There are multiple ways of generating electricity. You can generate from any of a number of sources including oil, gas, coal, hydro power, nuclear, sun, wind, sea, geo-thermal etc. Each of these methods will cost differently because their inputs and infrastructures cost differently. Even using the same technique there are factors which can affect the cost of production. For example, the size of the project, location, availability and cost of expert labor, government regulations and incentives, etc., all influence the cost of production.Under any given set of conditions which method and which options will give the best net return per dollar? A popular parameter used by decision makers for making this decision is the levelized cost of electricity (LCOE) it is expected to generate. LCOE is normally calculated per kilowatt-hour or per megawatt-hour.
Levelized cost of electricity production in a given project takes into account:
- All costs
- Over the entire lifetime of the project.
- Converted to the present dollar value
Thus, it becomes an assessment of the average total cost to build and operate a power-generating set-up over its entire lifetime divided by the total amount energy produced by it over the lifetime. The LCOE is also regarded as the minimum average cost at which electricity must be sold out in order to achieve a break-even over the lifetime of the project.
What categories of costs have to be factored into calculation of the LCOE? All significant costs must be included. These include:
- Initial Investment-Includes the investment which goes into all actions leading to initial commissioning of the project. This can vary greatly depending on type and size of the project. Initial invest will be relatively low for fossil-based power, higher for wind and photovoltaic, and very high for nuclear, hydro-power, solar thermal, waste-to-energy conversion, and tidal.
- Fuel costs – These are virtually zero for renewables, low for nuclear, and high for fossil fuel. Further costs of fossil fuel can vary widely and unexpectedly over the life-cycle due to geo-political conditions. The first and second oil shocks are compelling examples of this variability.
- Operation and Maintenance Costs-Includes all expenses on staff including salaries and perks, cost on premises, wastage, taxes and incentives, insurance.
Comparing LCOEs from different studies needs great caution as the LCOE calculation depends heavily on the assumptions on the terms of financing, capacity factor, and the technology to be used. LCOE calculation does not generally take into account many factors like:
- The uncertainties in matching production with the varying demand, on a short-term basis and in the long run.
- Currently, a huge percentage of the fuel is imported from the middle east which is a very volatile region. LCOEs can not account for changing international conditions and supply route availability.
- Similarly, LCOEs cannot predict government taxes and incentives.
- Technological development is another factor. Unexpected breakthroughs in technology can benefit a project or even kill it with competition from alternate processes.
- Wider system costs allied with each type of project, e.g., long distance transmission or balancing and reserve costs.
- Externals like ecological and health risks which can cause significant liabilities.
The US Energy Information Administration recommends the use of Levelized Avoided Cost of Energy (LACE) rather than LCOE when dealing with costs of non-dispatchable sources like wind and solar. This is the cost of the energy from other sources that would be used in the absence of this project.