Electricity costs in dollars according to data from Lazard

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. 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''''A Comparative Cost Assessment of Energy Production from ...''
Nian, Energy Procedia, 2016 or ''levelized cost of heating'' (LCOH), or ''levelized cost of thermal energy''.

Definition

The cost of electricity production depends on costs during the ''expected'' lifetime of the generator and the amount of electricity the generator is ''expected'' to produce over its lifetime. The levelized cost of electricity (LCOE) is the average cost 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 non-SI unit of energy equal to 3.6 megajoules (MJ) in SI units, which is the energy delivered by one kilowatt of power for one hour. Kilowatt-hours are a comm ...

or AUD per

megawatt-hour A kilowatt-hour ( unit symbol: kW⋅h or kW h; commonly written as kWh) is a non-SI unit of energy equal to 3.6 megajoules (MJ) in SI units, which is the energy delivered by one kilowatt of power for one hour. Kilowatt-hours are a commo ...

. LCOE is defined by the formula: :

\mathrm = \frac = \frac

:Input values are: ::

Applicability

LCOE is an estimation of the ''

cost Cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it i ...

of production'' of electricity and not the ''

price A price is the (usually not negative) quantity of payment or compensation expected, required, or given by one party to another in return for goods or services. In some situations, especially when the product is a service rather than a ph ...

of electricity''. The price of electricity may be influenced by additional factors including markup and

price controls Price controls are restrictions set in place and enforced by governments, on the prices that can be charged for goods and services in a market. The intent behind implementing such controls can stem from the desire to maintain affordability of go ...

. LCOE is commonly used for: *

Feasibility study A feasibility study is an assessment of the practicality of a project or system. A feasibility study aims to objectively and rationally uncover the strengths and weaknesses of an existing business or proposed venture, opportunities and threats pr ...

decisions for new electricity generation projects. *

Investment strategy In finance, an investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. Individuals have different profit objectives, and their individual skills make different tactics ...

decisions made by businesses and governments. *

Energy policy Energy policies are the government's strategies and decisions regarding the Energy production, production, Energy distribution, distribution, and World energy supply and consumption, consumption of energy within a specific jurisdiction. Energy ...

decisions made by governments. Significant caution needs to be applied to use of LCOE as outputs are highly sensitive to the selection of input values. The ability to interpret and compare LCOE model outputs is dependent upon the level of detailed justification provided for input values and the results of

sensitivity analysis Sensitivity analysis is the study of how the uncertainty in the output of a mathematical model or system (numerical or otherwise) can be divided and allocated to different sources of uncertainty in its inputs. This involves estimating sensitivity ...

against the selection of input values.Open access
/ref> For any given electricity generation technology, LCOE can vary significantly from region to region depending on factors such as the cost of fuel or availability of renewable energy resources. 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. An energy efficiency gap phenomenon exists due to observed lack of consideration of and implementation of demand-side

energy conservation Energy conservation is the effort to reduce wasteful energy consumption by using fewer energy services. This can be done by using energy more effectively (using less and better sources of energy for continuous service) or changing one's behavi ...

. LCOE is typically used in support of supply-side generation capacity replacement and expansion decision making. The energy efficiency gap phenomenon suggests demand-side

should also be considered in investment strategies and energy policy.

Limitations

LCOE is often cited as a convenient summary measure of the overall competitiveness of different generating technologies, however, it has potential limitations. 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 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 atmosphere of Earth, air or other gases relative to a planetary surface, planet's surface. Winds occur on a range of scales, from thunderstorm flows lasting tens of minutes, to local breezes generated by heatin ...

, 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 (US) or air con (UK), is the process of removing heat from an enclosed space to achieve a more comfortable interior temperature, and in some cases, also controlling the humidity of internal air. Air c ...

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 (LCOS) and the levelized avoided cost of energy (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, other environmental

externalities In economics, an externality is an indirect cost (external cost) or indirect benefit (external benefit) to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced ...

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 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.

Selection of input values

Electrical energy generated

The amount of electrical energy generated

E_t

or estimated to be generated is dependent upon a large number of factors including: *

Natural resource economics Natural resource economics deals with the supply, demand, and allocation of the Earth's natural resources. One main objective of natural resource economics is to better understand the role of natural resources in the economy in order to devel ...

and the availability of economically viable resources required for generator operation is variable per generation technology. For

generators, wind resource assessment and solar potential assessment are examples of methods used to assess the availability of resources required for wind turbines and solar panels to generate energy. For non-renewable generators, fuel availability over the lifespan of a generator may be temporarily impacted by geopolitical factors (an example being the

1970s energy crisis The 1970s energy crisis occurred when the Western world, particularly the United States, Canada, Western Europe, Australia, and New Zealand, faced substantial petroleum shortages as well as elevated prices. The two worst crises of this period wer ...

