Levelized Cost of Energy

Although the term itself is pretty scary, the idea is actually really simple. The levelized cost of energy (also known as the levelized cost of electricity or LCOE, because the energy industry loves to make life complicated) is an estimated measure of how the cost of an energy generation system compares against what it will provide. To you and me, it’s a mathsy way of answering the question – what’s the overall cost of this system?  It works for any energy generation installation, from biomass boilers to nuclear plants.

How is the levelized cost of electricity worked out?

Don’t panic, but I’m about to show you an equation. DON’T PANIC.

Levelized Cost of Energy - Algorythm

I feel like you’re panicking. 

Look, forget the end bit with all the numbers and letters and whatnot. The important part is that the LCOE is just the lifetime cost of the system divided by the energy produced over its lifespan. 

Don’t worry, we’re going to go through it step by step. The easiest way to show you how to do this is with an example – I’m going to use the example of a 4kW monocrystalline solar pv system.

Sum of Cost Over Lifetime:

Investment: How much the energy system costs you to buy as a yearly average. For a lot of systems this will be the cost of the initial installation divided by the life expectancy. If you’re buying in your energy from somewhere else (like the grid) then the investment will be you average yearly bill.

For our solar example the installation cost would be about £7000 + £0 buy-in costs. Divide that by the lifespan of the panel (on average about 25 years) and we get an It value of £280.

Operations and maintenance: Exactly what it sounds like – the yearly cost of maintaining the system. Boilers need to be checked once a year, biomass boilers need regular servicing, wind turbines need expert monitoring, etc etc.

Our solar panels will need regular cleaning – let’s budget £75  a year for that.

Fuel expenditure: The yearly cost of your fuel. Some technologies like wind and solar won’t have any fuel costs, but it’s a notable factor for wood burners and biomass boiler owners.

Our solar panel fuel costs are £0! Our favourite price.

That our lifetime costs sorted – an average of £355 per year for 25 years.

Sum of Electrical Energy Produced Over Lifetime:

Thankfully this one is much easier to figure out – it’s just the estimated annual output of your system multiplied by the estimated number of years it will run for.

Our solar panel is one of the best, so we’re looking at an annual output of around 3,400kWh. Multiplied by the 25 year lifespan we’ve given the system, our electrical energy produced over a lifetime is 85,000kWh. Not bad for a bit of sunshine.

Final Levelized Cost of Electricity:

You’ve got those two numbers? Great, just divide them.

8,875 ÷ 85,000 = 0.1044. That’s expressed as a fraction of a pound, so our levelised cost of energy for our solar system is 10.44p/ kWh. For our solar panel though we also need to take the Feed-In Tariff into account. At the moment this is set at 4.01p/kWh (this is set to drop slightly in the coming months and probably even more after that, but it will do for our estimates) – that means that our final levelised cost of energy is 6.43kWh. For comparison, the current average cost of electricity in the UK at the time of writing is between 12.3p- 13.2p.

What is the levelized cost of electricity used for?

The levelised cost of energy is generally used by big companies as a means of cost assessment – is a certain energy system worth investing in. It can be pretty handy for everyone though – our solar panel example demonstrates how it can be used in a domestic context.

What are the problems with the levelized cost of electricity?

The biggest problem with LCOE is that nearly everything is based on assumptions. For the solar panel example above, we assume that the system will last as long as it’s designed to without breaking, that the Feed-In Tariff won’t drop too dramatically, that the inverter won’t need replacing, that maintenance costs won’t go above what we budgeted, etc etc etc. None of these are exact, and even small changes can throw off the equation quite significantly.

The other problem is that it doesn’t take into account the time effect of supply and demand. Imagine you’re enjoying a sunny day in Spain in August – the sun is shining and you’ve got your aircon ramped up, but that same hot sun is also powering your electricity. Although demand for electricity is high, the supply is also high because of the correlation. This kind of time effect is not taken into consideration for levelized cost of electricity, so high cost renewables like wind and solar can have inaccurate LCOE.

The main thing to take away from this article is that the levelized cost of electricity is a useful tool to ascertain whether investing in a certain energy system is financially viable. However the figure you arrive at should be taken with a pinch of salt, especially given the rapidly changing face of the energy industry.

Think we missed something? Do you have a different opinion?

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