The Cost of Producing Electricity in Denmark

What is the consequence on the costs of generating electricity when a new technology is introduced into a country's power system? There could be large consequences for aggregate production costs if (i) the new technology is producing at a higher cost compared to the existing technologies in the power system; (ii) existing technologies cannot be phased-out at a similar pace as the new technology is phased in, leading to over-capacity in the power system; and (iii), the requirements of the existing power system to meet certain types of electricity demand change. These are all important questions to address when countries decide to move towards new technologies for generating electricity. Leading examples include introducing renewable energy sources like wind or the substitution of conventional energy sources like natural gas instead of coal. The main objective of this book is to study the costs of generating electricity in the Danish power system. Specifically, calculating and then comparing the costs of generating electricity across different types of generation technologies provides an opportunity to measure the trade-offs involved when new technologies are introduced into a power system.

By investigating the case of Denmark, this study provides important insights on the costs of overall electricity generation. Specifically, the actual average unit costs are estimated for the full generating capacity of the Danish power system. Denmark is a particularly interesting case to study because it is a world leader in terms of wind power penetration rates. In 2012, the wind power penetration rate in electricity consumption was equal to 30 percent, whereas it was equal to 34 percent for production, see International Energy Agency (2013). For comparisons, other regions are dwarfed by the Danish rates: The corresponding values were six percent for Europe, 3.5 percent for the US, two percent for China, and 2.5 percent for the world. The countries that are closest to Denmark in terms of wind power penetration rates are Portugal with 20 percent and Spain with 18 percent. Important lessons can be learned about the consequences of rapidly phasing-in a large amount of wind power on the electricity generating system. Studying wind power in Denmark is also interesting because wind penetration rates increased over a short period of time. In 1985, the share of wind power's generating capacity was essentially equal to zero. By 2012, the penetration rate of wind power in electricity consumption had increased to 30 percent.

The results on the costs of generating electricity obtained in this study are also of policy interest because the dynamics of the costs of generating electricity is an important determinant of the sustainability of Denmark's progress towards substituting away from electricity generated from fossil fuels. It is clear that the production cost of electricity must be an important consideration for policies designed to minimize greenhouse gas emissions{ particularly policies involving subsidies. For example, if using renewable generation technologies increases the production cost of electricity too drastically, then the support for such investment may erode because the standard of living of Danish consumers as well as the global competitiveness of Danish firms could deteriorate through increasing producer and consumer prices. Importantly, energy prices might change to such an extent that the political support for further progress towards a fossil fuel independent society vanishes. In other words, there are important trade-off between progress towards a fossil fuel independent society and the increase in the production cost of electricity.

The purpose of [chapter 1] is to present a summary devoted to describing the main findings of the study presented in the present study paper and in Levitt and Sørensen (2014). This chapter is written with the purpose to present the main results in such a manner that the study can be well understood without reading the other chapters of the book. Of course, having said that, we hope that this chapter inspires readers to continue reading. Power system economics and the economics of energy in general, is an important part of a country's macro-economy as well as the economy of individual households. It is without question that issues concerning energy and the environment, and power systems specifically, compose a large part of public debate and policy discussions at various levels of national governments as well as international institutions. The outcomes of the various policy debates concerning energy affects everyone: It pays to be informed.

Our study of the costs of electricity generation in Denmark can be viewed as an important document for understanding the nature of costs of the electricity generation sector in its power system. Indeed, our analysis of the various costs of generating electricity has produced a number of interesting findings. However, determining the cost of generating electricity in Denmark involved many computations involving thousands of generating units. The good news is that the chapters in this book detail the many calculations as well as the assumptions involved with computing the costs of generating electricity. In addition, Levitt and Sørensen (2014) is technical companion document which details the many calculations for specific types of generating units. Analysis of the results of the many calculations are also included in the various chapters of the present paper as well as in Levitt and Sørensen (2014). These are important because knowledge of the details of the calculations, and the accompanying assumptions, are important for interpreting the reported results.

[The eCite database entry for the Technical Companion to this report can be found here.]