) or impacted by gradual depletion of and discovery of new non-renewable resource reserves. Oil and gas reserves and resource quantification is an example of a method used to assess long term availability of economically viable fuel resources for non-renewable generators. * Electricity market effects of grid balancing may require a load-following power plant to curtail generation of energy if the grid does not demand energy (negative

spot price In finance, a spot contract, spot transaction, or simply spot, is a contract of buying or selling a commodity, security or currency for immediate settlement (payment and delivery) on the spot date, which is normally two business days after t ...

s) or allow a generator with high variable costs to be brought online to dispatch into a grid with significant unmet demand and high spot prices. Battery,

run-of-the-river hydroelectricity Run-of-river hydroelectricity (ROR) or run-of-the-river hydroelectricity is a type of hydroelectric generation plant whereby little or no water storage is provided. Run-of-the-river power plants may have no water storage at all or a limited amou ...

with pondage,

and natural gas turbine generators are examples of dispatchable generators. Seasonal diurnal cycles and climatology, as well as short term meteorological events have significant impacts to grid balancing from both supply and demand perspectives. The geographical region within which LCOE is being assessed, the mix of generators in a grid, the proportion of demand flexibility (or conversely firm power demand) within a grid and transmission capacity limits within a grid also significantly influence required generation curtailment. * The cost of operational availability

A_o

(known as

availability factor The availability factor of a power plant is the duration it achieves production of electricity divided by the duration that it was planned to produce electricity. In the field of reliability engineering, ''availability factor'' is known as operat ...

for electricity generators) is variable per generation technology. Different generator technologies require differing levels of planned and unplanned maintenance preventing

nameplate capacity Nameplate capacity, also known as the rated capacity, nominal capacity, installed capacity, maximum effect or gross capacity,power outages and lack of resilience against natural disasters and military attack on electricity grids. Examples of historical events impacting grid resilience are the 1991 Gulf War air campaign against civilian infrastructure, 2015 Ukraine power grid hack,

2021 Texas power crisis In February 2021, the state of Texas suffered a major Energy crisis, power crisis, which came about during three severe winter storms sweeping across the United States on February 2021 North American ice storm, February 10–11, February 13� ...

and Russian strikes against Ukrainian infrastructure (2022–present). Low risk tolerance may require electricity grids to be more significantly overbuilt to mitigate the potential costs of electricity grid interruptions and outages, impacting on a technology-by-technology basis the amount of generation curtailment necessary under normal grid conditions. For a proposed generator with only the proposed nameplate capacity known, observed

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 ...

data available for similar existing generators can be used to estimate the electrical energy generated for the proposed new generator.

Expenditures

Investment expenditures

I_t

, operations and maintenance expenditures

M_t

and fuel expenditures

F_t

are influenced by a variety of

taxes A tax is a mandatory financial charge or levy imposed on an individual or legal entity by a governmental organization to support government spending and public expenditures collectively or to regulate and reduce negative externalities. Tax co ...

commonly imposed by governments including tariffs impacting the cost of importing generation equipment and fuels, excises impacting the cost of production of fuels,

carbon taxes A carbon tax is a tax levied on the carbon emissions from producing goods and services. Carbon taxes are intended to make visible the hidden social costs of carbon emissions. They are designed to reduce greenhouse gas emissions by essentially i ...

for offsetting the

social cost of carbon The social cost of carbon (SCC) is an estimate, typically expressed in dollars, of the economic damages associated with emitting one additional ton of carbon dioxide into the atmosphere. By translating the effects of climate change into monetary t ...

and other taxes for recouping shared industry costs of

electric power transmission Electric power transmission is the bulk movement of electrical energy from a generating site, such as a power plant, to an electrical substation. The interconnected lines that facilitate this movement form a ''transmission network''. This is ...

and research and development of energy technologies. Expenditures can also be influenced by a variety of energy subsidies. Assumptions are required to be made due to the subjective nature of prediction of future levels of taxation and subsidies and influence of the

politics of climate change The politics of climate change results from different perspectives on how to respond to climate change. Global warming is driven largely by the Greenhouse gas emissions, emissions of greenhouse gases due to human economic activity, especially t ...

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 ne ...

expressed as the discount rate

r

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, 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.

References

{{Reflist Electricity economics