Declining LCOE of Renewable Energy – What Measures Can the Government Take?
1. A major factor in achieving carbon neutrality is the decline in the unit cost of renewable energy generation• At the end of last year, the "2050 Carbon Neutral Promotion Strategy" was adopted, followed by the 9th Basic Plan for Electricity Supply and Demand and the 5th Basic Plan for Renewable Energy, with new and renewable energy generation goals of 20.8% (2030) and 25.8% (2034), respectively. Aside from the question of whether these goals aresufficient to achieve carbon neutrality by 2050, it is clear that achieving this intermediate goal will not be easy given that the new and renewable energy generation in 2019 accounted for only 5.62% of total generation.[1] Furthermore, there is a plan to increase 2030 nationally determined contribution (NDC) within this year, so it will be necessary to continue pushing for carbon neutrality. • Due to the difficulties involved in energy conversion and the extremely high costs associated with it, such as in the industrial sector, the conversion sector is the one most in need of achieving carbon neutrality. It is also within this sector that carbon neutrality can be achieved at a relatively low cost. Above all, there is an alternative called renewable energy. The decarbonization of the conversion sector will improve overall industrial export competitiveness by reducing greenhouse gas emissions as well as Scope 2 emissions. • Despite many policy attempts over the past two decades, grid parity remains a distant dream. This is evidenced by the relatively low proportion of renewable energy generation at 5% as mentioned above, as well as the reversal of the growth of new and renewable energy companies and their employees as of 2019 as compared to 2018, at 9.5% and 4.8%, respectively. A slow rise in renewable energy installations due to high unit cost of power generation, so-called the “levelized cost of energy” (LCOE), leads to additional unit generation costs dropping slowly as a result of technological learning. slow reduction in unit generation costs of generation drop due to technological advancements. This creates a vicious cycle in which the government's goal of providing renewable energy is further delayed by impeding the profitability of renewable energy generation projects. In contrast, if the cost of renewable energy generation falls, the business feasibility of the project increases, resulting in a greater amount of renewable energy installed and lowering the generation unit cost again through learning effects. Therefore, the most important and urgent goal for the government at this point is to bring about a decline in the unit generation cost of renewable energy, thereby leading to a virtuous cycle. 2. Solar and wind power LCOE as of 2020: A Snapshot • Levelized Cost of Energy (LCOE) is calculated by dividing the total cost required for the life of a generator by the total amount of power generated during that period. In addition to LCOE, other methods have been developed to measure the unit cost of renewable energy generation, and LCOE has its own limitations; however, LCOE is the most intuitive and straightforward way to calculate and compare renewable energy unit costs. Figure 1 shows the LCOE of solar and onshore wind powers in Korea as of 2020. The LCOE includes capital expenditures (CAPEX), operating expenditures (OPEX), land costs (LAND), financial costs and corporate taxes (Taxes). • According to Figure 1, CAPEX accounts for the largest share of both solar and wind power, which are a single item on all scales. This indicates the characteristic that, despite renewable energy's large initial investment cost, it does not require fuel costs for energy production. In the case of solar power, land cost and finance cost are both 10%, while OPEX is 15%. In onshore wind power, land costs are minimal, but OPEX and financing costs are high. Onshore wind power's high OPEX is attributable to the direct employment of electrical safety managers. 3. What measures can the government take 3.1 CAPEX• CAPEX accounts for the highest proportion (more than 60%) in LCOE of solar and onshore wind power, so lowering CAPEX would help to effectively reduce LCOE. The learning effect is the most important mechanism driving the decline in CAPEX. The learning effect is a phenomenon in which productivity increases and unit costs decrease because of learning-by-doing in production, economies of scale, and standardization as the cumulative installation capacity increases.The rate at which the price of technology decreases each time installation capacity doubles is called the learning rate,[5] and the higher the learning rate, the greater the cost reduction for the same increase in installation capacity. In contrast, even with the same learning rate, if the cumulative installation capacity increases significantly, the cost decreases significantly. Additionally, even if the existing learning rate is high, if the cumulative installation