By conventional logic, low oil and gas prices suppress demand for low-carbon alternatives, and conversely high oil and gas prices spur substitution. There is some debate that the current low oil prices will slow the transition to low carbon energies. I argue below that we should not be worried about low fossil-fuel prices undermining the energy-transition, but rather the complete opposite. High fossil-fuel prices will be a bigger problem.
In corporate finance the concept of the Weighted Average Cost of Capital (“WACC”) is well known. This is the total cost of how the company funds itself through equity and debt. Simply put, the cost of funding a corporate entity is the percentage of equity times by the cost of equity and the percentage of debt times by the cost of that debt, thus:
- WACC = (%E*costE) + (%D*costD) where %E+%D=100%.
When thinking about the concept of embodied or embedded energy I have adopted and adapted the idea of the WACC to better explain the issues. In this new model I call the Weighted Average Cost or Energy – I am trying to capture, albeit very simplistically, the idea that making wind-farms and solar panels requires a large energy input, and the cost of that energy input(“cRE”) is today dictated by the cost of fossil-fuel power (“cFF”). This statement is true given that roughly 85% of the world’s primary energy comes from fossil fuels – so it stands to reason that this will underpin the cost base. Thus, the WACE can be expressed:
- WACE = (85% * cFF) + (15% * cRE)
If you are constructing a renewable energy project today, the WACE for your project will be dominated by the 85%, that is by the cost of fossil-fuels. This has important implications for the Energy Transition: if the cost of fossil fuels increase, the cost of renewable energy increases also.Continue reading “How to explain Embodied Energy: introducing the “WACE”: Weighted Average Cost of Energy”