Levelized cost of electricity

The levelized cost of electricity (LCOE) is a measure of the average net present cost of electricity generation for a generator over its lifetime. It is used for investment planning and to compare different methods of electricity generation on a consistent basis.

A line graph tracking the levelized cost of major electricity sources between 2009 and 2023 in dollars, according to data from Lazard. With time, the cost of renewable energies goes down significantly, most notably solar, for which the price goes from 359 dollars per megawatt-hour in 2009 to 60 dollars in 2023
Average unsubsidized levelized cost of energy. With increasingly widespread implementation of sustainable energy sources, costs for sustainable have declined, most notably for energy generated by solar panels. Data source is Lazard.[1]

The more general term levelized cost of energy may include the costs of either electricity or heat. The latter is also referred to as levelized cost of heat[2] or levelized cost of heating (LCOH), or levelized cost of thermal energy.

The LCOE "represents the average revenue per unit of electricity generated that would be required to recover the costs of building and operating a generating plant during an assumed financial life and duty cycle", and is calculated as the ratio between all the discounted costs over the lifetime of an electricity generating plant divided by a discounted sum of the actual energy amounts delivered.[3] Inputs to LCOE are chosen by the estimator. They can include the cost of capital, decommissioning, fuel costs, fixed and variable operations and maintenance costs, financing costs, and an assumed utilization rate.[4]

Definition

The cost of energy production depends on costs during the expected lifetime of the plant and the amount of energy it is expected to generate over its lifetime. The levelized cost of electricity (LCOE) is the average cost in currency per energy unit, for example, EUR per kilowatt-hour or AUD per megawatt-hour.[5] The LCOE is an estimation of the cost of production of energy, thus it tells nothing about the price for consumers and is most meaningful from the investor’s point of view.

The LCOE is calculated by adding up all costs of production, divided by the total amount of energy it is expected to generate. In formula:[6][7][8]

It :investment expenditures in the year t
Mt :operations and maintenance expenditures in the year t
Ft :fuel expenditures in the year t
Et :electrical energy generated in the year t
r :discount rate
n :expected lifetime of system or power station
Note: caution must be taken when using formulas for the levelized cost, as they often embody unseen assumptions, neglect effects like taxes, and may be specified in real or nominal levelized cost. For example, other versions of the above formula do not discount the electricity stream. The real lifetime may be considerably longer or shorter than expected.

Care should be taken in comparing different LCOE studies and the sources of the information as the LCOE for a given energy source is highly dependent on the assumptions, financing terms and technological deployment analyzed.[9] For any given electricity generation technology, LCOE varies significantly from region to region, depending on factors such as the cost of fuel or energy resources such as wind.[4]

Thus, a key requirement for the analysis is a clear statement of the applicability of the analysis based on justified assumptions.[9] In particular, for LCOE to be usable for rank-ordering energy-generation alternatives, caution must be taken to calculate it in "real" terms, i.e. including adjustment for expected inflation.[10][11]

Assumptions

Capacity factor

The assumption of the capacity factor has a significant impact on the calculation of LCOE as it determines the actual amount of energy produced by specific installed power. Formulas that output cost per unit of energy ($/MWh) already account for the capacity factor, while formulas that output cost per unit of power ($/MW) do not.[12]

Discount rate

Cost of capital expressed as the discount rate is one of the most controversial inputs into the LCOE equation, as it significantly impacts the outcome and a number of comparisons assume arbitrary discount rate values with little transparency of why a specific value was selected. Comparisons that assume public funding, subsidies, and social cost of capital tend to choose low discount rates (3%), while comparisons prepared by private investment banks tend to assume high discount rates (7-15%) associated with commercial for-profit funding. Assuming a low discount rate favours nuclear and sustainable energy projects, which require a high initial investment but then have low operational costs.

In a 2020 analysis by Lazard,[13] sensitivity to discount factor changes in the range of 6% - 16% results in different LCOE values but the identical ordering of different types of power plants if the discount rates are the same for all technologies.

Usage and limitations

LCOE is often cited as a convenient summary measure of the overall competitiveness of different generating technologies, however, it has potential limitations. Investment decisions consider the specific technological and regional characteristics of a project, which involve many other factors not reflected in some instances of LCOE.[4] One of the most important potential limitations of LCOE is that it may not control for time effects associated with matching electricity production to demand. This can happen at two levels:

  • Dispatchability, the ability of a generating system to come online, go offline, or ramp up or down, quickly as demand swings.
  • The extent to which the availability profile matches or conflicts with the market demand profile.[4]

In particular, if the costs of matching grid energy storage are not included in projects for variable renewable energy sources such as solar and wind, they may produce electricity when it is not needed in the grid without storage. The value of this electricity may be lower than if it was produced at another time, or even negative. At the same time, variable sources can be competitive if they are available to produce when demand and prices are highest, such as solar during summertime mid-day peaks seen in hot countries where air conditioning is a major consumer.[9]

To ensure enough electricity is always available to meet demand, storage or backup generation may be required, which adds costs that are not included in some instances of LCOE.[14] Excess generation when not needed may force curtailments, thus reducing the revenue of an energy provider. Decisions about investments in energy generation technologies may be guided by other measures such as the levelized cost of storage (LCOS) and the levelized avoided cost of energy (LACE), in addition to the LCOE.[4]

Another potential limitation of LCOE is that some analyses may not adequately consider the indirect costs of generation.[15] These can include the social cost of greenhouse gas emissions, other environmental externalities such as air pollution, or grid upgrade requirements.

