The economics of electricity is shaped by its physics. A well know example is the non-storability of electricity that causes its price to fluctuate widely. More generally, physical constraints cause electricity to be a heterogeneous good along three dimensions – time, space, and lead-time. Consequently, different generation technologies, such as coal and wind power, produce different economic goods that have a different marginal economic value. Welfare maximization or competitiveness analyses that ignore heterogeneity deliver biased estimates. This paper provides an analytical welfare-economic framework that accounts for heterogeneity for unbiased assessments of power generators. The framework offers a rigorous interpretation of commonly used cost indicators such as โ€˜levelized electricity costsโ€™ and โ€˜grid parityโ€™. Heterogeneity is relevant for all generators, but especially for variable renewables such as wind and solar power. We propose a definition of โ€˜variabilityโ€™, derive the opportunity costs of variability, and link that concept to the โ€˜integration costโ€™ literature. A literature review shows that variability can reduce the value of wind power by 20-50%. Thus it is crucial that economic analysis accounts for the physics of electricity.

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Suggested citation: Hirth, L., F. Ueckerdt, O. Edenhofer, (2014), ‘Why Wind Is Not Coal: On the Economics of Electricity’, Nota di Lavoro 39.2014, Milan, Italy: Fondazione Eni Enrico Mattei.