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The levelized cost of electricity (LCOE), or levelized cost of energy, 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. 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. Inputs to LCOE are chosen by the estimator. They can include the
cost of capital In economics and accounting, the cost of capital is the cost of a company's funds (both debt and equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate new ...
, decommissioning, fuel costs, fixed and variable operations and maintenance costs, financing costs, and an assumed utilization rate.


Calculation

The LCOE is calculated as: : \mathrm = \frac = \frac :: : Typically the LCOE is calculated over the design lifetime of a plant and given in currency per energy unit, for example, EUR per
kilowatt-hour A kilowatt-hour (unit symbol: kW⋅h or kW h; commonly written as kWh) is a unit of energy: one kilowatt of power for one hour. In terms of SI derived units with special names, it equals 3.6 megajoules (MJ). Kilowatt-hours are a common bil ...
or AUD per
megawatt-hour A kilowatt-hour (unit symbol: kW⋅h or kW h; commonly written as kWh) is a Units of measurement, unit of energy: one kilowatt of power for one hour. In terms of SI derived units with special names, it equals 3.6 Joule, megajoules (MJ). Kil ...
. LCOE does ''not'' represent the cost of electricity for consumers and is most meaningful from the investor’s point of view. 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.Open access
/ref> 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. Thus, a key requirement for the analysis is a clear statement of the applicability of the analysis based on justified assumptions. 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.


Assumptions


Capacity factor

The assumption of the
capacity factor The net capacity factor is the unitless ratio of actual electrical energy output over a given period of time to the theoretical maximum electrical energy output over that period. The theoretical maximum energy output of a given installation is def ...
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.


Discount rate

Cost of capital In economics and accounting, the cost of capital is the cost of a company's funds (both debt and equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate new ...
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 Social cost in neoclassical economics is the sum of the private costs resulting from a transaction and the costs imposed on the consumers as a consequence of being exposed to the transaction for which they are not compensated or charged. In other w ...
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 Lazard Ltd (formerly known as Lazard Frères & Co.) is a financial advisory and asset management firm that engages in investment banking, asset management and other financial services, primarily with institutional clients. It is the world's lar ...
, 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. 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. In particular, if the costs of matching
grid energy storage Grid energy storage (also called large-scale energy storage) is a collection of methods used for energy storage on a large scale within an electrical power grid. Electrical energy is stored during times when electricity is plentiful and inexp ...
are not included in projects for
variable renewable energy Variable renewable energy (VRE) or intermittent renewable energy sources (IRES) are renewable energy sources that are not dispatchable due to their fluctuating nature, such as wind power and solar power, as opposed to controllable renewable ener ...
sources such as solar and
wind Wind is the natural movement of air or other gases relative to a planet's surface. Winds occur on a range of scales, from thunderstorm flows lasting tens of minutes, to local breezes generated by heating of land surfaces and lasting a few hou ...
, 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 Air conditioning, often abbreviated as A/C or AC, is the process of removing heat from an enclosed space to achieve a more comfortable interior environment (sometimes referred to as 'comfort cooling') and in some cases also strictly controlling ...
is a major consumer. 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. 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 Different methods of electricity generation can incur a variety of different costs, which can be divided into three general categories: 1) wholesale costs, or all costs paid by utilities associated with acquiring and distributing electricity to ...
(LCOS) and the
levelized avoided cost of energy Different methods of electricity generation can incur a variety of different costs, which can be divided into three general categories: 1) wholesale costs, or all costs paid by utilities associated with acquiring and distributing electricity to ...
(LACE), in addition to the LCOE. Another potential limitation of LCOE is that some analyses may not adequately consider the indirect costs of generation. These can include the
social cost of greenhouse gas emissions The social cost of carbon (SCC) is the marginal cost of the impacts caused by emitting one extra tonne of greenhouse gas (carbon dioxide equivalent) at any point in time, inclusive of 'non-market' impacts on the environment and human health. Th ...
, other environmental
externalities In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either co ...
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 Energy efficiency may refer to: * Energy efficiency (physics), the ratio between the useful output and input of an energy conversion process ** Electrical efficiency, useful power output per electrical power consumed ** Mechanical efficiency, a ra ...
and
conservation Conservation is the preservation or efficient use of resources, or the conservation of various quantities under physical laws. Conservation may also refer to: Environment and natural resources * Nature conservation, the protection and managem ...
unless their costs and effects are calculated, and included alongside LCOE numbers for other options such as generation infrastructure for comparison. If this is omitted or incomplete, LCOE may not give a comprehensive picture of potential options available for meeting energy needs.


See also

*
Cost of electricity by source Different methods of electricity generation can incur a variety of different costs, which can be divided into three general categories: 1) wholesale costs, or all costs paid by utilities associated with acquiring and distributing electricity to ...
* Levelized cost of water


References

{{Reflist Electricity economics