Levelized Cost of Energy

The levelized cost of energy (LCOE) is similar to the LCC method, in that it considers all the costs associated with an investment alternative and takes into account the time value of money for the analysis period. However, it is generally used to compare two alternative energy supply technologies or systems,

2These methods are treated in detail in Ruegg and Marshall Building Economics: Theory and Practice, Chapman and Hall, New York, NY, 1990.

e.g., two electricity production technologies. It differs from the LCC in that it usually considers taxes, but like LCC, it frequently ignores financing costs.

The LCOE is the value that must be received for each unit of energy produced to ensure that all costs and a reasonable profit are made. Profit is ensured by discounting future revenues at a discount rate that equals the rate of return that might be gained on other investments of comparable risk, i.e., the opportunity cost of capital. In equation form, this is represented as:

where N is the analysis period, Qt is the amount of energy production in period t, Ct is the cost incurred in period t, d' is the discount rate or opportunity cost of capital. If d' is a real discount rate (excludes inflation) then the LCOE will be in real (constant) dollar terms, whereas the LCOE will be in nominal (current) dollar terms if d' is a nominal discount rate. The discount rate, d, is used to bring future costs back to their present value. If those costs are expressed in real dollars, then the discount rate should be a real discount rate; if they are in nominal dollars, the discount rate should be a nominal discount rate.

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