# ELECTRICITY GENERATION AND THE ENVIRONMENT:ECONOMICS OF ELECTRICITY PRODUCTION

#### ECONOMICS OF ELECTRICITY PRODUCTION

What, exactly, is the cost of a unit of electricity today? That is not an easy question to answer. In basic economic terms the cost depends on the cost of the power station—how much it costs to build (this figure should include the cost of any loans needed to finance the construction and this can end up being one of the main contributors to the final cost of the electricity)—the cost of operating and maintaining it over its lifetime, which is typically 30 years for a combustion plant; and the cost of fuel. If all these numbers are added up and divided by the number of units of electricity the plant produces over its lifetime, then this is the basic unit cost of electricity. In most cases there will then be an addition to cover either profits if the plant is owned by the private sector or for future investment if the plant is publicly owned, to arrive at the cost to the consumer of the power.

With some adjustment for the change in the value of money over the lifetime of the plant, this calculation results in a figure called the levelized cost of electricity (LCOE) for a particular plant or technology, a figure that is often used to compare the value of different types of power plants.

The LCOE calculation is theoretical. It is impossible to know in advance exactly how a power plant will perform economically, because future conditions and costs are impossible to obtain in advance. On the other hand, anybody building a facility will want to know if it is going to be economical before actually construct- ing it. To get around this problem, guesses have to be made about the future performance and costs over its lifetime. Assumptions must also be made about some economic factors that take account of the changing value of money. These add a great deal of uncertainty to the result but the basic equation remains the same.

When this calculation is carried out for a range of different types of generating plants, the cheapest new source of electricity in many developed regions of the world will prove to be a natural gas–fired combined-cycle power plant. This type of plant is cheap, quick to build, and relatively easy to maintain. Capital cost of construction is low but the fuel price is relatively high, so for a plant of this type the cost of fuel is the most significant determinant of electricity prices. While gas is cheap, so is electricity. However, when gas prices rise, the plant can rapidly become uneconomical compared to other sources.

Gas prices have a history of volatility and this adds an element of risk when calculating the cost of electricity from a plant of this type. Other power stations, particularly those that use renewable energy where the energy source (the fuel) is free, are not exposed to this volatility. So while the cost of electricity from a plant of this type may be on average more expensive, it is also more stable. This is being recognized as a significant factor when evaluating the economic viability of new sources of electric power.