Discount And Hurdle Rates: The Dark Horses Of Capacity Expansion Planning

Discount and hurdle rates: the dark horses ofcapacity expansion planningSmaranda Sgarciu, Iegor Riepin, Felix MüsgensBTU Cottbus-SenftenbergIEWT 09.09.21

Research focusHurdle ratesDiscount ratesThe Hurdle Rate (HR) is the minimum requiredrate of return on a project required by aninvestor (Mellichamp, 2017).The Discount Rate (DR) is the time dependentdecrease in the future cash flows of a socialplanner reported to the present time (Karp andTraeger, 2013).DF 11 DR yy 1 nAnnuity calculationAnnuity HR Costsovernight൫1 HRሻtObjective functionInvestment costsOperational costsHow sensitive are the outputs of state-of-the-art capacity expansion modelsand related policy take-aways to changes in the discount and hurdle rateassumptions?BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.212

Our contribution Analyzing the impact of hurdle rates and social discount rates on keyoutputs of the generation capacity investment model: the investment mixand carbon emission intensity. Illustratingthe energysystemdevelopmentpathways resulting fromvarious assumptions onhurdlerates,socialdiscount rates and threeenergyfuturesfromTYNDP (ENTSOE, 2018).Fig. 1: Using Sankey diagram to accentuate whichparameter combination will lead to certain investmentsBTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.213

Methodology Bottom-up investment optimization model. Greenfield cost minimization problem which determines investmentsin both conventional and RES technologies; capacity of storagesystems is implemented exogenously. Pan-EU geographical scope country-based nodal structure. Hourly dispatch of electricity three years (2020, 2025, 2030).BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.214

TechnologyLow riskMediumriskEUCOHigh risk17.4%Lignite8.9%10.2%19.4%Hard 5.3%Photovoltaic6.9%8.5%13.4%Wind Onshore7.5%8.7%13.3%Wind Offshore9.3%10.9%14.2%Fuel costOCGTCCGTHard coalLigniteNuclearDGO&M costFig. 2: Cost data for each scenario from the TYNDP 2018 %Load [GW]10.5%OCGTSTCO2 priceNuclearCCGTTechnology specific hurdle rates (NERA,2015) Risk types: allocation, carbon pricevolatility, policyHard coal15%Lignite13%Nuclear11%OCGT9%CCGT7%Hard coal5%Lignite3%140120100806040200NuclearDiscount rates /MWhScenario set-uphoursEUCOSTDGFig. 3: Load duration curve for Germany in each TYNDP scenarioBTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.215

Mathematical formulationObjective function 𝑔𝑖,𝑛,𝑡,𝑦,𝑠 𝑉𝐶𝑖,𝑛,𝑡,𝑦min tc OCs DFy capi,n,y,s ICis𝑜𝑐𝑠 𝐷𝐹𝑦 i,n,y,s𝑖,𝑛,𝑡 𝑠ℎ𝑒𝑑𝑛,𝑡,𝑦,𝑠 𝑉𝑂𝐿𝐴𝑛𝑠,𝑦𝑛,𝑡Market clearing �� 𝑔𝑐𝑜𝑛𝑣,𝑛,𝑡,𝑦,𝑠 𝑔𝑟𝑒𝑠,𝑛,𝑡,𝑦,𝑠 𝑠ℎ𝑒𝑑𝑛,𝑡,𝑦,𝑠 𝑓𝑙𝑜𝑤𝑛𝑛,𝑛,𝑡,𝑦,𝑠 ��𝑛𝑣𝑟𝑒𝑠𝑛𝑛Selected system constraints𝑐𝑎𝑝𝑖,𝑛,𝑦 1 𝑐𝑎𝑝𝑖,𝑛,𝑦 𝑖, 𝑛, 𝑦𝑔𝑐𝑜𝑛𝑣,𝑛,𝑡,𝑦,𝑠 𝑐𝑎𝑝𝑐𝑜𝑛𝑣,𝑛,𝑦,𝑠 𝐴𝐹𝑖,𝑛 𝑛, 𝑡, 𝑦, 𝑡,𝑦,𝑠 ���,𝑦,𝑠 𝐴𝐹𝑟𝑒𝑠𝑒𝑟𝑣𝑜𝑖𝑟,𝑛 𝑟𝑒𝑠𝑒𝑟𝑣𝑜𝑖𝑟 𝑖, 𝑛, 𝑡, 𝑦, 𝑠𝑔𝑟𝑒𝑠,𝑛,𝑡,𝑦,𝑠 𝑐𝑎𝑝𝑟𝑒𝑠,𝑛,𝑦,𝑠 𝑃𝐹𝑟𝑒𝑠,𝑡,𝑛 𝑟𝑒𝑠 𝑖,𝑛, 𝑡, 𝑦, 𝑠𝑚𝑎𝑥𝑐𝑎𝑝𝑖,𝑛,𝑦,𝑠 𝐶𝐴𝑃𝑖,𝑛 𝑖, 𝑛, 𝑦𝑒𝑥𝑖𝑠𝑡𝑖𝑛𝑔BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.216