capacity does not increase further, the price does not decrease over time. • The methodology for estimating the cost of technology using the learning rate is called the Learning Curve Methodology. In this paper, the estimated LCOEs for the three scenarios (Base, High, Low) were calculated by applying the univariate learning curve methodology on the goals for solar and wind power installation recently announced in the 9th Basic Plan for Electricity Supply and Demand and the 5th Basic Plan for Renewable Energy in Korea and the historic data of direct investment costs (Figure 2). All remaining values other than CAPEX were assumed to be fixed during the analysis period. For the assumptions and basic data needed to calculate LCOE, Lee Keun-dae& Kim Ki-hwan (2020) of the Korea Energy Economics Institute was used. The LCOE value may vary if assumptions and basic data are changed. • In solar power, although there are slight differences based on the size, it is expected that even in 2050, power generation costs per kWh will range from 89 to 113 won/kWh. Particularly in the case of onshore wind power, the learning rate is lower than that of solar power, so only a very modest level of unit price decline is possible. According to the IEA's Projected Costs of Generating Electricity 2020 Edition published every five years,onshore wind LCOE in Belgium, Denmark, and Finland in 2020 is 78.33, 29.18, and 44.88 USD/MWh (86.2, 32.1, 49.4 won/kWh), respectively. This means that even if all the current national renewable energy installation targets are met, the decline in CAPEX by 2050 through learning effects will not be sufficient. • The following reasons explain why the decline in CAPEX due to learning effects cannot be relied upon entirely: • 1) It takes a long time. Prices only fall after all the required installations have been completed, as described above. • 2) There is uncertainty about the learning rate. In general, learning speed slows down as technology advances. Thus, the U.S. EIA concluded, when estimating the unit generation cost, that learning potential gradually decreased, and divided the period into three, and applied different (decreasing) learning rates to each (EIA, 2020). In this paper, it was determined that Korea still has a high generation cost and thus a high learning potential, so a fixed learning rate was applied. • 3) There is uncertainty about the price of raw materials. As can be seen from the solar power case, in which module prices have increased due to the recent rise in silicon costs (Figure 3), CAPEX may not fall or slow down despite the learning effect. Raw materials such as steel, aluminum, and copper, which are the main materials of wind power generators, may not be able to fully benefit from learning because prices may rise due to increased demand when the global economy is recovering from COVID-19. • 4) For amplifying the CAPEX declineby way of learning effects in policy, the target for renewable energy installation should be significantly increased. However, whether renewable energy installation goals can be raised further is not easy, and there are limitations when considering the domestic renewable energy market and social acceptability. • Taken together, the decline in CAPEX due to learning effects cannot be solely attributed to the decline in power generation unit prices, thus it is essential to implement additional policy measures to create a virtuous cycle of lowering power generation unit prices. 3.2 OPEX • In contrast to traditional fossil fuel-based power sources, renewable energy does not require fuel, so OPEX accounts for a relatively small proportion of LCOE. Insurance premiums, Internet costs, safety manager appointment costs, and inverter replacement costs are included in OPEX. Since the Internet cost is about 30,000 won per month, which is a very small amount, the effect on the overall power generation unit price is very small. The inverter has an economic life of 10 years, and if solar and wind power have an economic life of 20 years as discussed in this paper, a one-time replacement expense would be incurred. As discussed in the CAPEX case above, inverter replacement costs are expected to decrease as technological advances and cumulative installation capacity increase. • The rest of the costs are insurance premiums and the cost of appointing safety managers, and since both of these factors are safety-related, it will be difficult for the government to actively reduce them. Also, encouraging IT technologies such as AI to reduce costs will conflict with the country's top policy goal of creating jobs through the Green New Deal, so it will also be a measure that cannot be introduced quickly. However, if the risk of renewable energy facilities is set higher than it actually is, and insurance premiums are calculated higher than other facilities, efforts can be made, such as providing data, in order to dispel this misunderstanding and reduce information asymmetry. 