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Fillable Printable A Social Cost-Benefit Analysisof an Electric Vehicle

Fillable Printable A Social Cost-Benefit Analysisof an Electric Vehicle

A Social Cost-Benefit Analysisof an Electric Vehicle

A Social Cost-Benefit Analysisof an Electric Vehicle

MSc. In International Economic Consulting Authors:
Anders Schriver Christensen
(Exam ID: 280665)
Ebbe Ernst Christensen
(Exam ID: 281209)
Academic Supervisor:
Jan Børsen Bentzen
Department of Economics
A Social Cost-Benefit Analysis
of an Electric Vehicle
August 2011
Abstract
The Danish government has in the “Energy Strategy 2050” outlined a number of goals
for the Danish energy future. The main goals are to increase the share of renewable
energy and lower the energy consumption. The accomplishment of the goals should be
reached by promoting different energy efficient solutions, such as an electric vehicle. In
order to investigate whether the electric vehicle introduced by Renault and Better Place
is a possible part of the solution for the society, a Social Cost-Benefit Analysis is con-
ducted. The electric vehicle is compared to a diesel vehicle, as the diesel vehicle is as-
sessed the most environmentally friendly alternative of the conventional vehicles. The
analysis is performed as a national assessment in the current settings.
The results of the analysis show that the costs to society of the diesel- and the electric
vehicle are nearly the same over the life time of the vehicles, but the electric vehicle is
marginally less costly to society. This is based on a difference in the cost structure,
where the electric vehicle has a higher initial investment cost, but lower cost of driving.
The conclusion of the analysis has however large uncertainties attached, as changing the
critical assumptions will affect the results significantly.
The socio economic analysis is put into perspective by analyzing the purchase decision
from a private economic point of view. This is done in order to assess whether there is a
private economic incentive to purchase the electric vehicle. The analysis shows that the
electric vehicle is 22 percent more expensive for the private consumer to purchase.
Thus, there is no private economic incentive for purchasing the electric vehicle. The
cost difference is mainly due to the operation costs and the time used for switching the
battery.
The overall recommendation based on the two analyses is that it would be an option for
society to focus on the electric vehicle as a possible part of the solution in order to meet
the goals of the Energy Strategy 2050. However, in practice an expansion seems unrea-
listic in the current settings. Therefore, if the government wishes to meet the established
goals by promoting electric vehicles, such as the solution from Renault and Better
Place, it is necessary to create better conditions for energy efficient vehicles. It is fur-
thermore concluded that it is necessary to make broad long term political agreements to
secure a reliable foundation if investments in new sustainable solution should be ac-
complished.
Table of Contents
1. Introduction .................................................................................................................. 1
1.1 Problem Statement .................................................................................................. 2
1.2 Delimitations .......................................................................................................... 3
2. Methodology ................................................................................................................. 3
2.1 Cost-Effectiveness Analysis ................................................................................... 4
2.2 Cost-Benefit Analysis ............................................................................................. 4
2.3 Choice of Approach ................................................................................................ 5
3. Theoretical Foundations of Cost-Benefit Analysis ...................................................... 6
3.1 Willingness-to-Pay and Consumer Surplus ............................................................ 6
3.2 Producer Surplus and Economic Rent .................................................................. 10
3.3 Price Level ............................................................................................................ 11
3.4 Prices .................................................................................................................... 11
3.5 Transfers and Dead Weight Loss.......................................................................... 14
3.6 The Social Discount Rate ..................................................................................... 15
3.6.1 Empirically Derived Discount Rates ............................................................. 16
3.6.2 Theoretically Derived Discount Rates ........................................................... 17
3.7 The Discounting Procedure .................................................................................. 20
4. The Analytical Framework ......................................................................................... 24
5. Purpose of the Project and the Alternatives................................................................ 25
5.1 The Alternatives ................................................................................................... 25
5.2 The Product from Renault and Better Place ......................................................... 28
5.3 The Electricity System and Production in Denmark ............................................ 29
6. Scope and Standing .................................................................................................... 31
7. Identification of Cost .................................................................................................. 33
7.1 The Diesel Vehicle ............................................................................................... 33
7.1.1 Investment ..................................................................................................... 34
7.1.2 Operation ....................................................................................................... 34
7.1.3 Maintenance................................................................................................... 34
7.1.4 Environmental Impact ................................................................................... 34
