The Economist: the hidden costs of renewable energy

It matters when it comes to producing electricity. A barrel of oil is a barrel of oil, whether it is drawn at noon or midnight, but a megawatt hour (MWh) of electricity is worth far less when you are sleeping than in the middle of the day or, indeed, at times when everyone decides to put water in the kettle to boil. The difficulty of bottling electricity makes its economics unusual: it is not only a question of "how much", but also of "when".

At the same time, if there is one thing everyone knows about renewable energy, it is that it is getting cheaper every day. Wind and solar costs are said to be falling every year as the ability to harness the world's natural resources improves.

In 2014, the normalized cost of offshore wind, a measure for comparing different methods of generating electricity, was around $200 per megawatt hour, according to the U.S. Energy Information Administration (EIA), an official agency; by 2023, it had dropped to $127, not accounting for subsidies.

However, the industry is struggling. Six governors recently pleaded with President Joe Biden to intervene to rescue producers, Bloomberg news service reported. In the UK, the most recent annual tender for offshore wind power attracted no bids.

To understand what is happening we need to consider the normalized cost of energy in more detail. We also need to move away from solar and wind back to a world where the only options are gas, coal or nuclear. These sources are different in terms of both fixed and variable costs. The costs of a nuclear power plant are mostly fixed: once built, it does not cost much to produce another electrical unit. With natural gas plants the opposite is true: most of the costs are related to the fuel, so they are variable.

The normalized cost is obtained by taking the fixed and variable costs of the total plant lifetime and weighting them by the expected number of watt hours the plant will produce. This results in a comparable measure. According to the EIA, the normalized cost of nuclear power is $91 per megawatt hour. If this is compared with expectations for the price of electricity, you can be fairly certain whether or not it is worthwhile to develop a new plant.

But these costs vary depending on how often a source produces power. A nuclear plant will be the cheapest if it is always in operation, since the high initial costs will have been offset by higher production. Gas, with low fixed costs and high variable costs, has lower economies of scale.

Coal lies in the middle of these two sources. If only the financial merits are considered, the optimal energy mix is for nuclear to cover the "base load," or the minimum level of demand, coal the "intermediate load," and finally natural gas the "peak load," when demand is at its highest. Add to that a carbon price, and coal will be displaced by natural gas, which is less polluting, as has happened in Europe in recent decades.

Unfortunately, renewables disrupt this dynamic, as the energy they provide is weather-dependent and often requires the rest of the energy system to match its needs. Gas, with its low fixed costs and high variable costs, can easily do this. Nuclear, with high fixed costs and low variable costs, becomes much more expensive. It is not cheap to build a nuclear power plant just to cover the hours when there is no wind.

On their own, solar panels and wind turbines are less beneficial than they appear. If they cannot reliably produce electricity when needed, their generating capacity is not as valuable as that of a traditional power plant. To truly compare these two sources, one must measure not only how much it costs to produce each megawatt hour, but the value of that particular hour.

In an idealized market, with prices that are updated from one moment to the next and according to their geographic location from one node to another in the power grid, the relative benefit of either energy source would be easy to calculate: it would depend on the "capture rate." This is the difference between the market price given to a source and the average price of electricity over a given period.

Prices tend to rise when people demand more electricity, which raises the capture rate of the sources producing power at that time. Fortunately for renewables, this tends to happen during daylight hours, which is why solar power is useful, or during windy and cold months.

But as more renewables are added to the grid the capture rate will drop, as a large number of solar panels means that when it is sunny, electricity prices are very low or even negative.

Looking at these costs, taken from EIA measurements in the United States, most renewables don't look that competitive: solar's cost of $23 per megawatt hour falls below an average capture rate of $20 for the electricity generated.

That's still enough to outperform any other source except onshore wind, geothermal power, and increased battery storage on the grid. In contrast, offshore wind represents no competition at all: the capture rate for its electricity is around US$30 compared to a cost of US$100 per megawatt hour, with only nuclear and coal having lower rates. Add to that rising costs, due to higher interest rates and disrupted supply chains, and it is no surprise that many offshore wind suppliers are facing difficulties.

SCOTTISH ENERGY

Most electricity markets are not ideal. Prices do not reflect the true value of time and place, i.e., they are not a perfect guide to how much society wants each megawatt hour of electricity. Let's look at the United Kingdom. Wholesale electricity prices are set by half-hour blocks, which should mean that prices provide a pretty clear idea of whether renewables produce electricity at inopportune times of the day.

But there is only one price for the whole country. Most onshore wind power is produced in Scotland as, until recently, England had a de facto ban on the construction of such wind farms, although there is more demand for electricity in the south of England. As the grid does not have enough capacity to move electricity south, the grid manager pays to deactivate wind turbines in Scotland and activate gas-fired plants in England.

Over time, increasing the grid's capacity to move and store electricity will solve these problems. But for now, comparing costs to the capture rate would not give us an accurate picture of the relative benefits of building more wind farms in Scotland. The true costs of renewable energy are greater than they appear.