Chairman’s Message

<Main Points>

Integration costs must be included to capture the full cost of variable renewable energy (VRE).

Integration cost includes backup cost, storage investment cost, storage loss cost, curtailment cost, and grid expansion cost.

Integration cost increases with higher penetration of VRE.

Power system cost for Japan in 2050 is minimized at a 51% VRE share.

Power system cost can be lowered by further utilization of demand response, batteries and nuclear power, but cost-optimal VRE share remains around 50%.

Even with expanded use of demand response and batteries, thermal power plants remain the primary source of backup.

1. Integration costs must be included to capture the full cost of variable renewable energy.

The energy crisis triggered by the Iran war is prompting many countries to accelerate the deployment of renewable energy to reduce their dependence on oil and gas. It is generally argued that renewable energies could enhance energy security and reduce costs at the same time. But the energy security aspect must be scrutinized, as the shift to renewable energy could create a new and different security concern through dependence on a dominant supplier. I would like to address this issue in another Chairman’s Message in the near future.
　In this month’s Message, I would like to focus on the cost issue. Many people argue that renewable energy is the cheapest source of power generation. It is true that, on an LCOE (Levelized Cost of Electricity) basis, solar power and wind power are cheaper than most other sources of power generation today. But LCOE only captures the stand-alone cost of power generation. It does not capture the cost to integrate variable renewable energy power into the power system. This cost is called the integration cost. The full power system cost must include this integration cost in addition to the LCOE. To design a cost-optimal power system, the evaluation must be based on the total power system cost rather than just the LCOE.
　My institute, IEEJ, has recently issued a study on integration costs. This month’s Message is based on this study.

2. The components of integration costs in the IEEJ study.

To deal with the intermittency of VRE, such as solar power and wind power, the supply and demand of the power system must be balanced at every second. One approach is to maintain sufficient backup thermal power capacity to enable thermal power generation to address the possible shortage of power during nighttime, cloudy days, and windless days. Another approach is to have sufficient power storage capacity to absorb excess power when VRE generates maximum power and to release the power during periods of power shortage. Power can be stored not only with batteries but also through pumped hydro, which pumps water up to a higher-altitude pond using excess power and releases the water to generate hydropower in times of need. The third approach is to curtail power generated by VRE to avoid supplying excessive power to the system. This approach may appear to waste power but can avoid the cost of power storage.
　These approaches to balance the supply and demand of the power system will incur substantial cost. Backup thermal power will require substantial capital investment cost. Power storage must factor in the CAPEX of expanding the storage capacity and the cost of operating power storage, including the cost of power as an input to storage and the cost of battery losses. Curtailment must account for the lost revenue.
　As most large-scale VRE resources are located far away from the demand centers, the cost of long-distance interregional transmission line expansion must be incorporated. These grid-related costs and the cost from generation-demand mismatch are the two main pillars of integration cost. The IEEJ study is based on the integration cost captured within this scope.

3. Integration cost is dynamic, increasing with higher VRE penetration.

One important aspect of the integration cost is that it will increase as the penetration of VRE becomes higher. When the penetration of VRE is low, the balancing can be achieved by utilizing the existing dispatchable power sources without additional investment. Consequently, the fuel savings from VRE in thermal power generation exceed the balancing costs, leading to a reduction in system costs. The picture will progressively change as the penetration of VRE becomes higher, requiring more balancing. As the penetration level rises, large-scale VRE will be located farther away, requiring more investment in transmission lines. In this model, no upper limit is imposed on transmission expansion. In addition, a decline in the capacity utilization rate of thermal power leads to a rise in the cost of backup power. In the case of battery storage, investment costs rise as it is scaled up to provide larger-magnitude and longer-duration backup. Thus, it is very important to note that the integration cost is not static. It is dynamic, depending on the penetration level of VRE.