7.1.5 Noise .............................................................................................................. 36
7.1.6 Refueling Time .............................................................................................. 36
7.1.7 Marginal Excess Tax Burden ........................................................................ 37
7.2 The Electric Vehicle ............................................................................................. 37
7.2.1 Investment ..................................................................................................... 37
7.2.2 Operation ....................................................................................................... 38
7.2.3 Maintenance................................................................................................... 38
7.2.4 Environmental Impact ................................................................................... 39
7.2.5 Noise .............................................................................................................. 39
7.2.6 Switching Time ............................................................................................. 40
7.2.7 Marginal Excess Tax Burden ........................................................................ 40
7.2.8 Perception Barrier .......................................................................................... 41
8. Quantification and Monetization of Cost ................................................................... 44
8.1 The Diesel Vehicle ............................................................................................... 44
8.1.1 Investment ..................................................................................................... 44
8.1.2 Operation ....................................................................................................... 46
8.1.3 Maintenance................................................................................................... 48
8.1.4 Environmental Impact ................................................................................... 49
8.1.5 Noise .............................................................................................................. 50
8.1.6 Refueling Time .............................................................................................. 51
8.1.7 Marginal Excess Tax Burden ........................................................................ 54
8.2 The Electric Vehicle ............................................................................................. 56
8.2.1 Investment ..................................................................................................... 56
8.2.2 Operation ....................................................................................................... 58
8.2.3 Maintenance................................................................................................... 62
8.2.4 Environmental Impact ................................................................................... 63
8.2.5 Noise .............................................................................................................. 66
8.2.6 Switching Time ............................................................................................. 66
8.2.7 Marginal Excess Tax Burden ........................................................................ 68
9. Discounting ................................................................................................................. 70
10. Sensitivity and Scenario Analysis ............................................................................ 73
10.1 Sensitivity Analysis ............................................................................................ 73
10.2 Scenario Analysis ............................................................................................... 76
11. Private Economic Analysis ....................................................................................... 79
12. Recommendation ...................................................................................................... 83
13. Conclusion ................................................................................................................ 85
14. Reference List ........................................................................................................... 89
15. Appendix .................................................................................................................. 97
Page 1
1. Introduction
The growth in the 20
th
century was mainly driven by the access to cheap and copious
amounts of coal, oil and gas (Danish Government 2011). Within the next 25 years the
world energy consumption is expected to increase with 33 percent and in the same time
the stocks of coal, oil and gas is expected to decrease. Thus it becomes necessary to find
new paths and methods in the 21
th
century, if future growth must be ensured. The Da-
nish government has, with its own words, outlined an ambitious course in the “Energy
Strategy 2050”. The goal of the strategy is to be independent of fossil fuel in 2050. In
order to meet this goal, the strategy contains several objectives. Two of these objectives
are to increase the share of renewable energy to 33 percent in 2020, and lower the ener-
gy consumption in 2020 with 6 percent compared to 2006 (Danish Energy Agency
2011a and Danish Government 2011). This ambitious plan is established to ensure that
Denmark will be independent of unstable oil nations and fluctuating oil prices in the fu-
ture. Furthermore, initiatives to encourage development of greener technologies are es-
tablished with the aim of helping to limit the global heating problems.
Based on the outlined sub-objectives, two main challenges appear; a higher degree of
fluctuating supply of energy from renewable energy sources and how to reduce energy
consumption. It is therefore necessary to promote energy and economically efficient
technologies. In order to meet the goals, it is relevant to look on the transportation sec-
tor, as a third of the total energy consumption is used in this sector (Danish Energy
Agency 2011b). Furthermore, the main part of the energy used in the transportation sec-
tor is extracted from fossil fuel. This has lead to that one of the sub-objectives in the
“Energy Strategy 2050” is to obtain 10% renewable energy in the transportation sector
in 2020.