3.3 Land price • In order to find out how LCOE in land price varies with the land category where the power plants are located, the solar power plant LCOE was calculated by the size of six sites (fields, paddies, forest, farmland, factory site, grassland) (Table 1). Under the assumption that the power plant site is leased, the land cost LCOE was calculated based on the annual rental cost. As can be seen, the LCOE of power plants of the same size could vary greatly from 0.7 to 87 depending on which land they are installed on. Therefore, a power plant built on land owned by the operating person or corporation and without incurring any land costs can gain significant price competitiveness in competitive bidding, etc. In addition, because land prices continue to rise, even if a power plant of the same size is built in the same location, land costs are likely to rise in the future (Figure 5). • Solar power plants installed in forests or farmland have frequently been the target of speculative activities towards capital gains from rising land prices following the completion of the power generation project by giving incentives to change the land category to grassland. Since such a system was abolished and the "temporary use permit system" was implemented in mountain areas and farmland, it is expected to be difficult for the government toagain introduce a system that directly benefits land purchases for power generation projects to reduce land costs. The reason is that there may be controversy that government policies are used to increase the assets of renewable energy generation companies. • As an alternative, a policy that supports a rented power generation site can be considered. For instance, the total area of national, provincial, and county lands in the current territory is 33,718 km2. If 337.18 km2, or 1% of the total area, is rented free of charge for solar power plants, a total of 34.5GW of solar power generation facilities could be added by applying the 29,339m2 needed for 3MW solar power plant installations.• Expansion of renewable energy through free rent of state-owned land can directly or indirectly impact the unit price of renewable energy production. This can directly eliminate land costs for renewable energy generators and increase price competitiveness, allowing more companies to enter the renewable energy generator business. Consequently, renewable energy installation capacity expands rapidly, which in turn reduces CAPEX through learning effects, indirectly resulting in further decreases in renewable energy generation costs. 3.4 Financial cost • Financial cost refers to the expense incurred by receiving loans from financial institutions for the remaining amounts from the total capital required to install renewable energy facilities, excluding equity capital, and paying interest on those loans. It is possible that financial costs may vary greatly depending on the equity ratio or interest rate, as well as the energy source and size. Table 2 shows the financial costs of each energy source and each power plant size in terms of changes in interest rates. Commercial banks' Project Financing (PF) loans were used to determine the percentage of loans (80% of construction costs) and interest rates (fixed interest rates), and the financial cost (interest amount) for the loan amount was calculated in equal monthly repayment of principal and interest for 20 years without grace. In the case of equal principal and interest repayment, the following equation can be used to determine the monthly repayment amount (principal + interest). • Given that the actual loan rate available from commercial banks is 2.93% for 100 kW solar power and 4% for the rest of the base power plants, Table 2 shows that those that start with 100% equity capital have a low unit price ranging between 17 won/kWh and 25 won/kWh. In addition, even if the equity capital is equally 20%, the power generation cost can be reduced by about 5 to 7 won/kWh by simply lowering the interest rate by 1%. • Projects providing long-term low-interest loan support have already been available for some time. A project called "New and Renewable Energy Financial Support Project" has been conducted by the Korea Energy Agency since 2006. It provides funds for facilities, production, and operations to individuals (including cooperatives) and small and medium-sized businesses that manufacture or install renewable energy-related facilities. When receiving support from the project, the repayment period is usually ten years with a five-year grace period, and is subject to quarterly variable interest rates. Interest rates on the "New and Renewable Energy Financial Support Project" have remained at 1.75% since the fourth quarter of 2012, about half the rate of commercial banks. Even with support from this project, Renewable Energy Certificates (RECs) can still be issued. Considering the loan rates that are currently available from commercial banks, financial costs will be significantly reduced by about 6 won/kWh for 100 kW solar