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LCOE – the metric that helps us evaluate energy-related projects

Recent blogs have looked closely at various renewable energy sources’ levelized cost of energy (LCOE). This measure has been, and will likely remain, an essential metric when it comes to comparing energy-related projects. A key advantage is that LCOE is expressed in currency per megawatt-hour or kilowatt-hour, and is flexible through its use of each assets’ development and operational parameters.

We have already concluded that LCOE inputs differ between energy sources. Consequently, slight adjustments to the generalized, simplified formula must be made to more accurately capture actual costs. However, even with these adjustment, not every possible scenario can be included, especially once we include uncertain future events into today’s calculation. 

The very generalized formula for calculating the per-megawatt cost for all kinds of energy-related projects is as follows: 

LCOE = [Stn=1 (It + Mt + Ft) / (1+r)t] / [Stn=1 E/ (1+r)t] ; 

where (i) Iis the invested capital in period t, (ii) Mare the costs of maintenance in period t, (iii) Fis the cost of fuel in period t, and (iv) Et is the energy output in period t. 

This formula works pretty well for already mature technologies such as hydropower, where low-cost projects already are the status-quo. Less mature technologies like hydrogen, wind, and solar PV have more specific requirements and technical demands. Hence, the simplified and generalized formula needs well-considered adaptations to produce a more accurate metric that allows for better comparison across these diverse energy sources. 

Wind Energy LCOE’s

Onshore wind farms outperform offshore wind farms across virtually all associated costs (mainly due to more expensive materials–marine technologies–higher EPC and O&M costs, a more complex connection to the grid, and a host of logistical difficulties). Even so, a higher load factor, mainly the result of taller towers and longer blades that are able to capture more wind, is an advantage for offshore wind that will become more dominant once economies of scale drive down its costs still further. 

With the increasing use of power purchase agreements (PPA’s), the LCOE calculation for wind energy needs still more input parameters to account for as possible penalties, royalty fees and other variables that affect a wind farm’s cost over its operational life. 

A possible extension to the general formula LCOE is the following: 

LCOE = [Sni=0 (Ii + OMi + Fi – TCi – D– T+ Peni + Ri) / (1+r)i] / [Sni=1 E/ (1+r)i] ; 

where (i) Iis the invested capital in period i, (ii) Mare the costs of maintenance in period i, (iii) Fis the cost of fuel in period i, (iv) Ei is the energy output in period I, (v) TCis the tax credit in year i, (vi) Peni is the sum of the production loss and the penalty (paid for non-compliance) in year I, (vii) Di is the depreciation in year i, (viii) Ti is the tax levy, and (iv) Ri) are the royalties of the corresponding year. Tax credit and penalty are subject to each specific PPA.[1]

For almost two-thirds of the world’s countries, wind is already one of the least-cost energy sources; Brazil has seen lows of US$30/MWh. With the global weighted average LCOE for onshore and offshore wind in 2019 standing at US$53 and US$115 per MWh, respectively, wind energy is becoming a go-to technology when it comes to upscaling renewable energy[2].

Solar PV LCOE’s

With the global weighted average LCOE for utility-scale solar photovoltaic (PV) falling an astonishing 82% between 2010 and 2019, largely due to declining module prices and balance-of-system (BoS) cost reductions, solar energy is competing directly with wind energy to be the least-cost energy source. Recent technology advancements accounted for a global weighted average LCOE decline of 13% year-on-year in 20192

Not only have utility-scale projects seen cost declines, but also commercial and private rooftop installations, which have experienced cost reductions of between 42% and 79% over the past decade. Rooftop applications usually show a higher cost structure and a lower efficiency rate than utility-scale projects. Even so, rooftop projects enjoy low cost and high demand. India and China have seen the lowest LCOE’s for commercial rooftop applications at US$62 and US$64 per MWh, respectively2.

India also demonstrated the lowest LCOE’s for utility-scale solar projects at US$45/ MWh, an impressive 34% lower than the global weighted average of US$60/MWh. Spain and China also have shown their ability to install low-cost, competitive solar farms with weighted average values of US$54 and US$56 per MWh, respectively, in FY20192.

LCOE’s of commercial and utility-scale solar PV applications and projects can be more accurately calculated by using the same formula that we used to calculate wind energy LCOE’s.  The types of costs do not differ, only their distribution, which is irrelevant to the formula itself. 

However, to be able to provide owners of residential applications with an accurate formula to calculate this useful metric, the following adjustments are required: 

LCOEresidential = {PC – CBI – PVPBI – S + Sni=1 [LPi/(1+r)i] – Sni=1 [INTi/(1+r)i]*ETR + Sni=1 [OMi/(1+r)i] / [Sni=1 E/ (1+r)i]; 

where (i) PC is the project costs, (ii) CBI is cost-based incentives, (iii) PVPBI is the present value performance benefit incentives (relevant in many US states), (iv) S is country-specific subsidies, (v) LPi is the discounted  loan payments in period i, (vi) INTi is the discounted interest payments in period i multiplied by the ETR (effective tax rate), (vii) OMi is the discounted Operations & Maintenance costs, and (viii) Ei is the energy output in period i. (Note that O&M costs are included in the formula; however, it is uncommon to consider these costs for residential systems due to their relatively high amount when compared to marginal gains.)

