Incremental Capital Investment Advantage of Renewable Energy Sources

A comment Nick made about interest on the capital costs of a photovoltaic power plant got me thinking: maybe one of the reasons that wind and solar power are experiencing such explosive growth is their small incremental capital cost. Wind turbines typically come with a power rating of 1000 - 300 kW while photovoltaic systems can be built in any practical increment. On the other hand, a nuclear power plant, a hydroelectric dam, or any other centralized power plant can only be built in extremely large increments (300+ MW). The capital cost for a nuclear or coal power plant is three or four orders of magnitude higher than that of a wind turbine. Because of this, a wind power investment can grow much closer to the exponential curve than big thermal power plants.

The financial advantage essentially works like this: assume that you have a nuclear plant and a wind farm and that both systems have the same rate of return. For my case study, I will assume that the system's net revenue is 20 % of its capital cost every year. Nominally you could build a new centralized power plant every five years if you reinvested all of your profits. Consider instead a wind farm that produced the same average power (with the same capital cost per Megawatt). If each turbine cost 1/1000th that of a major nuclear plant then a new one could be purchased every two days. As it will become apparent, the law of compound interest greatly favours the source that can be built in smaller increments.

In order to test this theory I constructed a model to compare the growth of an abstract wind farm and nuclear plant investment. Both the nuclear and wind farm investor took a loan sufficient to build 1000 MW of capacity. This is assumed to be average capacity, with the capacity factor of each already included. I will also incorporate a 2 % interest rate − indexed to inflation − on all cash balances held (positive or negative). The last thing I would like to model is a delay between the allocation of funds and the power plant actually coming on-line. For the 'nuclear' the delay is two years to account for construction, for 'wind' the delay is thirty days.

The interest rate is quite small compared to the profit on the plants so it should take approximately five years for the nuclear plant to payoff the loan, another five years to accumulate enough capital to pay for a new one, and two more years to actually build the plant. That's twelve years before the second nuclear plant can be constructed. For wind, it will take the same five years to payoff the loan but then it will only take two days to earn enough money to build another turbine and then thirty days for the turbine to be installed. One can guess that this is not going to turn out well for the nuclear option but nothing illustrates this better than a figure.

Figure 1: Step-like growth of large capital nuclear power plants (red) versus
more continuous small capital wind turbine farm (blue). Exponential
growth curve (black) at given rate of return (0.2/annum) added for reference.

After twenty years the wind farm will already have outgrown the nuclear capacity by a factor of 17850 MW to 5000 MW. The wind-based power system will provide 3.6x more power than the nuclear based system. This doesn't let wind power off the hook with regard to its intermittent nature but it certainly goes a long way to explain why solar and wind are seeing such explosive growth around the world. One could certainly play with my model to include other factors, change the rate of return or interest rates. However, the big picture isn't going to change unless the large capital investment power installations can massively outperform solar and wind with regards to the rate of return.

The growth rate advantage is not the whole story, of course. It is much easier to secure a few million in financing than a few billion. Similarly, the incremental risk of putting up a new wind turbine is quite low. The risk is also reduced by the fact that there are no fluctuating fuel costs associated with renewables versus fossil or nuclear fuels.