The role of capital costs in decarbonizing the electricity sector

By Lion Hirth, Jan Steckel. 2016

196 citations recorded by the source corpus.

Low-carbon electricity generation, i.e. renewable energy, nuclear power and carbon capture and storage, is more capital intensive than electricity generation through carbon emitting fossil fuel power stations. High capital costs, expressed as high weighted average cost of capital (WACC), thus tend to encourage the use of fossil fuels. To achieve the same degree of decarbonization, countries with high capital costs therefore need to impose a higher price on carbon emissions than countries with low capital costs. This is particularly relevant for developing and emerging economies, where capital costs tend to be higher than in rich countries. In this paper we quantitatively evaluate how high capital costs impact the transformation of the energy system under climate policy, applying a numerical techno-economic model of the power system. We find that high capital costs can significantly reduce the effectiveness of carbon prices: if carbon emissions are priced at USD 50 per ton and the WACC is 3%, the cost-optimal electricity mix comprises 40% renewable energy. At the same carbon price and a WACC of 15%, the cost-optimal mix comprises almost no renewable energy. At 15% WACC, there is no significant emission mitigation with carbon pricing up to USD 50 per ton, but at 3% WACC and the same carbon price, emissions are reduced by almost half. These results have implications for climate policy; carbon pricing might need to be combined with policies to reduce capital costs of low-carbon options in order to decarbonize power systems.

Subfields: Economics and Econometrics, Environmental Engineering, Finance

View Paper: https://www.semanticscholar.org/paper/9a46e11b8491a3b78f9fc0ece621636167a21817

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Citations in the corpus

How do policies mobilize private finance for renewable energy?—A systematic review with an investor perspective (2019, background): “Reducing risks, and thereby lowering the investment hurdle rate, is particularly important for RE investments due to their high upfront capital and resulting high financing requirements [26,27,44].”
Carbon pricing and deep decarbonisation (2018, background): “Policies to improve access to capital for low-carbon investment are of particular relevance, not least because a high cost of capital can significantly undermine the effectiveness of carbon pricing (Hirth and Steckel, 2016).”
Financial de-risking to unlock Africa's renewable energy potential (2019, background): “The high upfront investment cost of renewable energy projects makes them sensitive to variations in required returns [6,28,30].”