Microgrids Require Macro Investment

The energy landscape is rapidly changing in response to concerns over resilience, climate change, and energy independence. Several cities around the world have pledged to become partially or completely carbon-free over the next couple of decades. But how does a city reach this goal? Municipalities often enter contracts with utilities providing renewable energy, purchase renewable energy credits (RECs), and encourage businesses and homeowners to install rooftop solar panels. Microgrids are gaining popularity, and for good reason, as they provide a host of benefits.

Microgrids are smaller, self-sufficient electricity grids. They can tie into larger, traditional power grids or operate independently as an island. That means if power generation is out in one region, the area operating on the microgrid remains undisturbed. Microgrids have become increasingly popular for their ability to use distributed renewable energy resources, and effectively manage electricity supply and demand. Producing electricity on-site as opposed to sending it over transmission lines is another plus for cost savings and efficiency, as less transmission infrastructure is required, and energy is preserved through less transportation and transformation. Microgrids can provide energy autonomy and raise social equity of disadvantaged communities by localizing electricity production.

Up to this point, the case for microgrids from an economic lens has been mixed. A study of Israeli electricity markets found microgrids to provide net benefits over conventional generation (Parag and Ainspan 2019, 78), while another research study implies that renewable-based microgrids cannot compete when a traditional grid connection is accessible (Zachar, Trifkovic, and Daoutidis 2015, 374). Economists face difficulties analyzing microgrids for two reasons. First, they are financed by a large number of stakeholders. Second, some of the benefits created by microgrids—such as cleaner air—are difficult to quantify monetarily. In response to mixed literature, the research team of Wang et al. are looking to reach conclusions about the economic feasibility of microgrids and how local governments can make them a reality.

The study by Wang et al. combines data on 24 microgrids from different geographical regions and countries with differing levels of renewable resource adoption. This heterogeneous sample with a larger number of observations allowed for a more robust analysis. The microgrids analyzed are nearly all in developed countries and range from 188 kW to 112,500 kW of capacity. Renewables only make up partial capacity. The authors then use three universally accepted measures of economic analysis and apply them to each microgrid: life-cycle cost (LCC), economies of scale, and net-present value (NPV). Detailed calculations are provided in the study, but below is a brief overview of the three economic measures:

• LCC considers installation costs, operating costs, and maintenance. In this study, the operating costs were not publicly available, so the authors had to assume operating costs were 10 percent of capital costs.
• Economies of scale aims to measure if a technology gets cheaper with larger quantities produced. A smaller calculated value correlates to a stronger economies of scale effect.
• NPV discounts future profits to what they would be worth if you had the money today. To be a successful investment, the NPV must be a positive value.

Unsurprisingly in the field of economics, the different analyses led to different conclusions. Wang et al. find that the microgrids have an economies of scale factor of 0.9, which means microgrids will get cheaper with more installations, but just barely so. The NPV is found to be negative, which suggests an unattractive investment due to large capital costs. This implies that large upfront investments are required to build a project. For instance, one of the selected sites, the Amtrak Sunnyside Yard microgrid in the United States, had the highest capital costs at $31 million. The large capital required for installation is likely the largest barrier to entry. However, investment costs are projected to fall and match non-renewables by 2025. With lower capital costs for microgrids, future NPV calculations will likely indicate a profitable investment. On the other hand, the LCC analysis offers good news for microgrids. Based on LCC, the renewable energy microgrids have operating costs comparable to natural gas combustion, but considerably higher investment costs.

Based on this analysis, microgrids likely will not be considered by private investors as an economic opportunity and feasible alternatives to fossil fuel-powered grids until 2025 at the earliest. Considering the global climate emergency and energy equity issues, as well as the numerous societal benefits microgrids accrue, a lag of five years may be considered unacceptable. Fortunately, when the free market does not lead to outcomes considered socially efficient to much of the electorate, the government can intervene and exercise certain regulatory powers.

Typically, renewable energy policy has taken a production-based approach. The study finds that incentive-based policies are the best way to stimulate the installation of microgrids so as to ease the high upfront investment costs. Following from this, policymakers should also focus on providing incentive-based policies, such as subsidizing investment costs, to match those of non-renewable generators, or correlating subsidy funding with the percentage of renewables powering the microgrid. However, traditional production-based policies focusing on quantity and price are beneficial when the microgrid is operational and act complimentary to incentives. While microgrids are not a silver-bullet to battling climate change, they deserve further research for their social benefits, and should remain on the radar as a tool for furthering renewable energy capacity.

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Parag, Yael, and Malcolm Ainspan. 2019. “Sustainable microgrids: Economic, environmental and social costs and benefits of microgrid deployment.” Energy for Sustainable Development 52 (October): 72-81. https://doi.org/10.1016/j.esd.2019.07.003.

Wang, Richard, Shu-Chien Hsu, Saina Zheng, Jieh-Haur Chen, and Xuran Ivan Li. 2020. “Renewable energy microgrids: Economic evaluation and decision making for government policies to contribute to affordable and clean energy.” Applied Energy 274. https://doi.org/10.1016/j.apenergy.2020.115287

Zachar, Michael, Milana Trifkovic, and Prodromos Daoutidis. 2015. “Policy effects on microgrid economics, technology selection, and environmental impact.” Computers & Chemical Engineering 81 (October): 364-375. https://doi.org/10.1016/j.compchemeng.2015.03.012.