Results (i). The impact of Hurdle Rate oninvestments in generation technologiesEUCODriver: Increasing theHurdle Rate penalizesthecapitalintensivetechnologies.STDG : HR low —› HR : HR low —› HR : HR low —› HR : HR low —› HR : HR low —› HR : HR low —› HRmediumhighmediumhighmediumhigh20.00%10.00%Wind Offshore:-26% in EUCO-64% in DG-68% in STSolar PV:-35% in EUCOInvestment shift %Wind Onshore:approx. -10%-70.00%-80.00%Hard CoalCCGTOCGTWind OnshoreWind OffshorePVFigure 4: Shifts of investment mix relative to low risk HR scenario, keeping DRconstant at 5%.BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.217

Results (i). The impact of Hurdle Rate on Carbonemission intensityTake-away: A lower hurdlerate results in a system withlowercarbonemissionsintensity.60050011.6 %In the EUCO setting, a low riskhurdleratecausesaremarkable fall of 27% in thecarbon emission intensity.g CO2 e/kWh7.5 %10.6 %7.2 %400The ST and DG setting exhibita similar pattern in theemission intensity reduction,approx. 10% (if HR high istaken as a reference).7.5 %27.5 %3002001000HR lowHR mediumEUCOHR highHR lowHR mediumHR highHR lowHR mediumSTHR highDGFigure 5: Carbon emission intensity of the investment mix.BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.218

Results (ii)The impact of Discount RateDG10.0%5.0%5.0%5.0%Investment shift [GW]Investment shift [GW]Investment shift %-15.0%-20.0%DR 55DRDR77DRCCGTHard CoalDR99DROCGTCCGTDRDR1111DRDR1313DRDR15 15Wind OnshoreOCGTWind Onshore-25.0%DR 5Hard CoalDR 7CCGTDR 9OCGTDR 11DR 13DR 15Wind OnshoreST10.0%Take-away: Smaller discount ratebenefits the transition to renewableenergy sources.Investment shift [GW]5.0%0.0%-5.0%-10.0%-15.0%-20.0%-25.0%DR 5Hard CoalDR 7CCGTDR 9OCGTDR 11DRDR 1313DRDR 1515Careful: results depict sensitivity to DR,while having HR fixed to a single value(High Risk).WindWind OnshoreOnshoreFigure 6: Shifts of investment mix in relative terms based on [DR 3%] scenario in the EUCO, ST and DG settings.BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.219

Results (iii)Sankey DiagramTracking down the overlappingeffects of the three degrees offreedom:1. choice of the HR2. choice of the DR3. development of energysystem parameters (costlevels, demand) form threeTYNDP energy futures.Take-away:Low HR in combination withlower DRs (below 7%) drivemost of the investment in RES.Gas-fired power plants arepredominantly invested withhigh HR and DR.Figure 6: Sankey diagram depicting the distribution of the investmentflows for each technologyBTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.2110

ConclusionsModelling take-aways The choice of risk-based hurdle rate exerts substantial influence on the keyoutputs of the investment optimization models (investment mix, carbonemission intensity). Lower hurdle rates facilitate larger shares of renewable technologies in theoptimal investment mix, leading to a more decarbonized system. Certain combinations of discount and hurdle rate lead to a systemconfiguration, which favors RES installations or to one mainly dominated bygas and coal-fired technologies.Policy take-aways Low discount rates fostered by the European Central Bank make climateand energy targets attainable.BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.2111

Contact information:Smaranda SgarciuChair of Energy EconomicsBTU Cottbus-SenftenbergSmaranda.Sgarciu@b-tu.de 49 (0) 355 69-4513BTU – Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.2112

BTU -Chair of Energy Economics Smaranda Sgarciu Discount and hurdle rates: the dark horses of capacity expansion planning IEWT 09.09.21 Discount rates The Discount Rate (DR) is the time dependent decrease in the future cash flows of a social planner reported to the present time (Karp and Traeger, 2013). Annuity HR Costsovernight .