How can developers use levelized cost of electricity to compare technologies?

Speeches Shim

Short Answer

Levelized cost of electricity (LCOE) allows project developers to compare the cost of electricity produced by different generation technologies with varied capital costs, fuel costs and lifetimes. Agencies such as the U.S. Energy Information Administration track LCOE across generation technologies to help policymakers and others identify the most cost-effective options.

LCOE accounts for capital expenditure costs, fuel and other operations and maintenance (O&M) costs, taxes, resource availability, cost of capital, efficiency and useful lifetime of the plant to determine the cost of electricity, expressed as “$/kWh” produced by a generator.

The LCOE of a mini-grid depends on the following variables:

  • Technology used in a mini-grid’s design
  • Size of mini-grid (bigger is generally cheaper due to economies of scale)
  • Cost of capital (high interest rates lead to higher LCOE)
  • Tenure of the loan (long loans make for lower LCOE)
  • Cost of labor, backup fuel (diesel) and replacement equipment (batteries)
  • Risk factors (political, payment and price variability)
  • Project location (remote projects tend to have higher LCOEs because of higher construction and O&M costs).

The following table shows the ranges of LCOEs for village mini-grid technologies.

Relative Cost of Energy Across Mini-grid Technologies
Resource LCOE – low ($/kWh) LCOE – high ($/kWh)
Wind .043 .076
Hydropower .057 .070
Biomass .085 .125
Geothermal .043 .053
PV .058 .143
Solar thermal .177 .373
Nuclear .096 .104
Natural Gas .052 .148
Coal .103 .196
Source: U.S. Department of Energy (DOE) Energy Information Administration (EIA), 2017.

Further Explanation of Key Points

The following data, at minimum, are required for an LCOE calculation.

Financial Lifetime of Project (years)
The number of years over which financial calculations are made. The financial lifetime of the project is typically equal to the estimated equipment life.
Discount Rate (percent)
The interest rate at which future cash flows are discounted. A good proxy for this is the weighted average cost of capital of the project. Low discount rates favor capital-intensive technologies with low operating costs (renewables), whereas high discount rates favor technologies with low capital costs but high operating costs (fossil fuel).
Capital Cost of Turn-Key Project ($/kW)
The “overnight cost” (all costs minus interest, as though the project were completed in a single day) of a completed power plant that is ready for use.
Capacity Factor (%)
The actual energy output divided by the theoretical power output if the plant ran continuously at 100 percent of its rated capacity.
Fixed O&M Costs ($/kW-year)
O&M costs that do not fluctuate with varying power output.
Variable Costs ($/kWh)
Plant costs that vary depending on power output.
Heat Rate (Btu/kWh)
The amount of energy used by a power plant to create one kWh of electricity. (Applies only to thermal power plants).
Fuel Cost ($/MMBtu)
The cost of power plant fuel. (Applies only to thermal power plants).

Putting it Into Practice

There are several tools available to calculate LCOE, which vary in level of complexity and detail of project modeling. The best choice depends on the type of information and data available to the project developer.

National Renewable Energy Laboratory Levelized Cost of Electricity Calculator

The National Renewable Energy Laboratory’s (NREL’s) simple, online Levelized Cost of Energy Calculator can be used to determine the LCOE of renewable energy mini-grids. The calculator considers only eight key factors (project financial lifetime, discount rate, capital cost, capacity factor, heat rate, fuel cost and variable and fixed O&M costs cost) and provides simple “slider bars” to experiment with the impacts of different assumptions and compare the results to the cost of utility electricity.

The calculator does not address cost of capital, future replacement or depreciation. The NREL calculator also does not model electricity storage in its calculations. It is thus suitable for preliminary estimates for grid-connected renewable energy projects, but for isolated mini-grids, the lack of storage modeling limits the calculator’s use to preliminary estimates for hydropower, biomass or diesel mini-grid projects that generate electricity upon demand.

Small Power Producer Evaluator: Spreadsheet Model

The project viability evaluation model developed by Tanzanian regulator, Energy and Water Utilities Regulatory Authority, is somewhat more complicated than a simple online calculator. The one-page spreadsheet, created for shared use with the Tanzanian Rural Energy Agency, generates a year-by-year cash-flow model. Inputs include all of those in the NREL online calculator and information on financing (grant, equity; debt, including interest rates and grace period; depreciation rate and schedule), taxation and construction timelines. Outputs include the calculation of the cost recovery tariff—essentially, the LCOE plus levelized distribution costs. The spreadsheet also calculates other financial measures of interest to project developers, including the project’s Internal Rate of Return (IRR), IRR on equity and year-by-year calculation of the project’s debt service coverage ratio. Like the NREL online calculator, this Excel spreadsheet model does not explicitly include electricity storage.

Hybrid Optimization Model for Electric Renewables

Hybrid Optimization Model for Electric Renewables (HOMER) software is a sophisticated engineering-economics tool for modeling and optimizing mini-grids. HOMER allows users to enter technical and financial parameters to simulate the operation of thousands of possible mini-grid designs. Since HOMER simulates 8,760 hours of dispatch of each system, it requires information on the hourly and seasonal timing of loads and renewable energy resources, and detailed technical specifications of equipment, including curves of generator fuel consumption versus power output and battery cycles versus state of discharge.

Based on thousands of simulations based on variations in amounts of solar photovoltaic (PV) panels and battery storage, for example, HOMER identifies an optimized system configuration that has the lowest LCOE. Moreover, HOMER provides a detailed breakdown of the component costs of the LCOE (levelized capital costs of each major component, fuel and O&M). Although HOMER is sophisticated on the engineering aspect of LCOE, it is not financial analysis software. Users will probably want to use HOMER results in a financial model that considers equity, debt and grants, such as the small power producer evaluator discussed above.

Because some of these variables, such as capacity factor or variable costs, are difficult to determine during the early stages of mini-grid design, those interested in exploring mini-grid options will almost certainly find HOMER software useful. HOMER calculates the LCOE of optimized mini-grid systems using more basic data inputs, including:

  • Costs of specific component such as PV modules, batteries and diesel gen-sets
  • Cost of fuel such as $/liter of diesel fuel or $/kg of biomass
  • Load curve
  • Information on the abundance and hourly and seasonal variation of the renewable energy resource such as wind or solar data
  • Discount rate (%)
  • Fixed and variable O&M data at the component level such as diesel generator operating hours before overhaul, diesel overhaul costs, battery cycles before failure, battery replacement costs and O&M labor costs.

LCOE generally covers only electricity generation costs, because it is usually a tool for comparing different sources of generation, generally in a large-scale, utility context. HOMER allows for the user to add fixed costs (like distribution costs) so LCOE, including distribution, can be calculated. It is this “all inclusive” LCOE that is of particular interest when the mini-grid operator needs to determine what tariffs to charge in order to cover costs.

Relevant Case Studies

Adaptive Solar PV Mini-Grids in Tanzania. Devergy, an energy services company in Tanzania, is providing rural villagers with access to electricity using PV-powered mini-grids with smart payment and monitoring technologies. This case study describes connection costs and prices for solar mini-grid serving 1,266 households and businesses across 20 villages in rural Tanzania.

Last updated: February 14, 2018

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