefits and the cost and in some cases the costs occurr in the future the discount factor is very, very important. And it is particularly important because there is an asymmetry between renewable and between sources of energy that rely on coal and gas and more traditional ones. Renewable technologies are highly sensitive to the discount factors because they're highly capital intensive, but they have low marginal costs. So I have a it is quite different from what happens from coal and natural gas fired generation, because they depend very strongly on fuel costs and of the pricing of CO two emissions. So if I were comparing sources of energy with similar schedules of costs and benefits, the effect of the discount factor will to some extent, to first order cancel out. But since there is such a big difference between renewable, which are highly capital intensive, but with low marginal costs. Once I have built my solar panel, the sun doesn't cost anything once I've built my turbine, my wind doesn't cost anything. On the other hand, even after building the coal station, I still have to put in coal or gas all the time. Okay, now that we have understood this basic concept, we can begin to look at the levelized cost of energy for different sources of electricity. And I'm going to bring up a comparison of the levelized cost of energy for gas, coal, nuclear, solar and wind, in the next pictures. So, how is this picture organized? I am beginning to look at gas CCGT, stands for combined cycle gas turbines, coal and nuclear and with discount factors of 3%, 7% and 10%. And on the y-axis I have a levelized cost of energy which is in US dollars per megawatt hour. And the yellow squares, not dots are the medians of the different estimates. And you can see at low discount factor, nuclear is by far the cheapest and gas is the most expensive. As I increase with discount factor they are pretty much all the same at the 10% discount factor. It becomes more interesting if we put into the mix and now we look at residential photovoltaic. This new picture here shows a 3, 7 and 10%, residential photovoltaic commercial photovoltaic, solar panels, large ground mounted solar panels, offshore wind, an onshore wind. At 3%, we can just look at 3% and 7% and the message is that at this offshore wind is very expensive. We will look and understand why in the future, onshore wind is roughly on the same as photovoltaic. Residential photovoltaic becomes very expensive if we use a 10% discount rate, which obviously raises the question here seems to be making very different choices depending on which discount factor I used. Can we get any guidance about the right discount factor? We will look at this in detail in future sessions. [MUSIC]