Despite the
prevalence of its use in the world of energy analysis, and its apparent
simplicity, the formulation of common forms of the levelized cost of energy
(LCOE) is rarely addressed and the meaning of its parameters is often misstated.
The levelized cost of energy, also known as the levelized cost of electricity, or the levelized energy cost (LEC), is an economic assessment of the average total cost to build and operate a power-generating asset over its lifetime divided by the total power output of the asset over that lifetime. LCOE is often taken as a proxy for the average price that the generating asset must receive in a market to break even over its lifetime. LCOE is appealing because it is a first-order economic assessment of the cost competitiveness of an electricity-generating system that incorporates all costs over its lifetime: initial investment, operations and maintenance, cost of fuel, and cost of capital.
In the following, we derive the most common form of the LCOE. The LCOE is the cost that, if assigned to every unit of energy produced (or saved) by a system over the analysis period, will equal the TLCC (total life-cycle cost) when discounted back to the base year [1]. This definition of LCOE is represented by,
The levelized cost of energy, also known as the levelized cost of electricity, or the levelized energy cost (LEC), is an economic assessment of the average total cost to build and operate a power-generating asset over its lifetime divided by the total power output of the asset over that lifetime. LCOE is often taken as a proxy for the average price that the generating asset must receive in a market to break even over its lifetime. LCOE is appealing because it is a first-order economic assessment of the cost competitiveness of an electricity-generating system that incorporates all costs over its lifetime: initial investment, operations and maintenance, cost of fuel, and cost of capital.
In the following, we derive the most common form of the LCOE. The LCOE is the cost that, if assigned to every unit of energy produced (or saved) by a system over the analysis period, will equal the TLCC (total life-cycle cost) when discounted back to the base year [1]. This definition of LCOE is represented by,
where
r = discount rate (per year)
i = year
n = number of years over which the LCOE
applies
Ei = quantity of energy produced in
year i
TLCC = total
life-cycle cost.
Discrete compounding has been
assumed in Equation (1). Since LCOE is by definition constant (not
dependent on the year i), we can factor it out
of the summation and rewrite Equation (1) as,
Equation (2) is the most common form of LCOE in use today. Note, the denominator of Equation (2) appears to be discounting the energy (and some references refer to it as "discounted energy"), however, only costs can be discounted; the apparent discounting is actually a result of the algebra carried through from Equation (1) in which revenues (the product of Ei and LCOE) were discounted.
The total life-cycle cost (TLCC) can include several contributions
depending on the application. Commonly
it is formulated as,
where
Ii = investment
expenditure in year i including financing (this assumes that either the investment cost is paid over time or it is allocated over time using a depreciation schedule)
Mi
= operations and maintenance
expenditures in year i
Fi = fuel expenditures in
year i (for renewable energy generation, e.g., wind or solar, this may be zero).
Typically, the LCOE is calculated
over the lifetime of an asset, which is usually 20 to 40 years. However, care should be taken when comparing
different LCOE studies and the sources of the information as the LCOE for a
given energy source is highly dependent on the assumptions, financing terms and
technological deployment analyzed.
[1] Short,
W. Packey, D. J. and Holt, T. (1995). A
Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy
Technologies, NREL/TP-462-5173,
March. http://www.nrel.gov/docs/legosti/old/5173.pdf Accessed April 28, 2016.
