Discounted value of economic rent in hydro and geothermal expansion planning in Iceland

Abstract

In this paper we consider an expansion plan and the associated economic rent (ER) of projects for hydroelectric and geothermal resources in Iceland. In previous papers, optimization of such resources has been performed with respect to sequencing [14], sizing [10] and the economics of scale [15] for individual projects. Also in previous papers the economic rent of these resources has been listed, reviewed and estimated [16, 17] without considering the scope for timing of individual projects as a part of a comprehensive expansion plan. In this paper the 2 processes are linked by considering the timing of projects and calculation of their economic rent in an expansion plan based on market assumptions. We consider both a local market and the prospects for interconnecting to an foreign electricity market by a HVDC interconnector [9]. By discounting this rent value, considering explicitly the cost structure and timing in expansion plans and ranges of market scenarios, we get a comprehensive estimate of the resources' economic value. This can be carried out with varying assumption on such factors as on the rate of demand growth, market price and discount rate. Assuming an increasing demand function we capture some constraints in timing of realization of these resources. Price forecasts and assumptions are based on data from international electricity markets. Combining all these assumptions with an expansion plan based on the recently ratified Master Plan (MP) in the Icelandic Alþingi (Parliament), we get an unprecedented clear view of the economic rent of these important energy resources for the economy of Iceland from a given time reference. In recent year the growth of energy demand from local intensive industry has been explosive. In this paper an estimate is presented for these resources based on a range of domestic and international market and price assumptions. The economic rent here is defined as the difference between a market reference unit price and unit cost, multiplied by quantity and discounted to a common reference. Therefore projects early in the project sequence contribute more to the total value than projects later. Two factors contribute to a diminishing value later in the process. First, the increasing cost when moving from economical projects early in the sequence to projects to be realized later. Secondly the discounting effect that decreases the value of projects realized later. However this decrease is offset by assumptions on forecasted and increased market prices for green, emission free energy from hydro and geothermal realized in the future. The electric power system utilizes renewable energy resources to the greatest extent of almost any country in the world. For this reason the Iceland energy situation and resources with their economic rent is of special interest with potential export and local utilization. The results therefore cast a light on the economic significance and future scenarios harnessing these extremely important renewable resources in the form of economic benefit.