What Is the Levelized Cost of Energy?

The levelized cost of energy, abbreviated LCOE and also called levelized energy cost or levelized cost of electricity, is a summary metric that expresses the average cost per unit of electricity produced by a generating asset over its economic lifetime. It is computed as the discounted sum of all costs incurred by the project divided by the discounted sum of all energy delivered, and it is quoted in currency per megawatt-hour or per kilowatt-hour. Equivalently, LCOE is the constant price at which the electricity would have to be sold for the project's net present value to equal zero, which makes it a break-even price rather than a market price.

The metric became standard practice in power system economics because it collapses a stream of unlike quantities, upfront capital, annual operations spending, fuel purchases, and a time-varying output profile, into one number that can be compared across technologies with very different cost structures.

The Levelization Calculation

The calculation divides the present value of lifetime costs by the present value of lifetime generation. Costs include capital expenditure, fixed and variable operations and maintenance, fuel, and in some formulations decommissioning and taxes. Generation is the installed capacity multiplied by the hours in a year, the capacity factor, and any annual degradation factor. Both streams are discounted at a rate that usually reflects the project's weighted average cost of capital. Two conventions are common: the discounting method, which discounts costs and energy separately before dividing, and the annuitizing method, which converts capital cost into a fixed annual charge using a capital recovery factor. The US Energy Information Administration's levelized cost methodology sets out the fixed charge factor form of the equation and defines every term in it.

Inputs, Sensitivities, and Conventions

LCOE outcomes are driven more by a handful of inputs than by the arithmetic. For capital-intensive technologies with no fuel cost, such as wind, solar photovoltaics, and nuclear, the discount rate and the capacity factor dominate; a shift of two percentage points in the discount rate can move the result by twenty percent or more. For gas and coal plants, fuel price forecasts carry most of the uncertainty. Assumed economic life, financing structure, tax credits, and depreciation schedules all change the answer, which is why comparisons drawn from different studies are frequently not comparable. The IEA and NEA study Projected Costs of Generating Electricity publishes plant-level cost data for 243 power plants across 24 countries together with a calculator that varies the discount rate, fuel price, and cost of carbon, and reading such conventions is a prerequisite to using any published LCOE figure.

Limitations and Extensions

LCOE says nothing about when electricity is produced or what it is worth at that moment. A solar plant and a dispatchable gas plant with identical LCOE values do not deliver identical system value, because the solar output is concentrated in midday hours when prices may be depressed by other solar. Several corrections address this. Levelized avoided cost of energy compares a project's cost against the cost it displaces, value-adjusted LCOE weights output by hourly market prices, and system LCOE adds the integration costs of balancing, transmission, and firm capacity. Storage introduces further complications, since a battery consumes energy as well as delivering it, and analyses such as an assessment of LCOE for photovoltaic and grid-scale storage systems show that round-trip efficiency and cycle life must enter the denominator explicitly. The metric also excludes externalities unless a carbon price or damage cost is added deliberately.

Applications

Levelized cost of energy is used in a range of settings, including:

• Technology screening and resource planning by utilities
• Integrated resource plans and capacity expansion modeling
• Power purchase agreement pricing and project finance
• Renewable energy policy design and subsidy evaluation
• Research and development target setting for emerging generation technologies
• Comparative assessment of distributed generation and storage investments