The LCOE for a given generator tends to be inversely proportional to its capacity. For instance, larger power plants have a lower LCOE than smaller power plants. Therefore, making investment decisions based on insufficiently comprehensive LCOE can lead to a bias towards larger installations while overlooking opportunities for energy efficiency and conservation[16] unless their costs and effects are calculated, and included alongside LCOE numbers for other options such as generation infrastructure for comparison.[17] If this is omitted or incomplete, LCOE may not give a comprehensive picture of potential options available for meeting energy needs.

See also

References
  1. "2023 Levelized Cost Of Energy+". Lazard. 12 April 2023. p. 9. Archived from the original on 27 August 2023. (Download link labeled "Lazard's LCOE+ (April 2023) (1) PDF—1MB")
  2. A Comparative Cost Assessment of Energy Production from ... Nian, Energy Procedia, 2016
  3. Lai, Chun Sing; McCulloch, Malcolm D. (March 2017). "Levelized cost of electricity for solar photovoltaic and electrical energy storage". Applied Energy. 190: 191–203. doi:10.1016/j.apenergy.2016.12.153. S2CID 113623853.
  4. U.S. Energy Information Administration (March 2022). "Levelized Costs of New Generation Resources in the Annual Energy Outlook 2022" (PDF).
  5. K. Branker, M. J.M. Pathak, J. M. Pearce, doi:10.1016/j.rser.2011.07.104 A Review of Solar Photovoltaic Levelized Cost of Electricity, Renewable and Sustainable Energy Reviews 15, pp.4470–4482 (2011). Open access
  6. Walter Short; Daniel J. Packey; Thomas Holt (March 1995). "A Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy Technologies" (PDF). www.nrel.gov. National Renewable Energy Laboratory. pp. 47–50. Retrieved 17 July 2022.
  7. Lai, Chun Sing; Locatelli, Giorgio; Pimm, Andrew; Tao, Yingshan; Li, Xuecong; Lai, Loi Lei (October 2019). "A financial model for lithium-ion storage in a photovoltaic and biogas energy system". Applied Energy. 251: 113179. doi:10.1016/j.apenergy.2019.04.175.
  8. Lai, Chun Sing; Jia, Youwei; Xu, Zhao; Lai, Loi Lei; Li, Xuecong; Cao, Jun; McCulloch, Malcolm D. (December 2017). "Levelized cost of electricity for photovoltaic/biogas power plant hybrid system with electrical energy storage degradation costs". Energy Conversion and Management. 153: 34–47. doi:10.1016/j.enconman.2017.09.076.
  9. Branker, K.; Pathak, M.J.M.; Pearce, J.M. (2011). "A Review of Solar Photovoltaic Levelized Cost of Electricity". Renewable and Sustainable Energy Reviews. 15 (9): 4470–4482. doi:10.1016/j.rser.2011.07.104. S2CID 73523633. Open access
  10. Loewen, James; Gagnon, Peter; Mai, Trieu. "A resolution to LCOE is not the metric you think it is". Utility Dive. Retrieved 7 October 2020.
  11. Loewen, James (August–September 2020). "Correction to Electricity Journal papers in July 2019 issue and in July 2020 issue by James Loewen". The Electricity Journal. 33 (7): 106815. doi:10.1016/j.tej.2020.106815. S2CID 225344100. Retrieved 7 October 2020.
  12. "Analysts' inaccurate cost estimates are creating a trillion-dollar bubble in conventional energy assets". Utility Dive. Retrieved 2021-04-08.
  13. "Lazard's Levelized Cost of Energy Version 14.0" (PDF). Lazard.com. Lazard. 19 October 2020. Archived (PDF) from the original on 28 January 2021.
  14. "Comparing the Costs of Intermittent and Dispatchable Electricity-Generating Technologies", by Paul Joskow, Massachusetts Institute of Technology, September 2011". Retrieved 2019-05-10.
  15. Hwang, Sung-Hyun; Kim, Mun-Kyeom; Ryu, Ho-Sung (26 June 2019). "Real Levelized Cost of Energy with Indirect Costs and Market Value of Variable Renewables: A Study of the Korean Power Market". Energies. 12 (13): 2459. doi:10.3390/en12132459.
  16. Bronski, Peter (29 May 2014). "You Down With LCOE? Maybe You, But Not Me:Leaving behind the limitations of levelized cost of energy for a better energy metric". RMI Outlet. Rocky Mountain Institute (RMI). Archived from the original on 28 October 2016. Retrieved 28 October 2016.
  17. "Levelized Cost of Energy Analysis 9.0". 17 November 2015. Retrieved 24 October 2020.
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