Levelized Cost of Energy (LCOE)
The Levelized Cost of Energy or Levelised Cost of Electricity (LCOE) is the average net present cost of producing energy for a specific system. It considers all the costs over the lifetime of the energy-producing system.
It is an important metric for assessing energy projects’ practical applicability, cost-effectiveness, and economic soundness. If the method results indicate an unviable situation, then the energy project installation can be discontinued. It is an example of an economic measure used to compare projects based on different technologies without any framework conditions affecting the evaluation.
Table of contents
- Levelized Cost of Energy (LCOE)
- Levelized Cost of Energy (LCOE) Explained
- Formula
- Calculation
- Importance of LCOE
- Frequently Asked Questions (FAQs)
- Recommended Articles
Key Takeaways
- The Levelized Energy Cost (LCOE) definition presents it as the net present value of the total cost incurred by the power generating system over the lifetime divided by the net present value of the total power generation over its lifetime.
- Items like investment, operation, maintenance, and fuel expenditures constitute the total cost. Therefore, details of the total cost with other factors like the discount factor and power production over the lifetime are important to calculate the LCOE.
- It is important for evaluating energy projects’ financial viability and cost-effectiveness. Without any framework constraints influencing the evaluation, it illustrates an economic metric that compares projects based on different technologies.
- If LCOE is less than the price at which production may be sold, the project is at least marginally profitable and should be further examined to see whether it is a sensible investment. On the other hand, the project is not a good long-term investment if the LCOE exceeds the price at which power may be supplied.
Levelized Cost of Energy (LCOE) Explained
The Levelized Cost of Energy or Levelized Energy Cost is useful to derive the average minimum price at which the power generated by the project should be sold to offset the entire production costs over its lifetime. In addition, the LCOE assesses if a project will be profitable or reach a break-even point.
Comparison of LCOE with the price at which the power generated could be sold gives insight into the project’s financial viability. The project is at least marginally profitable and should be further investigated to see whether it is a feasible investment if LCOE is less than the price at which output can be sold. On the other hand, the project is not a good long-term investment if LCOE is more than the selling price of the output power.
The process gets complex when we use LCOE to compare different projects because projects may exhibit intense diversity in their design and other features like R&D structure, markets, tax benefits, government subsidies, environmental impact, impacts on public health, and the chance of environmental damage, etc.
Levelized Cost of Energy Formula
The LCOE formula indicates that the method considers a combination of costs to arrive at the total cost. For instance, it uses investment, operations, maintenance, and fuel costs. Furthermore, the method focuses on the net present value and uses the discount factor to arrive at the net present value of the cost. Furthermore, LCOE calculations usually involve 20 to 40 years of lifetime. The result is expressed in terms of money per kilowatt-hour, such as USD/kWh or EUR/kWh or per megawatt-hour (USD/MWh).
Levelized Cost of Energy Formula
LCOE = Sum of costs over lifetime / Sum of output produced over the lifetime
= Total lifetime cost / Total lifetime output
and the formula is:
where,
I: Investment expenditures
M: Operations and maintenance expenditures
F: Fuel expenditures
E: Energy generated
r: Discount rate
t: Year
n: Expected lifetime
Calculation
Let us look at a calculation example to understand the concept better:
For example, a solar farm has an expected lifetime of 20 years. The present value of the total lifetime cost is $120 million. The total lifetime output or energy production is 2,000,000 MWh. Therefore, the Levelized Cost of Energy – the solar farm is:
LCOE = $120 million/2,000,000 MWh
= $60/MWh
Importance of LCOE
LCOE is a valuable indicator since it can analyze a project to determine its viability. It allows comparisons of various projects to determine the most competitive power-generating project. The application of this method identifies the break-even and profitability characteristics of the project under consideration.
The LCOE computation enables project managers and analysts to compare power-generation technologies such as solar, wind, nuclear, gas, and coal while at the same time taking into consideration project lifespans, capital costs, fuel costs, capacity size, and risk. In essence, the Levelized Energy Cost by source contributes to whether to stick to the project under consideration or look for alternatives.
The innovations and advancements in energy-producing technologies increased the importance of LCOE applications. The method is useful in comparing projects with diverse characteristics like different lifespans, cost structure, size, and input features.
It is an index for comparing various sorts of power projects, ranging from renewable projects such as wind, hydropower, and solar power projects to non-renewables like natural gas plants. The present energy crisis, which has driven up oil and gas costs, has only made renewables more appealing from an LCOE standpoint. Because the LCOE of oil and gas plants has risen, at the same time, renewable energy’s LCOE has remained unchanged. As a result, increased energy prices yield bigger profits for renewable generators than fossil fuel generators, considering higher input or fuel expenses.
Frequently Asked Questions (FAQs)
The LCOE calculation involves taking the net present value of the total cost over the lifetime and dividing it by the net present value of the total power generation over its lifetime. Items like investment, operation, maintenance, and fuel expenditure constitute the total cost. Hence details of total cost and power production over the period are important to calculate the LCOE.
Lower LCOE is better. The project could be profitable if the LCOE is lower than the maximum power price the plant can get. On the other hand, the project will probably not be economical if the LCOE is higher than the cost of power.
At a glance, reducing the cost and increasing the output can reduce the LCOE.
Recommended Articles
This article has been A Guide to What is Levelized Cost of Energy (LCOE). We explain its importance, formula, and calculation using an example. You can learn more from the following articles –
- Industrial Revolution
- Project Finance
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This post first appeared on Free Investment Banking Tutorials |WallStreetMojo, please read the originial post: here
