What is LCOE, Levelized Cost of Energy? The Concept Explained & Formula …

Energy Transport & Conversion

What is the Levelized Cost of Energy (LCOE)?

The Levelized Cost of Energy (LCOE) is a calculated measure of the costs of a power system that allows policymakers & researchers to compare various methods of electricity generation on a consistent basis. The LCOE equation is an economic assessment of the average total cost to build and operate a power-generating asset over its lifetime divided by the total energy output of the asset over that lifetime. The various electricity generation methods are also different in cost. Calculations of these costs could be made at the point of “connection to a load” or “to the electricity grid”. The costs are typically given per kWh or MWh units. It includes factors such as the initial capital, discount rate, as well as the costs of continuous operation, fuel, & maintenance. Some factors could be not applicable to some electricity generation methods.

Source [2]

Why is the Levelized Cost of Energy Important?

The LCOE equation will determine if a project will break even or be profitable. If not, then the firm will not go ahead with building the power-generating asset and will look for an alternative. Using the LCOE equation to assess a project is one of the first fundamental steps taken in analyzing projects of this nature.[4]

It is also important for comparing different energy-producing technologies such as wind, solar, and nuclear power sources financially.

How to Calculate the LCOE?

The LCOE equation could also be regarded as the average minimum price at which electricity must be sold in order to break even over the lifetime of the project. This type of calculation assists policymakers, researchers, and others to guide discussions & decision-making about investment in a power system project or not.

LCOE Formula
Source [3]

In the calculations above, we have the following parameters.

  • 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

[1] Wikipedia
[2] Fraunhofer.de
[3] EnergyEducation.ca

[4] https://corporatefinanceinstitute.com/resources/valuation/levelized-cost-of-energy-lcoe/