power and more than 10 won/kWh for the rest of the standard power plants if they are supported by the "renewable energy financial support project." • The total budget for "New and Renewable Energy Financial Support Project" in 2021 was 524 billion won, a double increase from the previous year (2020's budget was 262 billion won). However, even if this amount is not used as production and operating funds but rather is used to install all 3MW-class solar power plants, only about 470MW of additional facilities will be added.The total size of newly installed solar facilities in 2020 is 4,069MW, which means that only 11.5% businesses are eligible for financial aid. • In contrast to installation subsidies, financial support, such as long-term low-interest loan programs, provides loans. As such support can be recouped over time, the actual amount is insignificant in comparison to the budget being organized. The government should expand its budgets to encourage renewable energy installation and use it as a pump-priming mechanism to reduce power generation costs. 3.5 Corporate tax • In December 2020, the system of investment tax credits was completely reorganized as part of a revision of federal tax law. In the past, renewable energy generation facilities were eligible for "Tax Credits for Investment, etc. in Safety Facilities" (Restriction of Special Taxation Act, Article 25), allowing SMEs to receive a deduction rate of 1/100, mid-sized companies to receive 3/100, and other companies to receive 1/100. The amended tax law, however, will apply a special case in recognizing the depreciation cost of the assets invested in plant and equipment as a deductible expense instead of the existing investment tax credit. Accordingly, the amortization range can be calculated by selecting 75/100 of standard durable years for SMEs and mid-sized companies, and by selecting standard durable years within the range of adding or subtracting 50/100 for other companies.The system is similar to the Modified Accelerated Cost Recovery System (MACRS)[18] in the United States, under which solar power generation facilities can deduct all facility investments with durable years of five years. According to the domestic tax law, solar power generation facilities can enjoy 20 years of depreciation standard durability (Kim Gyeong-nam, 2020). According to the revised tax law, small and medium-sized companies may apply standard durable years within the range from 5 years at the shortest to a maximum of 35 years, and other companies within the range from 10 years at the shortest to a maximum of 30 years. • Nevertheless, in practice, getting special tax reductions designed for SMEs may be more advantageous than the special system for renewable energy facilities. As for the renewable energy generation business, it is classified under "D. electricity, gas, steam, and air conditioning supply industry." Hence, renewable energy generation business can be recognized as a medium enterprise if its average sales exceed 12 billion won but less than 100 billion won, and as a small enterprise with less than 12 billion won in sales, as long as it meets all of the requirements of Article 3 of Enforcement Decree of the Framework Act on Small and Medium Enterprises. Special tax deductions or exemptions are available for SMEs in both of these cases. The tax credit rates by corporation size and location can be found in Table 3. A 7% investment tax credit rate was available to small and medium-sized firms before the tax law revision, but enterprises not located in Seoul metropolitan areas and not medium-sized can receive up to 30% tax reductions. • The minimum tax amount applies to special tax reductions and exemptions for SMEs, investment tax deductions, and special taxation for including depreciation costs in deductible expenses, meaning that more than 17/100 of the tax base (7/100 for SMEs) must be paid. A summary of the results of calculating the tax paid by the 100 kW solar power plant for each tax benefit can be found in Table 4. For the convenience of calculation, it was assumed that there were no other income deductions, inclusions in deductible expenses, or tax deductions other than (1), (2), and (3) and that 100% equity capital was used. Moreover, the assumptions used to calculate the profitability of the power plant were derived from those used to calculate the LCOE. As shown in the table below, even though the types of tax benefits differ, the amount of tax due is the same under the application of the minimum tax. The actual amount of tax is the same whether it is applied with a 7% deduction through an investment tax credit or a 30% deduction through a special tax reduction for SMEs. In the same way, an onshore wind power plant with a much larger capacity of 20MW produces the same result (Table 5). • Special taxation for including depreciation costs in deductible expenses is not really a tax deduction system, but rather a way to improve cash flow by deferring taxes to future years. At