What is ‘LCOE’ (and its Limitations)


Levelized Cost of Energy* (LCOE) is one of the most frequently-quoted metrics you’ll encounter in the business of power generation. As a result, it’s also one of the most widely misused and misinterpreted!

(*You may also find people using Electricity as the “E” in LCOE).

As the name suggests, LCOE is a metric to capture the cost of the energy produced by, for example, a power plant. So it will be quoted in units such as £ per MWh, cents per kWh or similar (i.e. some unit of money divided by energy).

It attempts to do so not simply based on short-term costs but on lifetime costs, which is important in providing a fair comparison between different sources of supply. In particular it can better compare different sources of supply with different cost structures: for example one with higher up-front cost but no fuel and minimal other operating costs (like solar PV) with one which may look cheaper to build but could incur large operating costs – particularly paying for fuel – for the next twenty years or more (such as gas).

So, in the video lesson, we’ll briefly describe what LCOE is (and – importantly – what it isn’t).

Immediately below the video, are some links to some additional, external sources of information on the subject, if you wish to explore further.

Then (in the next lesson) there’s also another simple calculator to help illustrate how sensitive LCOE can be to both the assumptions behind it and the method of calculation. (In the next section some simple questions are presented to help you do this).

References:

There are numerous publications and reports which include information on LCOE; both methods of calculation and example results. As new ones are published or discovered, they get added to the Grey Cells Energy Virtual Library, which we’d recommend accessing on a regular basis to check for additions.

I’ve also written about LCOE, including this article “10 Comments on LCOE” and this one, which models the sensitivity of solar PV energy costs to different variables.

(1) The source used for the equation to calculate leveraged LCOE (both in the video lesson and our own online calculator) can be found here, courtesy of Mercom Capital.

(2) Another online calculator for simple LCOE can be found here. Note that for thermal power generation sources, this includes the input of heat rate, a concept which we noted at the end of a previous lesson (on efficiency).

(3) Finally, it’s worth stressing the point that LCOE is just one metric that aims to say something about energy costs – but it is certainly not without criticisms or alternatives. One interesting alternative – LACE, levelized avoided cost of energy – is described and compared here.