Reply to ‘Bias in energy system models with uniform cost of capital assumption’

Abstract

The commentary ‘Bias in energy system models with uniform cost of capital assumption’1 highlights the impact of the Cost of Capital (CoC) on the levelized cost of electricity (LCOE), and questions the choice of a uniform weighted average cost of capital (WACC) for all regions of the world. Since it is well known that CoC has significant impact on LCOE, having an accurate assumption is important for energy systems modeling. The commentary raises the relevant point that a uniform assumption could result in both underestimation and overestimation of the cost of renewable energy in different regions of the world. However, we consider it the best choice available for the transition period 2015 to 2050, as it was implemented in our study2. In addition, it is consistent with values published in leading scientific journals and international reports. To this end, we offer further explanation of the assumption used and discuss how modeling can be improved. The most relevant aspect of energy system scenario development is ignored in the commentary: modeling needs more accurate methods to project WACC/ CoC for future periods up to 2050 and 2100 for all countries globally. First, the commentary by Egli et al. would be applicable to any scientific publication or major international report in the field of energy system modeling. Currently, all major global energy system studies use uniform WACC assumptions, or quasi-uniform assumptions, as in the latest reports of the International Renewable Energy Association (IRENA). Our assumptions are in line with major scenarios: the International Energy Agency (IEA) uses 7% WACC and IRENA uses values of 7.5–10% in their latest reports. And the same WACC is uniform for all years in their scenarios. We use a WACC of 7%. Further, leading research teams in the world examining high shares of renewable energy for the global energy system analysis, such as Jacobson et al.3, Teske et al./German Aerospace Center4, DIW5, VTT6, and our team2, use similar uniform WACC assumptions. Second, the commentary by Egli et al. shows that a challenge remains for the field of energy system analysis. The question of how to project WACC to 2050 and beyond remains unanswered in a satisfactory manner. Likewise, it must be acknowledged that regional differences of the future are difficult to predict and may not accurately be seen through a modern lens. There are many unknown factors of the future that could influence CoC in different regions. The same holds true for Integrated Assessment Models (IAMs), which are the basis of IPCC reports, as recently summarized for that specific community by Krey et al.7 for capital expenditures. This publication does not comment on variable WACC but assumes a uniform discount rate of 5%. The IAM scenarios are also heavily dependent on the choice of WACC assumptions due to typically wide use of nuclear energy and fossil carbon capture and storage technologies, which require substantial capital. Third, while CoC values are very uncertain, current values for countries shown in the commentary are the result of an estimation method based on 10-year average German CoC values for PV projects and current Moody’s sovereign ratings8 and these values should be used for 2050 calculations. This is a questionable method of projecting future CoC and does nothing to improve upon the dominant method of using uniform values. A uniformly acceptable and better method for long-term WACC estimation for countries does not exist, which is not adequately reflected in the commentary, nor was a better method offered. Analysis of ratings history indicates that many countries have shown significant changes in risk levels in the past decades. South Korea as an example is not unique as many Eastern European countries show substantial risk reductions. At the same time, the countries with the highest CoC, as shown in the commentary, are unstable countries experiencing civil unrest. However, it would be strange to discuss a transition towards 100% RE in these countries while considering that current civil disorders continue until 2050 or 2100. So, it would be inaccurate to use a current CoC value for the long term. Nevertheless, WACC has the highest impact on capital intensive technologies, like renewable energy generation and storage technologies, while conventional power generation is not that strongly affected. This makes it most vital to have realistic WACC assumptions in the steps leading towards the end of a transition, closer to the year 2050, when the share of RE in the energy system becomes dominant. In essence, our WACC assumption is for the year 2050, and then this value is also used for previous years. Since future CoC estimation methods for individual countries are not available, and direct extrapolation of current rates for all https://doi.org/10.1038/s41467-019-12469-y OPEN