present, small and medium-sized businesses can expand to 75% of standard durable years, so standard durable years can be set from at least five years to 35 years. In an accelerated depression, a large portion of revenue is treated as expenses, which lowers the tax base itself. However, if the minimum tax amount is set as it is in Korea, the benefits of accelerated depression are limited, and in that case, there is no incentive to exhaust investment costs early. Depreciation costs that exceed the depreciation limits under the tax law can still be included in a future deduction using a reservation of non-inclusion of excess deductible expenses. But this is only possible because the limit itself has been increased significantly, leaving no amount to be reserved, as renewable energy generation projects are currently eligible for special cases for the inclusion of depreciation deductions. The given tax benefits are fully attained by a corporation that is not a small or medium enterprise if it has two or more renewable energy power plants built in different fiscal years and can handle much of its annual income through accelerated depreciation. • Taken together, unless the minimum tax is adjusted, the government’s simply increasing the tax reduction rate or allowing additional accelerated depreciation will not have a significant impact on the corporate tax reduction related to power generation costs; even if there is any impact at all, it will be minor. Several forward-looking policies, including lowering the minimum tax rate, are needed to achieve a significant drop in power generation unit prices. To accomplish this, a national consensus and social agreement should be formed first. 4. Conclusion: the government should first focus on expanding its support for land and financial costs • As examined in Section 3, policy-making is not easy, and there are many considerations that need to be taken into account. The reason is that support policies should be developed by comprehensively considering whether the policies will actually have an effect, whether there are any conflicts with higher-ranking plans, and whether they will harm equity between businesses or other major industries. • The analysis of this paper suggests that among the various options, land and financial costs appear to be relatively accessible solutions for the government. In the case of land costs, the decision-making process and policy implementation can be smooth since state-owned land can be utilized. When it comes to financial costs, since the renewable energy financial support system is already in place, expanding the project budget and support targets can allow for the provision of financial support to more renewable energy generation operators without too much difficulty, resulting in a significant drop in power generation prices across the industry. • Given the possibility that the decline in unit generation costs of renewable energy could result in a rapid increase in cumulative installation capacity and subsequent positive feedback that further reduces unit generation costs, it is imperative to "do whatever is possible" rather than just wait for the decline in unit generation costs to occur through learning effects. In a similar way that a fist-size snowball rolls and grows to the size of a snowman, swifter implementation of the policy will have an increasing impact through a virtuous cycle. • There is a pressing need to reduce greenhouse gas emissions to prevent climate change, and attempts are being made in each country to establish trade barriers using carbon emissions as weapons. This means that a country's overall greenhouse gas emissions matter, but decarbonizing the grid is also critical to overcoming carbon trade barriers. The government should now take bold and forward-looking actions to accelerate the virtuous cycle of reducing the unit costs of renewable energy. 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Institutional Incentives for Investment in Solar Energy Facility and Equipment: Analysis of the Economic Effects of the Depreciation Method, New and renewable energy, 16(4), 65-75.• Tsiropoulos, I, Tarvydas, D, Zucker, A, Cost development of low carbon energy technologies - Scenario-based cost trajectories to 2050, 2017 Edition, EUR 29034 EN, Publications Office of the European Union, Luxembourg, 2018, ISBN 978-92-79-77479-9, doi:10.2760/490059, JRC109894.• IEA (2020). Projected Costs of Generating Electricity 2020, IEA, Paris.• U.S. Energy Information Administration. Assumptions To AEO2021 – Electricity Market Module. (Released at Feb 3, 2021. Available online: https://www.eia.gov/outlooks/aeo/assumptions/• SEIA (Solar Energy Industries Association), https://www.seia.org/initiatives/depreciation-solar-energy-property-macrs (accessed on Jun 11, 2021)• e-Nara Indicators. https://www.index.go.kr/potal/main/EachDtlPageDetail.do?idx_cd=2728 (Accessed on Jun 18, 2021)
2021.06.24 / Eunsung Kim
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