Levelized Cost of Energy

LCOE is billed as the new metric for PV system evaluation— the replacement for cost per watt. What is it and how can PV system designers and developers use it?

Levelized cost of energy (LCOE) is a widely used term in the PV industry. It is often used as a marketing tool by PV equipment manufacturers or in discussions regarding utility-scale projects. How is it calculated and what are its uses? Is it purely an external metric, something the industry can use to compare its costs to that of other energy sources, or can it be an internal metric employed by developers, engineers and customers in making PV system investment and design decisions?

In this article, we discuss what LCOE is, how it is used and how it is calculated. We then focus on how it can and should be applied in the PV industry. In addition, we analyze some example PV systems and explore appropriate uses for the metric. We also discuss some of the pitfalls associated with LCOE and the limitations of its use.

LCOE Defined

LCOE is used to compare the relative cost of energy produced by different energy-generating sources, regardless of the project’s scale or operating time frame. As Thomas Holt and his co-authors define it in A Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy Technologies (see Resources), LCOE is determined by dividing the project’s total cost of operation by the energy generated. The total cost of operation should include all costs that the project incurs—including construction and operation— and may incorporate any salvage or residual value at the end of the project’s lifetime. Incentives for project construction and energy generation can also be incorporated.

LCOE = Total Life Cycle Cost / Total Lifetime Energy Production      (1)

As presented in Equation 1, LCOE is a metric that describes the cost of every unit of energy generated by a project in $/kWh (or ¢/kWh or $/MWh).

As will be shown directly, this basic definition of the LCOE can be expressed mathematically in more complex ways to account for all of the variables that impact the life cycle cost and total energy production for a PV system.

LCOE Uses

LCOE is most commonly used for evaluating the cost of energy delivered by projects utilizing different generating technologies. Specifically, it is used to rank options and determine the most cost-effective energy source. LCOE may also be used to compare the cost of energy from new sources to the cost of energy from existing sources. In this context, it is useful to policy makers deciding how future energy needs will be met and which technologies to support, and to utilities and project developers selecting technologies. It should be noted that energy-efficiency projects may also be evaluated using the metric.

Because it captures total operating costs, LCOE enables comparisons between significantly different technologies, but it may also be used to compare the cost of energy from variations of the same technology. Options related to components or system design can be evaluated to see what impact they have on LCOE. For example, a developer of a new PV module technology that is more efficient, but also more expensive, could use LCOE to determine performance or cost benchmarks that would need to be met in order for the technology to be competitive and adopted in the market. Similarly, LCOE could be used to identify areas where cost-savings research would be most valuable.

While LCOE is useful for comparing the cost of energy from multiple technologies or evaluating the differences between sources utilizing the same technology, it should not be the only metric that is considered when doing so.

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