If the goals within the transportation sector is to be fulfilled changes are needed, but the
changes have to be efficient solutions and not just a changes for its own sake. The gov-
ernment has chosen to focus on the electric vehicle by removing taxes on the vehicles
and investing 25 million DKK in charge spots (Ministry of Taxation 2011 and Danish
Government 2011). The focus on the electric vehicle is based on the argument that it
uses no fossil fuel directly, and therefore will contribute to solving the challenge. How-
ever, there are no thorough studies on the socio economic efficiency of an electric ve-
hicle, as the studies are primarily from a private economic point of view or anthropolog-
Page 2
ical studies of the user. The upcoming introduction of a new combined product from
Renault and Better Place in the autumn 2011 makes it interesting to investigate whether
electric vehicles are a suitable solution for society, because the new concept is one of
the first real alternatives to a conventional vehicle. It is a real alternative for the con-
sumers, as it deals with the former disadvantages of electric vehicles, such as limited
size of the vehicle, large uncertainty on the battery technology and limited driving
range. But is the electric vehicle from Renault an economically efficient alternative for
both the society and the private consumer, when Renault is the only manufacture of ve-
hicles that is producing electric vehicles with a switchable battery (FDM 2011a).
1.1 Problem Statement
The main purpose of this thesis is to conduct a socio economic evaluation of an electric
vehicle and compare it with a conventional vehicle. In order to recommend if the elec-
tric vehicle is a possible contribution to the solution of the challenges outlined in the in-
troduction, the analysis will quantify and monetize the impacts associated with both ve-
hicles. To accomplish this, the following research questions will be answered:
- Is it beneficial for the society today if a newly purchased vehicle is electric instead
of conventional?
In continuation hereof, to answer if it is realistic that the private consumer has incentive
to purchase an electric vehicle:
- Is it beneficial to purchase an electric vehicle from a private point of view?
In order to answer the problem statement the following questions will be investigated:
- What are the socio economic impacts from purchasing and operating a vehicle?
- How are the surroundings affected by the vehicles?
- What are the impacts of a limited driving range of the electric vehicle?
- Are there psychological obstacles for a purchase of an electric vehicle?
- Which socio economic factors are most important in the assessment?
Page 3
1.2 Delimitations
This thesis is not an attempt to promote or favor electric vehicles, as the aim is to make
an unbiased assessment of the alternative vehicles. To the extent it is possible the im-
pacts will be quantified and monetized, but some impacts will only be discussed, due to
time and size constraints of this thesis. Even though the latter impacts are not mone-
tized, they will still be discussed and finally considered in the recommendation.
The analysis will be conducted in the current settings, with the initial investment made
on the 1
st
of January 2012. The time frame of the analysis is set to 13 years, as this is the
average life time of a vehicle that the Ministry of Transportation (2010) operates with.
It is assumed that the purchase of an electric vehicle will not have an impact on the
prices on secondary markets, such as the market for diesel fuel and electricity, since the
current market size of electric vehicles is limited. It is assumed that the fuel for the di-
esel vehicle origins from refined North Sea oil and is produced in Denmark, as this is
the assumption made by the National Environmental Research Institute (DMU), in the
assessment of the environmental impacts from the production of diesel fuel (Slentø et
al. 2010).
In the analysis, Better Place will be perceived as a Danish company, as the largest Da-
nish energy company, DONG Energy, is a major shareholder, and the part of Better
Place that operates in Denmark is an independent entity under name Better Place Den-
mark. If not stated explicitly, Better Place will refer to Better Place Denmark in the suc-
ceeding chapters.
2. Methodology
In order to answer the problem statement and the derived research questions from
above, there are generally two approaches to consider a Cost Effectiveness Analysis
(CEA) or a Cost-Benefit Analysis (CBA). In the following sections, these two ap-
proaches will be described and discussed, and afterwards the best suited approach for
answering the problem statement will be chosen.
