Measuring Natural Resources in the National Accounts

Annex A. The Levelised Cost of Electricity method

Least cost alternative (LCA) methods have not been applied so far within an SNA context, but they have been applied in several cases of macro-economic research for the valuation of hydro resources. The most common LCA approach involves modelling two energy systems: one system where the renewable energy asset of interest provides a certain amount of electricity and another system where that resource is not present and other technologies increase their output to meet the amount of electricity produced by the resource of interest. The cost differential between the two systems is attributed as the renewable resource value. The modelling requirements are high and lie more in the field of energy modelling (Zuker and Jenkins, 1984[1]). This approach is therefore deemed infeasible for the purposes of valuing renewable energy resources in national accounts. Consequently, a more universally applicable cost-based method is required.

One possibility lies in applying an LCA method using the levelised cost of electricity (LCOE), a cost indicator that is widely used to compare the cost-competitiveness of energy technologies in the energy sector (IRENA, 2022[2]). The LCOE represents the sum of discounted costs per unit electricity generated over the project’s lifetime. The LCOE can also be defined as the electricity tariff at which an investor would precisely break even after paying the required rates of return to capital, given the costs incurred over the lifetime of a technology.

In its most basic and common form, LCOE can be calculated using Equation A.1, which is the method used by IRENA.

Equation A.1

$LCOE= \frac{{\sum }_{t=1}^n\frac{I_t+M_t+F_t}{{\left(1+r\right)}^t}}{{\sum }_{t=1}^n\frac{E_t}{{\left(1+r\right)}^t}}$

Where: $I_t$ = investment expenditures in the year t; $M_t$ = operations and maintenance expenditures in the year t; $F_t$ = fuel expenditures in the year t; $E_t$ = electricity generation in the year t; $r$ = discount rate; n = asset life.

Several organisations produce LCOE data (with varying degrees of technology, geographical and temporal coverage) (Bloomberg, 2015[3]; IEA, 2020[4]; IRENA, 2022[2]; Lazard, 2023[5]). For instance, the LCOE data from Lazard show that the LCOE of solar panels became lower than that of coal around 2010 and that of natural gas around 2015.

Figure A-1. Electricity costs according to data from Lazard

Source: Lazard (2023[5])

The resource rent can be estimated based on the difference in LCOEs between the focus resource (e.g. solar) and the least cost alternative (e.g. gas) multiplied with the electricity generated by the resource:

$\begin{array}{c}{R}_{A,t}=\left({LCOE}_{A,t}-{LCOE}_{x,t}\right)\times \left(P_{A,t}\right)\end{array}$

Where ${\mathrm{R}}_{\mathrm{A},\mathrm{t}}$ is the rent generated by resource A in year t in USD, ${\mathrm{L}\mathrm{C}\mathrm{O}\mathrm{E}}_{\mathrm{A},\mathrm{t}}$ the LCOE of resource A in year t in USD/MWh, ${\mathrm{P}}_{\mathrm{A},\mathrm{t}}$ is the amount of electricity generated by resource A in year t in MWh. A is the resource of interest, X the least cost alternative.

The results will depend on which resource is used as least cost alternative: all possible resources, only the ‘green’ resources or only the ‘grey’ resources. It seems most logical to select the LCA from the ‘grey’ resources, for several reasons. First, using a comparison with all resources or with green resources would imply that some renewable energy resources would obtain a positive value and some a negative value, as only 1 resource can be the LCA. Second, it will be the case in many countries that not all renewable energy resources technologies are feasible (legally, technically).

In a final step, the estimated rent can be used to estimate an asset value by using the NPV method.

An advantage of the LCOE based LCA method is that the results are easy to interpret. Rents become positive at the moment the resource in question has the lowest cost per unit electricity.

There are however a number of challenges with the method. First, LCOE data is not publicly available for all countries. Organisations such as the IEA and IRENA compile LCOE values, but not in the year-on-year time series that is required for this method. However, it should not be very difficult to calculate LCOE values directly. The main data requirements are investment and current expenditures on fuel and maintenance which should be available from business surveys. Information about generation should be available from energy statistics; expected lifetimes of the equipment can be taken as the same as used in the capital stock model.

The second issue is that LCOE calculation methods are not standardised and different sources take different factors into account. In some cases, additional cost components are considered. BloombergNEF and the IEA, also include carbon costs and the IEA also includes decommissioning costs. Further standardisation would be required.

The third and decisive issue is that the group of resources against which you value the resource drives the outcome. The method is based on applying a counterfactual approach (‘what if’’) which goes beyond the valuation principles commonly applied in national accounts which describe what actually happened in the economy, not what could have happened.

Therefore, the LCA is not considered a suitable method for application in a national accounts context. However, the approach may prove valuable for application in other analytical contexts.

References

[3] Bloomberg (2015), LEVELISED COST OF ELECTRICITY: DFID countries, https://assets.publishing.service.gov.uk/media/57a08991e5274a31e0000154/61646_Levelised-Cost-of-Electricity-Peer-Review-Paper-FINAL.pdf.

[4] IEA (2020), Projected Costs of Generating Electricity 2020, IEA, Paris, https://www.iea.org/reports/projected-costs-of-generating-electricity-2020.

[2] IRENA (2022), Renewable power generation costs in 2022, International Renewable Energy Agency, Abu Dhabi, https://www.connaissancedesenergies.org/sites/connaissancedesenergies.org/files/pdf-pt-vue/IRENA_Renewable_power_generation_costs_in_2022.pdf.

[5] Lazard (2023), LCOE analysis v16.0, https://www.lazard.com/media/typdgxmm/lazards-lcoeplus-april-2023.pdf.

[1] Zuker, R. and G. Jenkins (1984), “Blue Gold: Hydro-Electric Rent In Canada”, Development Discussion Papers.