4. Qualification: Underestimation of total system cost in the IEEJ study.

Theoretically, the scope of integration cost is much broader than that captured in the IEEJ study. Start-up and shutdown costs of thermal power must be considered as well as the thermal part-load operation costs and standby costs. Efficiency losses from thermal load-following operation are also cost-increase factors. Grid-related costs should include intraregional transmission expansion costs, distribution network expansion costs, and substation expansion costs.
　The LCOE must reflect the fact that, as the renewable energies are expanded, the incremental renewable energy sources will have less favorable conditions. One example is offshore wind power generation. As more offshore wind power generation is deployed, the bottom-fixed type will have to go deeper and farther away from the shore. Eventually, floating-type offshore wind power generation must be explored. Cost increases will be inevitable. The LCOE of renewable energies is thus not static.
　There is also additional cost beyond the grid-level system costs captured in the LCOE + integration cost formula. There are external or social costs outside the electricity system. The cost of the additional infrastructure, such as EV charging infrastructure, to support broad deployment of renewable energies must be incorporated to capture the total cost of the system. The IEEJ study does not capture such costs beyond the power system.
　Thus, I need to clarify that the IEEJ study is underestimating the full system cost associated with variable renewable energy deployment. But I believe that the IEEJ study is still very significant as one of the pioneering efforts to capture the integration costs and thereby reflect the total system cost arising from the broad deployment of VRE.

5. Power system cost for Japan in 2050 is minimized at a 51% VRE share.

The IEEJ study assumes carbon neutrality for Japan by 2050. It is based on a cost- minimization approach. It is also based on various assumptions, including the costs of various energy sources and nuclear power deployment.
　According to the IEEJ study, the power system cost is minimized at a 51% VRE share. Beyond this level, integration costs outweigh fuel savings, increasing total system costs.

2050 Power System Cost by VRE Share

　It must be noted that this analysis is based on Japan, which predominantly depends on solar power for its VRE and faces prolonged periods of cloudy days. As an island country, Japan has no transmission connections with other countries. The cost-minimum level of VRE can be significantly different for regions with different characteristics. But I believe that this total power system cost analysis, including integration costs, should be applied to other regions as well to design their future power mixes.

6. Power system costs can be lowered by various means, but the cost-minimum level of VRE penetration remains around 50%.

Power system costs can be lowered by further utilization of demand response, low- cost batteries, and nuclear power. The IEEJ study provides multiple scenarios, including 26% EV participation in demand response, 60% reduction in battery costs from the base case, and maximum extension of existing nuclear power plants plus full operation of planned reactors.
　These measures can lower the power system costs, especially when all of them are put in place.

Reduction in Power System Costs by scenarios (2050, 51% VRE)

　But the cost-minimum level of VRE penetration does not change very much from the base case. The cost-minimum level of VRE penetration is 52%, 53%, and 48% for the demand response scenario, the low-cost battery scenario, and the nuclear expansion scenario, respectively. With all the measures combined, the cost- minimum level of VRE penetration is 50%. 　

7. Even with expanded use of demand response and batteries, thermal power plants remain the primary source of backup

The IEEJ study looks into the mix of means to balance demand and supply of the power system. In the base case, thermal power is expected to provide the majority of the balancing. As the study assumes carbon neutrality for Japan in 2050, the thermal power in 2050 includes hydrogen/ammonia power generation, gas power generation with CCS, and biomass power generation.
　More aggressive use of demand response and low-cost batteries may help lower the integration costs, but thermal power will continue to play the most important role in ensuring the balance of the power system.

Load Frequency Control Reserves in 2050

8. Way forward: More analysis and the need to incorporate integration costs

The IEEJ study is not yet completed. Its scope of integration cost is limited. It does not capture costs beyond the power system, such as demand-side technology costs, including the portion of electric vehicle costs attributable to providing flexibility. But I believe that it shows the flaw in designing the future power mix by simply relying on the static LCOE figures.
　The cost-minimum level of VRE penetration can vary depending on the characteristics of the region and assumption of technology costs. The 51% level applies only to Japan in 2050 under a carbon-neutrality assumption in 2050. I would like to encourage other countries to engage in similar analyses with different assumptions to design their future power mixes.
　IEEJ is committed to further developing its total power system cost analysis. IEEJ is also willing to cooperate with other countries or organizations interested in integration cost analysis. Please feel free to contact me or my colleagues to explore future collaboration on this matter.
　The most recent IEEJ study on this issue can be accessed through the following URL. I look forward to deepening and broadening this analysis together with the interested parties around the world.

Japan’s energy scenario up to 2050 : Topic 1 Strategies for Reducing Power System Costs (Presentation materials） - The Institute of Energy Economics, Japan - IEEJ