Page 4
2.1 Cost-Effectiveness Analysis
A Cost-Effectiveness Analysis (CEA) is a tool for policy makers to choose between dif-
ferent alternatives, either with the goal of maximizing the effects for a given budget or
the goal of minimizing the costs for achieving a given effects (Johannesson 1995 and
Donaldson 1998). In a CEA it is assumed that each alternative will provide large
enough benefits to make it worth implementing, why the focus is on the cost side (Mi-
shan & Quah 2007). The different alternatives are compared using a single effectiveness
measure (Boardman et al. 2006). This measure is quantified but not monetized. Based
on the costs and the effectiveness measure, the cost-effectiveness ratio of each alterna-
tive is calculated. Examples of this could be costs per life saved, costs per accident
avoided, costs per ton CO2-emission reduced etc. The alternative with the lowest cost-
effectiveness ratio is considered the most efficient.
A general critique of using CEA as a tool to choose between alternatives is that a CEA
does not incorporate scales of alternatives (Boardman et al. 2006). Because of the miss-
ing consideration of scale, the highest ranked alternative, which is the most cost-
efficient, is not surely the alternative with the largest net benefit.
2.2 Cost-Benefit Analysis
A Cost-Benefit Analysis (CBA) is a policy assessment method, in which costs and ben-
efits are included irrespective of to whom they accrue (Boardman et al. 2006 and Jo-
hannesson 1995). The purpose of a CBA is to assess all costs and benefits to society
from a project. Derived from this assessment it is evaluated, whether the social benefits
exceed the social costs. The decision criterion for a CBA is known as the Kaldor-Hicks
criterion (Boardman et al. 2006). The criterion states that if the net social benefits are
positive, then the society as a whole will gain from adopting the policy, because those
who gain will be able to compensate the losers for their loss and still be better off. If the
policy under evaluation fulfills the Kaldor-Hicks criterion it represents a potential Pare-
to improvement.
A CBA relies on assessment of future costs and benefits, which naturally is subject to
uncertainty. Thus, a CBA is rather a tool to improve decision making on allocating the
society’s resources efficiently than it is an exact science (Boardman et al. 2006). In the
CBA all costs and benefits are identified, quantified and monetized. Making all costs
and benefits comparable in monetary terms is the largest advantage of a CBA, as it al-
Page 5
lows policy makers to make an informed decision based on comparable measures. On
the other hand it is also the largest disadvantage in practice, as it can be extremely diffi-
cult and time consuming to assign monetary terms to all costs and benefits. In cases
where it is impossible or too time consuming to monetize the impacts, it is important to
clearly state the assumptions made and describe the impacts not being monetized (Min-
istry of Finance 1999)
Many critics of CBA disagree in the utilitarian assumption of potential Pareto efficiency
behind the analysis (Boardman et al. 2006). The critics argue that the goal of maximiz-
ing the sum of the individual utility in society is not desirable, because it is not possible
to make a direct trade-off of utility gains for utility losses, as the marginal utility of in-
come is not constant. Another critique of CBA is the applicability of the analysis due to
timing of impacts, trade-offs between the present and the future and methods of mone-
tizing impacts. Other critics criticize the use of CBA because the valuation of costs and
benefits rely on the impact on human welfare and not on the well-being of the environ-
ment (Pearce 1998).
With these critiques in mind, a CBA is still a powerful tool to support policy makers’
decisions, as it is better to make an informed decision than guessing about the future.
2.3 Choice of Approach
According to the 1999-guidelines presented by the Danish Ministry of Finance the
choice between conducting a CEA or a CBA depends on the characteristics of the policy
under evaluation (Ministry of Finance 1999).
The alternatives under consideration, the purchase of a diesel driven vehicle or an elec-
tric vehicle, satisfy essentially the same need the transportation of persons. Given that
both alternatives can sufficiently satisfy the need, it is almost a question of which alter-
native is most inexpensive. These circumstances point in the direction of choosing a
CEA as approach for answering the problem statement.
