Economics of Climate Change

Rangan Banerjee

Forbes Marshall Chair Professor

Department of Energy Science & Engineering

2nd Summer School - Climate Science and Policy, 26th June 2015

Marginal Abatement Cost Curve

http://www.climateworksaustralia.org/project/national-plan/how-read-marginal-abatement-cost-curve 2

Global Cost Curve

3

India Abatement Curve

Source: McKinsey

Social Cost of Carbon

5Stern: The Economics of Climate Change

Source: IPCC, 2011 6

Cost of Electricity ($/MWh)

7

3 R

s./k

Wh

6 R

s./k

Wh

9 R

s./k

Wh

Bloomberg, 2014

Carbon Prices

Source: http://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/bd/bd1213a/13bd037 8

Viability of Mitigation Projects

What are the factors that determine the cost-effectiveness of the additional investment?

Cost of Carbon Saved

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Decision – Mitigation Project

Amount of Investment

Amount of Energy Saving (fossil fuel),

Carbon Saving

Price of Energy

Life of Equipment/ project

Time Value of Money

Renewables – usually higher initial cost,

lower operating cost10

Economic Criteria

Simple Payback Period (SPP)

Net Present Value (NPV)

Benefit/ Cost Ratio (B/C)

Internal Rate of Return (IRR)

Life Cycle Costing

Life Cycle Cost

Annualised Life Cycle Cost (ALCC)

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Simple Payback Period

No of years in which investment pays for itself

SPP = Initial Investment/ Annual Saving

Limitations?

A Inv Rs 100,000 , Saving Rs 50000

B Inv Rs 120,000, Saving Rs 40,000

Decision?

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Discount Rate

Compare investment today with expected future benefits

Discount rate represents how money today is worth more than in the future

No theoretically correct value

Lower bound – bank interest rate

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2015 2016 2015+k

Value in year 1 1 1Present Value 1 1/(1+d) 1/(1+d)k

Discounting the future

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Discount rate

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Inflation

Increase in the general level of prices

Wholesale Price Index (WPI)

Consumer Price Index (CPI)

Indexed to a base year when prices relatively stable

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A1 A2

Cash Flows

A3 An

n=1 n=2 n=3 n=20

Co

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Present Value

For constant annual cash flows A

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Capital Recovery Factor (CRF)

CRF = f (d,n)d – discount raten – life

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Capital Recovery Factor (CRF)

CRF(0.12,10) =0.12x(1.12)10 /((1.12)10 – 1)

o

n

kk

k Cd

ANPV

1 )1(

n

kk

ko

IRR

AC

1 )1(

NPV, IRR and B/C ratio

oC

n

1kk)d1(

kA

C

B

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Option Investment

C0 (Rs)

PV

Savings

(Rs)

NPV

Rs

B/C ratio

A 100,000 120,092 20,092 1.20

B 120,000 198,706 78,706 1.66

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A Inv Rs 100,000 , Saving Rs 50000 Life 3 years

B Inv Rs 120,000, Saving Rs 40,000 Life 8 years

Calculate CRF (d.n) for d = 12%

Example 2

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For A, CRF(0.12,3) = [0.12(1.12)3]/ [ (1.12)3-1] =0.416

For B, CRF(0.12,8) = [0.12(1.12)8]/ [ (1.12)8-1] =0.201

Example 2: Compute CRF

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Inflation

Increase in the general level of prices

Wholesale Price Index (WPI)

Consumer Price Index (CPI)

Indexed to a base year when prices relatively stable

Consumer Price Index Trend

0

100

200

300

400

500

600

700

800

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

Co

nsu

me

r P

rice

In

de

x

Year

Source: www.rbi.org.in › Publications‎/

Components of CPI

Wholesale Price Index (WPI)

Source: http://www.eaindustry.nic.in/WPI_manual.pdf

WPI weightages

Source: http://www.eaindustry.nic.in/WPI_manual.pdf

Annualised Life Cycle Cost

Annualised Life Cycle Costs (ALCC) - annual cost of owning and operating equipment

