The levelized cost of electricity (LCOE) is the key method through which we compare economic viability between renewable energy and fossil fuel power generation.
In its most basic form, the LCOE formula is:
This form of the LCOE formula isn’t very useful unless we already have both the lifetime cost and lifetime energy values – which is not likely.
In order to calculate the LCOE of power plants we are thinking about building, we have to use a more complex formula:
- w = time-averaged variable operating cost [$ per kWh]
- f = time-averaged fixed operating cost [$ per kWh]
- c = unit cost of capacity [$ per kWh]
- ∆ = tax factor
For a typical Natural Gas Combined Cycle Power Plant, the values are around:
- w = 4.4 cents per kWh
- f = 0.35 cents per kWh
- c = 1.06 cents per kWh
- ∆ = 1.32
The values above result in an LCOE of around 6.15 cents per kWh for a Natural Gas Combined Cycle plant.
But what happens if those w, c, f, and ∆ values are not available? Now we get to the fun part, and have to calculate those values individually.
LCOE Formula – Calculating “w”
This is the time-averaged variable operating cost in dollars per kWh.
To calculate this value, add up all of your variable costs such as wages, fuel, labor etc. on a kWh basis.
As an example, the final value you calculate might be something like 5 cents of variable cost incurred per kWh of output. Any business proposal for a new power plant will have this value readily available.
LCOE Formula – Calculating “f”
This is the time-average fixed operating cost in dollar per kWh.
To calculate this value, use the following formula:
The fixed operating costs should include things such as insurance, property taxes, interest paid on the land etc.
The 8760 is the number of hours in a year, and the CF is the “Capacity Factor”. We need to use a capacity factor because no plant is operating at 100% capacity all the time.
For example, a natural gas power plant might only be operating at an average of 85% capacity throughout the year so we have to de-rate the number of hours in a year by this capacity factor.
Another example on the capacity factor would be if we had a solar panel installation. The sun isn’t always shining, so the capacity factor might be something like 20% to account for the fact that the panels are not producing electricity around the clock.
LCOE Formula – Calculating “c”
This is to account for the capital cost of the plant, and can be calculated using the formula below:
- “SP” = System price in dollars per kW
- 8,760 = the number of hours in a year
- “CF” = capacity factory in percentage terms
- “T” = useful economic lifetime in years
- “Xt“= % of initial capacity that is functional in year “t” (Xt = 1 for fossil fuel plants)
- “r” = cost of capital expressed as an interest rate
One interesting value I want to elaborate on is the Xt component. This value accounts for potential system degradation over time. Most fossil fuel plants don’t suffer from this (which is why we set this value to 1 for them), but renewable energy technologies such as solar panels do degrade over time. This means that the power output in year five of a solar panel installation will be less than year one given exactly the same solar conditions.
If you’re not sure what Xt value to use for your solar panels, 0.995 is a good starting point. However, you should confirm this degradation value with the manufacturer for the technology you’re using.
LCOE Fomula – Calculating “∆”
This is to account for taxation policies affecting your power plant, and can be calculated using the following formula:
- i = investment tax credit in percentage terms
- α = effective corporate tax rate in percentage terms
- δ = factor by which the tax base of the asset is reduced (this is governed by tax laws)
- T0 = the facility’s useful life in years for tax purposes
- dt = allowable depreciation charges in year “t” for tax purposes
- r = cost of capital expressed as an interest rate
For reference, the typical tax factor “∆” for a natural gas combined cycle plant is around 1.3.
Typical LCOE Values
If we apply our formula to various types of power generation, we can compare the levelized cost of electricity produced by the different power plants.
Here are some LCOE values for power plants in the United States that enter service in 2022.