Even though both alternatives satisfy the same basic transportation need, there are dif-
ferences in the cost structure. The diesel driven vehicle has larger negative environmen-
tal costs than the electric vehicle in terms of higher levels of emissions from driving and
production of fuel. On the other hand, the electric vehicle experiences barrier costs in
form of less flexibility, due to a lower driving range, as it is necessary to plan the driv-
Page 6
ing route on long hauls in order to pass battery switching stations. Furthermore, it is
possible to quantify and monetize most of the costs, and not just compare cost effec-
tiveness measures. The latter arguments point in the direction of a CBA approach.
Based on the description of the available methodology and the discussion above, a eval-
uation of the cost to society of an electric vehicle compared to a diesel driven vehicle is
assessed to be most suited for conducting a CBA, as there are differences in the cost
structures of the vehicles, and it is possible to both quantify and monetize these costs.
3. Theoretical Foundations of Cost-Benefit Analysis
The methodology chosen for this study is as mentioned above the approach of CBA.
The purpose of CBA is to assess all costs and benefits to society from the project under
evaluation. The objective is to facilitate the most efficient allocation of the society’s re-
sources. This chapter will elaborate on the theoretically concepts in the approach and
clarify the importance and linkage to the project under evaluation. Hence, the section
will not describe all matters in the CBA, but it will focus on outlining the most impor-
tant and relevant aspects in the conduction of a CBA.
3.1 Willingness-to-Pay and Consumer Surplus
When evaluating a project, the appropriate measure of the net benefits for society is the
sum of the willingness-to-pay (WTP) of the individuals in society deducted the cost of
the project (Boardman et al. 2006). WTP is measured as the maximum amount the indi-
vidual would be willing to give up in order to obtain the change caused by the project.
Alternatively, willingness-to-accept (WTA) is the correct measure, when the project un-
der evaluation reduces the individual’s well-being. It is measured as the maximum the
individual would require in compensation in order to accept the change (Pearce et al.
2006). The distinction between the measures can be of importance because people have
a tendency to demand larger payments to accept small decrements in a good than they
want to pay for increments of exactly same size (Boardman et al. 2006). This is almost
always true when dealing with a normal good, which is purchased more frequently
when income increases (Mishan & Quah 2007).
Page 7
In practice the consumer surplus is often used as a measure of the impact of the project
on consumers. It is the difference between what individuals are willing to pay and what
they actually pay. For understanding the term consumer surplus the demand curve have
to be examined. The individual demand curve can be interpreted as the most a given
person is willing to pay for each successive unit of a good. This implies that a person
can be asked how much he or she is willing to pay for one unit of the good; then, what
is the most he or she will pay for one additional unit of the good and so on. For a normal
good, the different prices of various amounts of the good form a downward sloping in-
dividual demand curve, which contribute to the market demand schedule. When a con-
sumer purchases a given amount of the good, he pays the same price for every single
unit of good. As his demand curve is downward sloping, he was willing to pay more for
the first units of the good than for the last unit. This difference between the WTP and
the price can be seen as a surplus to the individual.
The market demand curve, being the horizontal summation of all the individual demand
curves, can be assessed as the marginal valuation curve for the society (Mishan & Quah
2007). The reasoning behind the downward slope is the principle of diminishing mar-
ginal utility. This entails that each extra unit of the good is valued slightly less than the
preceding one and therefore the consumer would be willing to pay less for one addition-
al unit of the good (Boardman et al. 2006). The consumer surplus for all individuals in
society can thus be interpreted as the area between the market demand curve and the
price line. Hence, the impacts of a project on consumers can be assessed by measuring
changes in consumer surplus (Mishan & Quah 2007).
The problem with using the changes in consumer surplus as a measure of WTP is ac-
cording to Møller and Jensen (2004) that it measures the utility changes along the nor-
mal demand curve, also called the Marshallian demand curve. Theoretically, the con-
cepts of Equivalent Variation (EV) and Compensating Variation (CV) would be more
correct indicators of the utility changes, because they convert the utility changes into in-
come changes more directly. Both EV and CV use the compensating demand curve, al-
so called the Hicksian demand curve, which states the demand at different price levels
holding the utility constant.
EV is defined as the income an individual is willing-to-pay with the original relative
price level to avoid the utility loss created by the change. Whereas CV is defined as the
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