Using real options to compare the economics of nuclear power and wind power with electricity from natural gas

The real options method provides one objective basis for judging when (if at all) it is reasonable to invest in a product in competition with another, the future price of which may exhibit a high degree of uncertainty. This article uses the real options technique to find the economically desirable start-up dates for three carbon-free methods of generating electricity, nuclear, onshore wind, and offshore wind, when facing competition from electricity generated from natural gas. The fact that the same assessment method has been used for each of the three carbon-free options allows intercomparability of the results. Nuclear power is projected to become competitive with gas-based electricity in 2015, even when no benefit is claimed for its carbon-free properties. Using the same yardstick, unaided onshore wind power first becomes competitive with gas in 2032 and unaided offshore wind power in 2040. There is thus a wide disparity among the dates of competiveness for the three methods of generation considered. Judged on a level playing field for carbon-free technologies, nuclear power emerges as a much better investment than onshore wind, while onshore wind is better than offshore wind. The analysis provides an explanation for the significant number of utilities who have declared an interest in New Nuclear Build in the UK in the near future. It shows that these utilities can be expected to make money immediately after their plants start up, even if they are given no credit for the carbon-free nature of nuclear generation. By contrast, the economics of wind power look more problematic. Even given the current level of intervention, 40 pound/MWh, equivalent to 90 pound/t CO2 avoided, onshore wind farms are not expected to become competitive with gas generation for about 15 years. That timescale stretches to over 20 years if no intervention is made. The situation is worse for offshore wind farms, which do not become competitive until 2028 even when given twice the aid offered to onshore wind farms: 80 pound/MWh, equivalent to 180 pound/t CO2 avoided. Without this high level of support, offshore wind farms are not expected to become competitive with gas generation for nearly 30 years even when allowance is made for the improved technology associated with series build. While wind technology is likely eventually to become competitive with gas, the real options analysis suggests that it would require significant cost reductions for a major, early deployment of wind power to become justified. It would appear to be a particularly questionable use of resources to spend money developing offshore wind farms so far in advance of their likely cost-effectiveness. The real options analysis suggests that large-scale construction of offshore wind farms should be delayed until the late 2030s.