ALCC = C0 CRF(d,n) + AC f + AC O&M

CRF (d,n) =[ d(1+d)n]/[(1+d)n-1]

discount rate d, Life n years, C0 Capital Cost,AC

f , AC O&M , annual cost - fuel and O&M CRF –Capital recovery factor

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Cost Of Carbon saved

Incremental ALCC

=ALCC Project- ALCC Base Case

Annual Carbon Dioxide Savings

= Annual CO2 Base Case -Annual CO2 Project

Cost of Saved Carbon = Incremental ALCC/Annual Carbon Dioxide Savings

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Telecom Tower

425,000 Towers – 16.5 Billion kWh, 5 Billion litres of diesel

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Example Problem

Demand :Peak 5 kW, Average 2 kW

continuous operation

Options

A: Diesel engine-generator

B: PV- Battery system

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A:Diesel Engine - Generator

Rating 5 kW

Cost Rs 1.9 lakhs, life 10 years,

efficiency 35%,

diesel price Rs 45-60 /kg, diesel NCV 42 MJ/kg (86% C by weight),

Non – fuel O&M cost Rs0.3/kWh

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B.PV-Battery system

Peak rating 8 kW

Module cost Rs 6 lakhs life 25 years,

Battery Rs 50,000 life 5 years,

Balance of system costs Rs 2 lakhs, 10 years

O&M cost Rs 0.25/kWh35

Source: Renewable Energy Technologies: Cost Analysis, IRENA, June 2012

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Solar Concentrators

Arun Technology

CLFR TechnologyParabolic Trough

Scheffler paraboloid dish

Heliostat

37

38

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Methodology - Cost Analysis

Solar Field Cost

Solar Field Efficiency

Turbine Efficiency

Loss %

Plant Efficiency

Operating Hours

Storage Size

Plant Size

Collector Size

Receiver Size

Solar Field Area

Land Area

Land Cost

HX Cost

HTF quantity HTF Cost

Power Block Cost

Storage Cost

Capital Cost

Plant Output

Solar Insolation

Capacity Factor

Discount Rate

Life

AnnualisedCost O&M

Replacement Costs

Cost of Generation

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Annual Plant output

Feed-in tariff

Annual Revenue Annual O&M Expenses

Annual Working Capital

EBITDA

Capital Cost

Annual Depreciation

Debt to equity ratio

Total Debt

Interest Rate

Interest EBT

MAT Rate

Taxes

Net Profit Depreciation

Rate

Salvage Value

Free Cash Flow to Firm

Loan repayment period

Net annual repayment

Free cash flow to equity

IRR Equity

Net repayment upto ith year

Summing Up

Incremental Cost

Discount Rate – Cost of Capital matters!

Price of CER – Various methods to decide – supply- demand – rules of game

Simple, transparent methods to calculate Cost of saved carbon

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References

R.Banerjee, Comparison of Distributed generation Options for India, Energy Policy 34, 2006,p101-111

IPCC 2011: IPCC, 2011: IPCC Special Report on Renewable Energy Sources and Climate Change Mitigation. Prepared by Working Group III of the Intergovernmental Panel on Climate Change [O. Edenhofer, R. Pichs-Madruga, Y. Sokona, K. Seyboth, P. Matschoss, S. Kadner, T. Zwickel, P. Eickemeier, G. Hansen, S. Schlömer, C. von Stechow (eds)]. Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA, 1075 pphttp://srren.ipcc-wg3.de/report

http://www.climateworksaustralia.org/project/national-plan/how-read-marginal-abatement-cost-curve

http://www.mckinsey.com/insights/sustainability/a_cost_curve_for_greenhouse_gas_reduction

http://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/bd/bd1213a/13bd037 http://www.wwf.se/source.php/1169157/Stern%20Report_Exec%20Summary.pdf Renewable Energy Technologies: Cost Analysis, IRENA, June 2012 http://www.eaindustry.nic.in/WPI_manual.pdf

Thank you 43

Email: rangan@iitb.ac.in /rangan.banerjee@gmail.com