Demystifying LCOE

Levelized Cost of Electricity (LCOE) is a valuable metric.  LCOE allocates the costs of an energy plant across its useful life, to give an effective price per each unit of energy (kWh).  In other words, it’s like averaging the up-front costs across production over a long period of time.  The nice thing about LCOE is that it gives a single metric that can be used to compare different types of systems – from renewable projects, where the up-front capital cost is high and the "fuel" cost is near zero, to a natural gas plant, where the capital cost is lower, but the fuel cost is higher.  And it can even be compared against the price you pay on your utility bill ($/kWh).

However, LCOE is also feared – mainly because it can be complex.  I’m going to try to change that here.

Instead of just giving a single overview of an LCOE model, I’m going to show a few different levels of detail, so you can matches the level of model complexity with what you’re trying to accomplish.  You can follow along by downloading the attached document, “Simple LCOE Model."

Level 1: Back of the Envelope: This is minimum amount of analysis needed to get to a number that even looks like an LCOE.  You only need four numbers:

• System size: This is often referred to as the ‘nameplate capacity’ of the system.  Specifically, it is a measure of how much power the system could produce when running at full strength.
• System cost: The cost to install the system – most often given on a per-watt basis.  For example, if you get a quote for someone to build a 10kW (10,000 watts) nameplate system for $40,000, that is a cost of $4/watt.
• Watt-hours per watt-peak: The nameplate power is only half of the story: you then need to know how much energy you get out (power delivered over a period of time).  So this number measures how many hours per year the system is operational – in other words, how many hours of sun does a system receive.
• Productive years: Since the production happens over time, it’s critical to understand how many years the system will work.  Most components are warranted for 20-25 years. ::continue::

Level 2 – If you want to include all assumptions that are significant, you need three more:

• Nameplate de-rating: Even if a system is supposed to produce 10,000W, it rarely produces that.  There are a lot of steps in processing the power (efficiency losses in the inverter, wire, and other operation), and they eat up about 20% of the power between the module and the grid.
• Discount rate: future value is discounted against today’s.  Otherwise, you could invest your money today, get a return, and then invest a larger amount tomorrow.  For the purposes of an LCOE, I discount future production – which accomplishes the same goal.
• Incentives: whether we like it or not, government incentives matter.  At the federal level, there is a 30% tax credit (refunds 30% of the system cost).  There are also dozens of state and municipal incentives (the best summary is www.dsireusa.org).

Level 3 – Three more variables will make you sound more credible when talking to people in the industry:

• Degradation: Systems degrade over time – and this includes the PV modules themselves.  Most assume that degradation is between 0.5% and 1% per year.  Note that most modules are warranted to perform up to 90% of their rated power for 10 years, and 80% of their rated power for 25 years – numbers that aren’t far off from 1% annual loss.
• Maintenance: Someone has to clean the modules and repair the broken ones.  This is often modeled as a percent of the initial cost (typically about 0.5%), recurring every year.
• Inverter replacement: Unfortunately, most inverters need to be replaced. While reliability is improving, most people assume that the inverter will have to be replaced at about year 10.

If you want to learn more about each of the assumptions, here is a summary of typical ranges, with further reading where possible:

Finally, keep in mind that the variables above still leave out a ton of complexity.  The system cost depends on hundreds of design decisions; the solar module’s production depends on its tilt angle and temperature (among other things).  But if you’re starting from scratch, this is a good place to start.