Levelized Cost of Energy

The technologies and industry processes used to deliver electricity to the grid carry widely different cost structures and performance characteristics. To make rational investment decisions, it is essential to use appropriate tools to compare them on an even basis.

Definition

The Levelized Cost of Energy (LCOE), also called the Levelized Energy Cost (LEC), is one such tool. The LCOE averages the cost of producing energy for a given generation plant across the whole life cycle for this plant:

LCOE = (Total Life cycle cost of the generation plant, in constant $)/ (Total energy produced by the plant over its life span, in kWh)

The LCOE is typically expressed in $/MWh, or in cents/kWh.

Calculations

The total life cycle cost of the plant includes:

  • capital cost of deployment
  • fixed operations and maintenance costs per year (those that are not proportional to the actual or estimated power output of the plant)
  • variable operations and maintenance costs per year (those that are proportional to the actual or estimated power output of the plant)
  • fuel costs
  • costs of end-of-life disposal or salvage benefits

The LCOE is expressed in present dollars per energy unit, using Net Present Value principles – i.e. future expenses and income are discounted yearly by the yearly cost of financing.

The total lifetime energy produced by the plant is a realistic estimate, using the plant’s capacity factor.

A delicate tool to use

The LCOE is a good way to compare different technologies, but requires rigorous comparative analysis to be useful, as even small differences in assumptions lead to widely different results. Assumptions must be rigorously similar when calculating LCOEs between different technologies. The following assumptions, in particular, may be the source drastic differences:

  • what is the discount rate used (often varies between 3% and 12%)?
  • does the LCOE include the impact of taxes, credits and incentives?
  • does the LCOE include the cost of end-of-life disposal?
  • does the LCOE include the cost of connecting to the grid?
  • does the LCOE include the cost of upgrading the grid, if it cannot bear the generation assumptions for the plant?
  • does the LCOE include the use of electricity required by the plant?
  • does the LCOE use idealized or realistic assumptions for the capacity factor? In particular for variable energies, does it assume no shedding*, or a statistically likely percentage?

*Shedding: as variable renewable energies vary widely independently of the demand load, grid operators sometimes refuse to accept energy coming from variable renewable energy plants at times when demand is low and when there is no good option to take down fossil fuel plant capacity.

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