Levelized cost of electricity: key drivers and valuation methods

Abstract

The aim of this paper is to propose an improvement over traditional

approaches to the levelized cost of electricity (LCOE). Basically

there are two methods available. The first one considers a yearly

timeframe, so it yields a yearly estimate of the LCOE. The second

one, instead, keeps the whole lifetime of the facility when

computing its LCOE; it thus results in a life-cycle estimate. This

said, they share some features, for example, their reliance on the

net-present-value methodology and the scant use of market prices.

Unfortunately, they also stumble on some common issues, such as

the proper way to account for risk.

The focus here falls on two power generating technologies from

renewable sources, namely wind and solar. Section 1 gives a

quick overview of their widespread deployment across the world.

Section 2 provides a thorough review of the two approaches to

the LCOE at a theoretical level. It also includes some remarks

about their underlying assumptions and pinpoints some of their

limitations. Section 3 shows numerical estimates of LCOE for

different technologies and countries following the two approaches.

It also looks at recent trends of LCOE estimates over time. Then

Section 4 presents a proposal for an improved LCOE, one that

uses public information available on the markets and deals with

the discounting of risk more properly. There is also a numerical

application to a standard wind park. Section 5 concludes.