The Levelised Cost of Electricity (LCOE) is defined as the lifetime costs of energy generating technologies divided by the amount of energy produced. The LCOE calculation considers all plant-level costs, such as initial investments, operation costs and fuel costs during the power plant’s lifetime.   Costs that incur at different points in time are discounted to a common basis, by considering the time value of money.  Hence the name “levelised”. Due to its transparent and easy-to-understand analysis method, LCOE has been the basis of comparison of different technologies (e.g. coal, natural gas, solar, wind and hydropower) with unequal life spans, project size, capital cost, risk and return.

For variable renewable energy (vRE) technologies such as solar and wind, it has been implicitly assumed that once their LCOEs are lower than conventional plants, their deployment should be competitive and economically efficient. A study by the International Renewable Energy Agency (IRENA), shown in Figure 1, shows that the global LCOE for solar PV has seen a significant drop of nearly 70% over the past seven (7) years, from USD 0.36/kWh in 2010 to USD 0.10/kWh in 2017. Although not as significant, offshore and onshore wind LCOEs have also decreased in 2017 to USD 0.14/kWh and USD 0.06/kWh, respectively. For both solar and wind, the study shows that their current LCOEs are well within the range of fossil fuel costs, which implies economic efficiency and competitiveness of both technologies.

However, despite the high hopes that LCOE metric brings to proponents of vRE, major drawbacks of using LCOE as a basis for comparison have been identified: it only measures generation costs within the perimeter of an individual plant and it does not consider the overall transformation cost to integrate vRE into the over-arching electricity system. The fact is, electricity-generating power plants do not exist in isolation as they interact with each other through the grid, which manages the supply and demand of electricity. As the demand of electricity fluctuates, the value of vRE depends on the time when their output is produced. Due to the focus on individual plants, the LCOE metric overlooks the temporal fluctuation of electricity and the natural intermittency of vRE. As the integration of vRE is not simply about adding vRE to the business-as-usual scenario, other metrics are needed to consider the system transformation as a whole when vRE is deployed.

Incorporating the values of different generating technologies into the overall electricity system can be done by considering the integration costs and the system costs. Integration costs are defined as the additional cost of accommodating wind and solar into the power system by comprising variability and uncertainty costs as liabilities of power producers and consumers, whereas system costs refer to the total costs to generate electricity at a given level of load and availability of supply. The linkages between plant-level costs or LCOE, integration costs and total system costs are illustrated in Figure 2.

Integration costs are classified into three main components; grid impacts, balancing impacts and adequacy impacts. Grid related costs capture the additional investment for vRE integration to the grid, such as to connect distant power plants, reinforce the transmission grid, or build additional interconnections with adjacent systems. Balancing costs are incurred due to the increased short-term variability and uncertainty of net load from vRE, resulting in additional operational costs to contain and use more reserves against forecast errors as well as increased ramping and cycling of power plants. Whereas adequacy costs arise from the fact that only partial output from vRE is available at times of peak demand.  Therefore, other plants are needed in the system to compensate for this variability and to ensure enough generating capacity to meet demands.

On the other hand, system costs explore the dynamic effects of vRE which in the long run significantly affects the operations and structure of electricity markets. Among other factors, system costs consider the volatility of electricity prices in wholesale markets due to the inflow of vRE with low marginal costs, and the load factor reduction of dispatchable power generators (such as natural gas), since intermittent vRE generators have power over dispatchable supply. Total system costs are also inclusive of those effects that are difficult to monetise such as environmental externalities, impacts on a country’s energy security and other effects related to technological innovation, economic development or competitiveness.

In conclusion, although LCOE could provide a basic comparison between various generating technologies due to its inherent simplicity, attention must be given to the increasingly important areas of integration costs and system costs.  This is necessary to ensure appropriate deployment of vRE and to avoid future challenges in the security of electricity supply.

References

Lecture by Christoph Menke and Jirapa Kamsamrong, the Joint Graduate School of Energy and Environment (JGSEE), King Mongkut University of Technology Thonburi (KMUTT) Thailand.

U.S. Department of Energy. 2015. “Levelised Cost of Electricity”. . Available: https://www.energy.gov/sites/prod/files/2015/08/f25/LCOE.pdf.

Ueckerdt, F., Hirth, L., Luderer, G., Edenhofer, O. 2013. “System LCOE: What Are the Costs of Renewables?”. Energy 63, 61-75.

International Renewable Energy Agency. 2017. “Renewable Power Generation Costs in 2017”. . Available: https://www.irena.org/-/media/Files/IRENA/Agency/Publication/2018/Jan/IRENA_2017_Power_Costs_2018.pdf.

OECD Nuclear Energy Agency. 2012. “Nuclear Energy and Renewables: System Effects in Low-carbon Electricity Systems”. . Available: http://www.oecd-nea.org/ndd/reports/2012/system-effects-exec-sum.pdf.

International Energy Agency. 2014. “The Power of Transformation: Wind, Sun and the Economics of Flexible Power Systems”. Available: https://www.iea.org/publications/freepublications/publication/The_power_of_Transformation.pdf.

Katzenstein, W., Apt, J. 2012. “The cost of wind power variability”. Energy Policy 51, 233-243.

Milligan, M., et al. 2011. “Integration of Variable Generation, Cost-Causation, and Integration Cost”. Electricity 24 (9).

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