The Full Cost of Electricity, Annual Update

(University of Texas at Austin) – Editor’s Note:  We are pleased to provide the University of Texas, Austin’s latest update to its annual Full Cost of Electricity (FCe-). Extensive research shows a continuing decline in the cost of generating power and electricity from new innovations and emerging technologies.

The following is an excerpt from the recent study; it offers historical background on the electrical grid as a way to understand rapid advances throughout the entire energy sector. In addition, we strongly encourage readers to access the original study.

Introduction

The generation of electric power and the infrastructure that delivers it is in the midst of dramatic and rapid change. Since 2000, declining renewable energy costs, stringent emissions standards, low-priced natural gas (post-2008), competitive electricity markets, and a host of technological innovations promise to change the landscape of an industry that has remained static for decades. Heightened awareness of newfound options available to consumers has injected yet another element to the policy debate surrounding these transformative changes, moving it beyond utility boardrooms and legislative hearing rooms to everyday living rooms.

The Full Cost of Electricity (FCe-) study, conducted by the Energy Institute at University of Texas-Austin, employs a holistic approach to thoroughly examine the key factors affecting the total direct and indirect costs of generating and delivering electricity. As an interdisciplinary project, the FCe- synthesizes the expert analysis and different perspectives, from engineering, economics, law, and policy. In addition to producing authoritative white papers that provide comprehensive assessment and analysis of various electric power system options, the study team developed online calculators that allow policymakers and other stakeholders, including the public, to estimate the cost implications of potential policy actions.

Summary of the report:  Researchers analyzed data for the most competitive sources of new electricity generation. Wind again proved to be the option with the lowest cost, on a levelized basis, for a broad swath of the country, from the High Plains, the Midwest and Texas, and even portions of the Northeast. Solar power is the cheapest technology in much of the Southwest, and, based on updated data, also in the eastern and northern regions of the U.S. Natural gas prevailed for much of the rest of the country.  The formula used to calculate generation costs, known as the Levelized Cost of Electricity (LCOE), factors in “externalities” such as the public health and environmental effects associated with electricity generation – which the LCOE formula typically does not include – to calculate truer costs for each generation technology.

 

A History of the Electricity Grid

The structure of the electricity industry — of generation, delivery, and use of electricity over the past century — has evolved significantly. For decades, scale economies associated with large centralized generation technologies encouraged vertical integration and drove down the cost of electricity, fostered universal access, and provided for reliable electric service delivered by a single utility in a given region. The (now) traditional vertically integrated electric utility model that evolved from these factors are shown in Figure 1.

Figure 1

 

The combination of service area monopoly and regulatory oversight was successful at providing the surety for utilities to raise capital for large scale investments. These two factors, combined with an obligation to serve electricity as an essential public good, eventually enabled delivery of reliable, universal, and relatively low-cost electric service to virtually all Americans. Starting in the 1970s, higher fuel prices, environmental and energy security concerns, technological innovations, and a desire for more economic efficiency led to the rethinking of this traditional vertically-integrated model. Following examples from other industries, policy makers began to rethink the notion that power generation and sales are (or should be) a natural monopoly. Policymakers were exploring means to unleash competitive and technological forces as they had observed in the telecommunications industry, for example.

Also, starting in the late 1970s and 1980s a series of government decisions deregulated both wellhead natural gas prices and the pipeline industry. These regulatory changes unleashed powerful market forces in the natural gas industry that ultimately increased gas supply where it was once thought to be far more limited. Ultimately, both natural gas and gas-fired power became much less expensive. The increased competition from merchant power generators (e.g., independent and competing for power sales) had the knock-on effect of encouraging restructuring of the electric power industry in many states, helping to further break down the vertical integration model.

During the same timeframe, innovations in finance were created that complemented these new technologies to help make them more cost competitive. An important example is the Power Purchase Agreement (PPA) for independent natural gas plant electricity production and, later, wind and solar plants. These agreements played a key role in financing non-utility owned generating assets by enabling their owners, known as independent power producers (IPPs), to raise investment capital, employ tax-exempt bond financing, and capture Federal tax credits. These structures enabled IPPs to provide renewable power at attractive long-term fixed prices to utilities.

By the mid-1990s, policy makers began to restructure the electricity system, seeking to take advantage of these same technological and competitive forces in order to promote innovation and reduce electricity costs. At the same time, policymakers incentivized alternative technologies, such as wind power. Both the federal and state governments implemented environmental regulations, tax credits, required targets for renewable generation, and other support programs for renewables. Solar technology, initially much more expensive than wind, did not benefit from these policies until the late 2000s and early 2010s when some states instituted programs that specifically supported solar installations. For both wind and solar, foreign government support for manufacturing has also been critical (e.g., Denmark for wind in its early days, and China for solar PV more recently). These technologies also enabled some customers to become “prosumers” by generating some of their own electricity such that they effectively compete with their local utility or competitive generators. In turn, this self-generation threatens both the traditional utility business model as well as the competitive market structure as they exist today.

Several technologies are combining to drive changes in the electric industry today: increasingly cost competitive wind and solar PV, inexpensive natural gas combined with flexible and efficient combined cycle gas plants, and electricity energy storage and demand response systems with progressively lower costs. There are many new alternative combinations of markets, regulations, and technologies possible, as shown in Figure 2. The transition to a new electricity system structure can be complex and introduce considerable uncertainty in an industry that has traditionally been fairly stable and had strong incentives to be conservative over many decades.

Figure 2

These and other technological changes will continue to encourage the industry to adopt new technology and business models, policy makers to consider alternative regulatory and electricity market structures, and electricity customers to pursue self-generation that competes with traditional utilities in ways that may further de-stabilize the existing order.

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The full study can be read here.

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