Improving the representation of cost of capital in energy system models

Lonergan, Katherine E.; Egli, Florian; Osorio, Sebastian; Sansavini, Giovanni; Pahle, Michael; Schmidt, Tobias S.; Steffen, Bjarne

doi:10.1016/j.joule.2023.02.004

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Improving the representation of cost of capital in energy system models

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Lonergan, Katherine E.
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Egli, Florian
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/persons/resource/Sebastian.Osorio

Osorio, Sebastian
Potsdam Institute for Climate Impact Research;

Sansavini, Giovanni
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/persons/resource/Michael.Pahle

Pahle, Michael
Potsdam Institute for Climate Impact Research;

Schmidt, Tobias S.
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Steffen, Bjarne
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Lonergan, K. E., Egli, F., Osorio, S., Sansavini, G., Pahle, M., Schmidt, T. S., Steffen, B. (2023): Improving the representation of cost of capital in energy system models. - Joule, 7, 3, 469-483.
https://doi.org/10.1016/j.joule.2023.02.004

Cite as: https://publications.pik-potsdam.de/pubman/item/item_28857

Abstract

Energy system models suggest optimal investment pathways and guide policymakers in implementing the low-carbon energy transition. Although model accuracy greatly improved over the last decade, it is unclear whether the cost of capital (CoC) is well represented, despite the parameter’s strong influence on model outcomes. In this perspective, we review 58 model-based publications that explicitly refer to CoC and observe that simply stating unfounded assumptions remains the most important “method” for determining the CoC. Overall, there appears to be a clear lack of guiding principles for how to appropriately determine CoC for use within models. To close this gap, we identify four barriers to a more accurate CoC reflection and suggest practical steps for overcoming them, including heuristic guidelines to support modelers in determining when differentiated CoC rates ought to be applied. Overall, we believe more rigorous treatment of the CoC will improve the quality of model-based policy advice.