Hydropower LCOE’s

Despite recent cost increases, hydropower remains one of the least cost energy sources worldwide. Since 2010, hydropower’s global weighted average levelized cost of energy has increased by 27% to around US$47 per MWh in FY2019. This uptick is due to rising installation costs, which are mainly due to new projects that are located in challenging locations. 

Meeting more than 16% of the world’s electricity demand, hydropower is the most substantial renewable energy source, for the time being. Even with the recent cost increases, 9 out of 10 new hydro installations beat new fossil fuel-fired alternatives in terms of cost per megawatt-hour[3].

Requirements for hydropower plants can differ significantly, and so can LCOE’s. One of the main reasons for this volatility in levelized costs is the difference between a plant that is required to have a high average capacity factor and a plant that is designed to meet peak demands and/or stabilize the grid. Even so, hydropower may offer the lowest-cost option to deliver ancillary services, due to higher correlating power prices. 

Because the process of planning and building a hydropower plant usually is lengthy and expensive, the cost of ownership can play a significant role. Civil construction work accounts for the largest portion of the installation cost pie. By contrast, O&M costs typically range between 1-6% meaning they are lower than for comparable fossil-fuel plants[4].

By applying the general formula of LCOE’s to calculate the per-unit costs of hydropower, the metric offers reasonable accuracy, and the calculation itself produces little error. This is largely a function of the already well-established and mature technology, which provides a deep pool of experience that better estimates future cost uncertainties. 

To be sure, hydropower has enjoyed low LCOE’s for a long time. This has contributed significantly towards the technology’s high penetration rate, even as deployment costs have risen over the past decade.

Hydrogen LCOE’s

Hydrogen provides easy and effective storage and transportation options, which makes it one of the more attractive sources that will help advance decarbonization and increase the share of renewable energy resources. One significant challenges that green hydrogen faces is its cost competitiveness, as electricity is required to produce hydrogen. With costs of solar, wind, and hydro energy at an all-time low, green hydrogen is now more feasible than ever before. 

With the help of power tariffs that range between US$20 and US$40, renewable hydrogen costs have the ability to stay under US$2.5 per kilogram[5], which makes it highly competitive. In addition, low-cost solar photovoltaic installations can contribute to green hydrogen’s growth. For example, Saudi Arabia has announced a US$5 billion plant to produce green hydrogen on an unprecedented scale, producing on the order of 650 tons of green hydrogen daily[6].

We may use the general LCOE formula to calculate the costs of hydrogen. In doing so, we need to be mindful that the cost of fuel will include input electricity and that end costs will be higher than the levelized costs suggest as logistics will be a factor. Logistic costs are not part of the production process and so are not included in the metrics calculation itself[7].

Additionally, we should not forget storage costs: The ability to store both large and small amount of hydrogen for multiple weeks is probably one of its biggest advantages.[8]

Conclusion 

Levelized costs of energy are an excellent metric for an initial assessment of whether a future power installation is feasible or not. Despite its advantages, this metric is not perfect as it is a simplification and a modelled decision tool. 

Despite this drawback, LCOE’s are useful to compare the overall competitiveness of different generating technologies.

Levelized avoided costs of electricity (LACE) are an additional metric, which, in combination with LCOE’s, enables us to get a better understanding of the economic competitiveness for each technology. LACE is defined as the costs that would be incurred to provide the electricity displaced by a new generating unit. The avoided cost is interpreted as the revenue available to the new generating unit.[9]

Another metric that includes some operational factors of various power plants–such as the ability to ramp electricity up and down, the ability to control frequency, the ability to produce energy at favourable times, and many more extra capabilities–is called value adjusted levelized costs of energy (VALCOE). 

However, one thing all of these metrics fail to include is the cost of carbon emissions. No single energy source is yet carbon-free. Therefore, the prices of carbon emissions need to be accounted for as well. We are currently working on a factor that can be included in the LCOE, LACE and VALCOE calculations, which will be the topic of an upcoming post.

If you have any material that could help us in pricing these carbon emissions in the most accurate way possible, send us an email at contact@electrifying.world. We will extend credit to you for the insight! 

From what we have learned to date (and ignoring the fact that carbon emission costs exist), renewable energy sources are justifiably less expensive than traditional fossil options. Why is it that companies still pursue these ‘dirty’ energy sources? 


[1] http://escml.umd.edu/Papers/Bruck%20LCOE%20PPA%20paper.pdf

[2] https://www.irena.org/publications/2020/Jun/Renewable-Power-Costs-in-2019

[3] https://www.eia.gov/outlooks/aeo/pdf/electricity_generation.pdf

[4] https://www.irena.org/documentdownloads/publications/re_technologies_cost_analysis-hydropower.pdf

[5] https://www.irena.org/-/media/Files/IRENA/Agency/Publication/2019/Sep/IRENA_Hydrogen_2019.pdf

[6] https://www.greentechmedia.com/articles/read/us-firm-unveils-worlds-largest-green-hydrogen-project

[7] https://www.hydrogen.energy.gov/pdfs/progress10/vii_6_steward.pdf

[8] https://www.sciencedirect.com/science/article/pii/B9780444626165000097

[9] https://ceri.ca/assets/files/CERI%20Electricity%20Report%20-%20April%202020.pdf

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