Your Guide to Lazard’s LCOE Analysis: Part 1. What is the Levelized Cost of Energy?

Before we discuss how wind and solar special interest groups routinely misrepresent Lazard’s Levelized Cost of Energy (LCOE) Analysis, we have to describe what the LCOE is and how it is calculated, some of the limitations of this analysis tool, and how we can improve it moving forward.

You can click here to access the table of contents for this series.

What is the LCOE, and how is it calculated?

Almost all studies that examine the cost of different electricity-generating technologies use a methodology called the LCOE to assess the cost of electricity generated by coal, natural gas, nuclear power plants, wind turbines, and solar panels.

The LCOE is a cost estimate that reflects the cost of generating electricity from different types of power plants on a per-unit of energy basis—generally megawatt hours (MWh)—over an assumed lifetime and quantity of electricity generated by the plant.

In other words, LCOE estimates are like calculating the cost of your car on a per-mile driven basis after accounting for expenses like initial capital investment, loan and insurance payments, fuel costs, and maintenance.

The main factors influencing the LCOE for power plants are the capital costs incurred for building the facility, fuel costs, heat rates, variable operation and maintenance (O&M) costs, fixed O&M costs, the number of years the power plant is in service, and the annual capacity factors, which allow us to calculate how much electricity the plant will generate during its useful lifetime based on the installed capacity of the facility, which is measured in megawatts (MW).

LCOE then, and now: Limitations on LCOE

While the use of LCOE may have been appropriate in the past when most if not all, newly proposed generating units were dispatchable, the introduction of intermittent renewable resources has made LCOE calculation less informative over time because this metric was developed to compare resources that were able to provide the same reliability value to the grid.

Because wind and solar are not able to supply reliable power on demand like dispatchable energy sources such as coal, natural gas, or nuclear power, it is not appropriate to compare LCOE estimates for dispatchable and non-dispatchable electricity sources because they are not an apples-to-apples comparison of value.

This is why the U.S. Energy Information Administration explicitly cautions readers against comparing the LCOE of dispatchable and non-dispatchable resources. Unfortunately, this word of caution is seldom heeded.

LCOE: Looking ahead

As the limitations of LCOE have become more apparent with the rising penetration of intermittent wind and solar technologies, the academic literature has acknowledged a need for an alternative metric that encapsulates the costs that wind and solar impose on the entire electric system, as well as costs that electricity customers are forced to pay as more wind and solar facilities are constructed.

To account for the shortcomings of the traditional LCOE analysis, Center of the American Experiment created an energy model that accounts for the additional expenses incurred from building intermittent renewable energy systems and allocates them to the unreliable resources that necessitate these expenditures.

These additional expenses include costs for additional transmission lines, rising utility profits, property taxes, and the cost of building “backup” power sources, such as natural gas or battery storage, to provide electricity when the sun is not shining, or the wind isn’t blowing, and the cost of “overbuilding and curtailing” wind and solar facilities to reduce the need for battery storage at high renewable penetrations.

Importantly, this model differs from Lazard because it allows us to calculate the cost of using wind and solar to serve each megawatt hour of load based on the entire cost of an electricity system instead of calculating the breakeven cost of an individual wind or solar facility operating in a vacuum.

Tomorrow, we will begin our discussion of the specific components of Lazard’s LCOE analysis.