CBA for RET

Direct Reading – CBA for RET

Introduction

This brief paper is a result of directed readings done under the guidance of Christopher Grandy during the fall semester of 2010. Because of my interest in energy transition, Professor Grandy recommended the study of Cost-Benefit Analysis (CBA) and the application of it to Renewable Energy Technologies (RET).

The present work is divided into four parts. It starts by talking briefly about CBA components; then quickly elaborates on the opportunities of applying CBA in decision-making processes; followed by the description of some challenges to design dependable analyses, and finally a case study concerning solar panels in households.

1 CBA

CBA is usually used by investors to make informed-decisions during decision-making processes. The analysis of costs and benefits help investors whether to undertake a project and oftentimes predict the Return On Investment (ROI) of a venture.

CBA framework methodology is divided into three sets of data: basic input, basic control, and output data. (Ogundale, 2009)

Net Present Value (NPV), Benefit-Cost Ratio (BCR), and Internal Rate of Return (IRR) are three decision criteria defining CBA. NPV is the most common since it provides more reliable information than BCR and IRR. NPV formula consists of Present Value Benefits (PVB) subtracted by Present Value Costs (PVC).

Besides costs and benefits, time and discount rate are two other elements that make up a CBA.

CBA is more like a process than a sequence of events. A few steps should be considered in any analytical process: scope (identifying gainers and losers), constraints, alternatives (“do nothing” is an option), quantify costs and benefits utilizing discount rate (which helps decision-makers value the future versus present costs and benefits), NPV, sensitivity for uncertainty (project life span), consumer equity issues and intangibles, test for viability (comparison of total discount benefits with total discount cost), and report. (Ogundale, 2009)

As mentioned earlier, CBA relies on data. The sampling technique can be either random or planned, and data collection methods derive from primary or secondary sources. Observation questionnaire method is also applied.

2 Opportunities

The main opportunity of CBA in the implementation of RET is that RET has become price-competitive and, if used properly, set standards of codes and practices for investors in the industry.

Valuing costs and benefits of intangible goods are one of the greatest challenges of CBA, especially for RET. Contingent Valuation Method (CVM) is the formula that help translate perceptions into numbers. CVM estimates Willingness to Pay (WTP) and Willingness to Accept (WTA). WTP is the maximum amount of money which an individual is willing to pay for a higher level of utility. WTA is the minimum amount asked by an individual to accept a given reduction in utility.

The list below points out few intangible costs and benefits. (Important to note that the longer is the timeline for ROI, intangible costs tend to become higher whereas perceived benefits diminish.)

Intangible costs:
• cleaning panels,
• destination and recycling of panels and existing equipment of electricity systems,
• environmental externalities,
• façade changes and risks on house property value,
• safety risks,
• supplier may disappear,
• and new technologies.

Intangible benefits:
• satisfaction of using RET,
• (incremental) house property value,
• water heating process (time and quality),
• selling additional power to the grid,
• getting off the grid and becoming a powerhouse,
• environmental incentives,
• and supporting economic and production decentralization processes.

3 Challenges

Collecting data and assigning monetary value to intangible goods are the main CBA challenges. Data collection is addressed by working closely with statistical departments or conducting primary data surveys. Giving a monetary value to intangibles is carried out by using Cost-Effectiveness Analysis (CEA), which estimates the costs of doing a particular activity in alternative ways. However, quantifying the monetary value of intangibles as well as environmental externalities is not consensual and; therefore, becomes a relevant CBA limitation.

Another challenge is selecting an adequate discount rate (DR). DR brings to present values future costs, and so make possible to compare future and present costs and benefits. However, DR is many times arbitrary defined. If it turns out not being realistic it greatly affects the reliability of outcomes. For instance, a higher DR reduces future values (benefits or costs) below levels with lower DRs.

4 Case Study

Giant-Solar, a Hawaiian Energy Solar Company, provided some figures on the installation of solar panels in a household of monthly electricity bill of $138 and 511 KwH/month.

Considering that i) benefits are the capital no longer spent on electricity after the installation of solar panels and ii) the total cost the sum of equipment, labor, standard and electrical permitting, and design, and iii) investment payoff of 5 years.

Calculation below:

Costs:
Household: 511 KwH/month and $138 electricity bill.
Diamond Head average peak sun hours: 6.1 hours
511 : 30 (days) = 17,03 KwH/day
Considering 17,5 KwH/day as a small contingency added for higher user days and months.
17,5 KwH/day x 1000 = 17.500 watts hours/day
17.500 : 6.1 (peak sun hours in Diamond Head area) = 2868 watts
2868 watts is the power needed.
Size of solar panels: 3x5 foot. Average 220 watts per panel.
2868 watts : 220 = 13,03 panels (suitable size 14 panels)
$7,10 is the cost for watt for complicated installations.
14 panels x 240 (panel range) = array of 3360 watts
3360 watts x $7,10 (watt cost) = $23.850,00 dollars (This is the cost of Giant Solar to install 14 solar panels in a household of 511 KwH/month).

Benefits:
$138 monthly electricity x 12 (months) = $1.656,00 annually on electricity /
20 years (time scope)
Assuming that DR is 5%, total discounted benefit becomes $20.637,00 (Net Benefits = B (Benefits) – C (Costs)) ($20.637,00 - 23.850,00 = Costs of $3.213,00)
Assuming that DR is 2%, total discounted benefit turns out being $27.077,00 ($27.077,00 - 23.850,00 = Savings of $3.227,00)

Conclusion:

The investment in solar panels is cost-effective if DR is 2%. 5% DR within a timeline of 20 years makes the investment payoff not possible. This problem is addressed if investor agrees on a longer timeline. However, 20 years is already a considerable large period for a household single investment, even though Federal and State credits are available reducing RET costs. The longer is investment payoff, the higher become the risks of externalities to arise and lower the perception of existing benefits.

Reference:

Ogundale, Abimbola Adegoke. 2009. “Comparative Cost-Benefit Analysis of Renewable Energy Resources for Community Development in Nigeria”. Thesis: North West University. Potchefstroom Campus.