The levelized cost of energy or LCOE is similar to the concept of the payback for energy systems. However, instead of measuring how much is needed to recoup the initial investment, the LCOE determines how much money must be made per unit of electricity (kWh, MWh etc. or even other type of energy like home heating) to recoup the lifetime costs of the system. This includes the initial capital investment, maintenance costs, the cost of fuel for the system (if any), any operational costs and the discount rate.
The LCOE is one way of determining whether or not a firm will build a project because if the project will not break even then it will not be built. The LCOE is a useful tool because it can combine both the fixed costs and variable costs into a single measurement to simplify analysis. To determine the LCOE, a firm will determine the necessary parameters such as the lifetime of the system, how much electricity it will produce and the input costs. All those factors will be used to form the following equation:
- Total Lifetime Cost =
- Total Lifetime Output =
- LCOE =
- LCOE =
- It = Investment and expenditures for the year (t)
- Mt = Operational and maintenance expenditures for the year (t)
- Ft = Fuel expenditures for the year (t)
- Et = Electrical output for the year (t)
- r = The discount Rate
- n = The (expected) lifetime of the power system
A LCOE analysis can help firms determine the benefits and drawbacks of various energy systems. When comparing conventional fossil fuel systems such as coal-fired power plants and natural gas power plants with renewable systems such as solar, wind or nuclear, a LCOE analysis can tell which is the most viable system to implement.
|Plant Size (MW)||Capital (Investment)(€m)
per unit of Capacity ($m/MW)
| Fixed Cost
|Fuel Cost ($/MWh)||Operational and
Maintenance Cost ($/MWh)
|Carbon Emission Cost ($/MWh)||Full Cost ($/MWh)|
|Combined cycle gas plant||750||770||1.02||9.9||37.4||4.4||5.5||57.2|
As the table indicates, there are pros and cons to each system. More traditional systems have ongoing fuel costs but lower capital costs, whereas renewable systems don't have fuel cost but they incur a higher capital cost. Perhaps the most important parameter is the last column—the full cost per MWh—which combines all the costs to show how much the production will cost per MWh of output. The full cost for the renewable systems is much higher when compared to that of traditional systems (with the exception of nuclear and geothermal) but the availability of subsidies for low-emission renewable systems can bring this cost down. Advancements in the technology, production materials and techniques used to produce these systems can also reduce the costs of more expensive systems.
All of these factors are considered when determining how to write the LCOE equation. For example, a subsidy from the government can reduce the capital cost of building the system. A system that does not produce carbon emissions does not incur the cost of emissions under a cap-and-trade system. There are a large number of other considerations which go into producing the parameters for the equation such as available technology, policy conditions, the LACE (Levelized Avoided Cost of Energy), geographical positing, utilization rate, available resource mix and others.
In short, subsidies, tax breaks, tax abatements and other government programs can help lower the LCOE for firms to encourage them to build sustainable, low-emission, renewable energy systems. For example, if a government gave a 25% subsidy for the capital investment of a photovoltaic system then the initial cost of building the system drops from $3025m to $2268.75m and the full cost will drop accordingly.
Problems with the LCOE Analysis
The LCOE analysis is not to able to cover all considerations and loses due to its standardized nature. This means that since these projects operate over several decades, it is difficult to fully estimate the changes in variable costs such as the cost of fuel and the dramatic fluctuations in price. In less regulated markets with more dynamic pricing models the LCOE is not as accurate. While maintenance costs are included, there are other considerations over the lifetime of a plant which can affect the stability of the price of the generated output. In addition it is not the best method for comparing vastly different generation methods due to the different considerations around each type such as the the level of regulation in a market.
For Further Reading
For further information please see the related pages below:
- Wikimedia Commons [Online], Available: https://commons.wikimedia.org/wiki/File:Crescent_Dunes_Solar_December_2014.JPG.
- A. Sayigh. Comprehensive Renewable Energy. Amsterdam: Elsevier Ltd., 2012, pp. 37.
- Chris Namovicz. "Assessing the Economic Value of New Utility-Scale Renewable Generation Projects". EIA Energy Conference, 2013, pp. 4.
- M. Bonass and M. Rudd. Renewables: A Practical Handbook. London: Globe Law and Business, 2010, pp. 51.
- U.S Energy Information Administration. Levelized Cost and Levelized Avoided Cost of New Generation Resources in the Annual Energy Outlook 2015. June 2015, pp. 1.
- International Energy Agency. Projected Costs of Generating Electricity Paris: OECD and IEA, 2010, pp. 164.
- VGB Powertech. Levelised Cost of Electricity. Essen: VGB Powertech e.V., 2015, pp. 17.