Q&A: Understanding system costs

What are system effects and why are they important?

System costs are defined as the total costs accrued beyond the perimeter of a power plant to supply electricity at a given load and at a given level of security of supply. System effects measure the impact that the integration of a power generation source has on the whole electricity system.

The NEA report entitled Nuclear Energy and Renewables: System Effects in Low-carbon Electricity Systems focuses on the system costs related to the electricity grid, i.e. 1) the cost of additional investments to extend and reinforce the transport and distribution grid as well as to connect new capacity, and 2) the cost of increasing short-term balancing (between supply and demand) and for maintaining long-term adequacy of electricity supply.

System effects of existing dispatchable technologies (nuclear power, coal and gas) are small and therefore have not needed to be taken into account by electricity grid operators. However, the technical and economic system effects of variable renewable technologies (offshore wind, onshore wind and solar) are mostly unaccounted for and are significant. Presently, these costs are borne by existing dispatchable technologies, grid operators and the general public through taxes or electricity tariffs. Failure to recognise and internalise system costs does not provide a true picture of the total cost of electricity supply and may lead to unintended consequences on longer-term security of such supply.

What are the main findings of the "System Effects" report?

There are two main findings. The first is that system costs of variable renewables are large, at least one order of magnitude higher than those of dispatchable technologies. They depend strongly on the country, the technology and the penetration level. In particular, system costs increase disproportionately as the share of renewables increases in the generation mix. This is not the case for dispatchable generation technologies such as nuclear, coal or gas.

The second finding is that the deployment of large shares of fluctuating electricity generating sources with nearly zero marginal cost has a profound impact on the functioning of electricity markets and on the structure and operation of generating capacity. In the short term, reduced load factors (the compression effect) and lower prices affect the economics of all existing dispatchable generators. Due to its low variable costs, nuclear will fare relatively better than coal or gas. In the long term, reduced load factors will make it more difficult to finance dispatchable capacity to provide short-term flexibility and long-term adequacy to the electricity system. Due to its high fixed costs, nuclear will be disproportionately affected. Without action to deal with these consequences, there will be a deleterious effect on security of electricity supply.

How high are system costs?

According to the report, estimations for system costs at the grid level lie in a range of 15-80 USD per MWh, depending on the country, technology and penetration level. If system costs are taken into account, a large share of variable renewables in the energy mix would significantly increase the total cost of electricity supply: a deployment of variable renewables to meet up to 30% of electricity demand would increase the electricity supply cost by between 16% and 180%, with wind being at the lower end and solar at the higher end. These large increases in electricity supply costs result from a combination of higher investment costs for renewables and system costs at the grid level.

Why are system costs higher for renewables than for nuclear, coal and gas?

The main reason is because of the variability and unpredictability of renewable output. This increases the costs associated with balancing short-term supply and demand variations and ensuring the long-term adequacy of electricity supply, which are two major components of the costs of running an electricity system. In addition, it is often the case that the production of renewables is located far away from where demand is situated and from the existing transmission grid. This requires the construction of new lines to connect the power plant to the transmission grid and to reinforce the whole transmission system. Accordingly, distance between demand and production is another factor which makes system costs higher for renewables.

Who pays for system costs?

At present, certain system costs are not transparently accountedfor, so in many countries it is not easy to establish who is paying for them. In most countries, transmission and connection costs are borne by the grid operator and then transferred to the public via an increase in transmission tariffs. The costs related to additional balancing requirements, as well as back-up and adequacy costs, are generally borne by other dispatchable technologies, with or without explicit compensation. In any case, system costs are not allocated to the generator that causes them and there is no "generator pays" system currently in place. One of the recommendations of the NEA report Nuclear Energy and Renewables: System Effects in Low-carbon Electricity Systems is that such a system is put in place and that these costs are "internalised" (see the Executive Summary).

What are the challenges of integrating renewables into electricity systems?

There are both technical and economic challenges associated with integrating renewables into electricity systems. From a technical perspective, integrating renewables requires a stronger and more developed transmission grid and a larger interconnected market. Balancing (between electricity demand and production) becomes more challenging because the variability in production must be adapted to the already existing variability in demand. As the penetration of renewables increases, it will become more difficult to balance demand and production. Finally, the electricity system must have sufficient capacity to satisfy electricity demand at all times, including when output from renewable sources is at a minimum.

From an economic perspective, electricity supply will become more expensive because of higher system costs and production costs from renewables. The economics of all existing dispatchable power plants will be affected by lower and more volatile prices and reduced load factors. The wedge between increasing cost of supply and reduced electricity market prices undermines the market incentives for building new dispatchable capacity and hence affects security of electricity supply.

What should be the proper balance between renewables and nuclear power?

The decarbonising electricity systems of the future will require contributions from all low-carbon technologies. As long as OECD member countries opt to subsidise variable renewables, their share will increase in both absolute and relative terms. However, system costs rise disproportionately with the share of variable renewables and will increasingly require accompanying measures to ensure the security of electricity supply. In planning for future electricity systems, it is important to note that nuclear power is the only major dispatchable low-carbon source of electricity other than hydropower, which is in limited supply. However for the two types of sources to co-exist will require explicit identification of system costs and financial or market incentives to ensure that sufficient supply is available at all times. The NEA report makes some recommendations as to how this might be done.

Related link

Press release: Low-carbon systems of the future must take system costs into account [FR]

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