Levelized cost of electricity

Key takeaways

Levelized cost of electricity belongs to science; place it in that map before memorising details.
Learn the definition first, then one example that makes the definition concrete.
Connect Levelized cost of electricity to a quantity you can measure, compute or draw — that is where exam questions come from.
Reproduce the core statement of Levelized cost of electricity from memory before moving on to harder problems.

Reference excerpt

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 one of several cost metrics 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 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 constant price per unit of energy that would yield a net present value of zero for the project, or, more technically, the "cost that, if assigned to every unit of energy produced (or saved) by the system over the analysis period, will equal the [total life-cycle cost] (TLCC) when discounted back to the base year." LCOE is defined by the formula:

L C O E = discounted sum of costs over lifetime discounted sum of electrical energy produced over lifetime = ∑ t = 1 n I t + M t + F t ( 1 + r ) t ∑ t = α n E t ( 1 + r ) t {\displaystyle \mathrm {LCOE} ={\frac {\text{discounted sum of costs over lifetime}}{\text{discounted sum of electrical energy produced over lifetime}}}={\frac {\sum _{t=1}^{n}{\frac {I_{t}+M_{t}+F_{t}}{\left({1+r}\right)^{t}}}}{\sum _{t=\alpha }^{n}{\frac {E_{t}}{\left({1+r}\right)^{t}}}}}}

Input values are:

Applicability LCOE is an estimation of the cost of production of electricity and not the price of electricity. The price of electricity may be influenced by additional factors including markup and price controls. LCOE is commonly used for:

Feasibility study decisions for new electricity generation projects. Investment strategy decisions made by businesses and governments. Energy policy 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 against the selection of input values. 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. LCOE is typically used in support of supply-side generation capacity replacement and expansion decision making. The energy efficiency gap phenomenon suggests demand-side energy conservation 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. Decisions about investments in energy generation technologies may need to 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. 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:

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Illustrations

Worked examples

Example 1 — a first encounter with Levelized cost of electricity

Start with the simplest possible case. Write down what Levelized cost of electricity claims or describes in one sentence, then invent the smallest concrete situation in which that sentence is true. In science, the smallest case is usually a single object, a single equation or a single measurement. Check that every symbol or term in your sentence has a meaning in that case.

Example 2 — changing one variable

Take the situation from Example 1 and change exactly one quantity: double it, halve it, or set it to zero. Predict what should happen to Levelized cost of electricity before you calculate. Comparing your prediction with the result is the fastest way to find out whether you understand the idea or only the words.

Example 3 — an exam-style question

Typical questions about Levelized cost of electricity ask you to (a) state it precisely, (b) apply it to given data, and (c) explain a limitation. Practise writing all three answers in under five minutes; the third part is what separates a full-mark answer from an average one.

Applications of Levelized cost of electricity

In research: Levelized cost of electricity appears in science research whenever the underlying quantities have to be modelled precisely. Papers usually cite it as a starting assumption and then explore where it breaks down.
In technology and industry: Engineering practice reuses Levelized cost of electricity in design rules, simulations and safety margins. Knowing the idea lets you read a specification sheet and understand why the numbers look the way they do.
In the classroom: Levelized cost of electricity is common in secondary-school and first-year university syllabi. It links to neighbouring topics Electricity economics, so understanding it makes those chapters shorter.
In everyday life: Look for Levelized cost of electricity outside the textbook — in sport, cooking, traffic, electronics or the sky above you. An example you found yourself is remembered far longer than one you were given.

How to study Levelized cost of electricity in 20 minutes

Read the reference excerpt below once, without taking notes.
Close the page and write down what Levelized cost of electricity means in your own words.
Compare your version with the excerpt and mark what you missed.
Work through the three examples above with pen and paper.
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Frequently asked questions

What is Levelized cost of electricity in simple terms?

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 one of several cost metrics used for investment planning and to compare different methods of electricity generation on a consistent basis.

Why does Levelized cost of electricity matter?

Because it connects several science ideas at once: it gives you a definition you can apply, a quantity you can calculate, and a way to check whether a result is plausible.

How should I study Levelized cost of electricity?

Read the excerpt, restate it from memory, then work through the examples and applications listed on this page. The five-step study plan above takes about twenty minutes.

What does this page cover?

It gives you a compact reference excerpt plus original lgStudy explanations, examples, applications and study material on Levelized cost of electricity.