What is “Levelised Cost of Energy (LCOE)” and why is it important?

With the financial ramifications of the COVID-19 pandemic continuing to be felt, businesses are increasingly looking for ways to reduce costs without sacrificing operational efficiency and effectiveness. Of these businesses, Small and Medium Enterprises (SMEs) have been particularly affected, with the Australian Bureau of Statistics’ (ABS) ‘Business Impacts of COVID-19 Survey’ finding Small Enterprise was “almost twice as likely to report that they expected to find it difficult or very difficult” (Australian Bureau of Statistics, 2020), to meet their financial commitments when compared to large enterprise (35% compared to 18%). One of these financial commitments is electricity and this is where measuring the cost of energy consumption using the Levelised Cost of Energy (LCOE) comes into play.

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A simple definition of LCOE

Most often associated with electricity, the Levelised Cost of Energy (LCOE) is a basic evaluative tool that helps efficiently determine the relative competitiveness of any given energy generation technology. Whilst a modeling of electricity generation or a more detailed project cash flow analysis is more suitable in evaluating the operational costs and performance of an electricity generation project, LCOE allows users to make simple comparisons between two potential projects over a period of time, expressed as a single ‘cost per kilowatt-hour (kWh)’ figure. Thus, in the context of solar energy, LCOE enables a consumer to universally determine whether paying for solar energy now will be a cheaper option when compared to continuing on with their existing electricity arrangement.


Breaking down LCOE

The Levelised Cost of Energy (also known as Levelised Energy Cost or LEC) model prices an energy-generating system based on all its lifetime costs which include initial investment, cost of capital, cost of fuel and operations and maintenance (O&M) costs. With these inputs, the LCOE model provides a ‘cost per kilowatt-hour (kWh)’ figure that determines the minimum price at which energy must be sold in order for any given project to break even. Generally, LCOEs are calculated to reflect a period of 20 or 40 year lifespans, given as a measure of currency per kilowatt-hour (e.g. AUD/kWh).


It should also be noted that should LCOE figures be compared, it is paramount that energy system bounds and included costs are clearly defined so that an accurate comparison can be made. Such considerations may include the decision to include or exclude variables such as research and development (R&D), tax and external impact implications such as environmental or public health issues originating from the system parameters.


Seen below in Figure 1.1 are the LCOE figures by technology and category for 2020, undertaken by CSIRO in their GenCost 2019-20 report. As shown, the price of energy derived from coal per MWh (1 megawatt equals 1,000 kilowatts) ranges from approximately AUD $80 per MWh to AUD $235 per MWh, depending on the type of coal, carbon pricing, carbon credit schemes and risk premiums. Similarly, the price of energy derived from Gas ranges from approximately AUD $65 per MWh to AUD $200 per MWh, depending again on the aforementioned variables. Finally the price of energy derived from Solar Photovoltaic means range from approximately AUD $35 per MWh to AUD $160 per MWh, depending on the storage technology used. As such, this figure gives us consumers a basic understanding of the overall pricing of various energy generation technologies at present.

Figure 1.1 Calculated LCOE by technology and category for 2020. Source: Australian Bureau of Statistics. (2020)


Criticisms of LCOE

Despite its advantages in providing a simple yet comprehensive figure that allows for the comparison of various energy generation systems, the LCOE model does have a few drawbacks.


The first of these is that LCOE doesn't account for the additional balancing costs related to variable renewable electricity generation technologies. Although there is no set definition of balancing costs, the CSIRO defines these as expenditures associated with meeting system demand stemming from “a combination of technologies with a given amount of reliability” and “other system services that support stability” (Foster et al., 2019). As such, consumers must be aware that the LCOE model provides an incomplete financial picture without these associated outlays. To mitigate this, one can group peak, variable and flexible technologies together in order to provide a more suitable comparison.


Further to this, LCOE applies the same discount rate across all technologies despite fossil fuel technology being most at risk of being impacted by the introduction of new climate change policies. To counter this, data can be sourced on fossil fuel technologies and its additional risk premiums along with any carbon prices these fossil fuel technologies may incorporate.


Finally, LCOE fails to recognise the varying roles and characteristics of different electricity generation technologies in the electricity generation system. Different electricity generation technologies may have different operating frequencies, thus resulting in varying costs. Despite these differences, LCOE values each technology on their capability to quickly provide capacity at peak times. That being said, these technologies can be presented alongside additional storage costs to alleviate such issues.


A semi-hypothetical example of LCOE


In order to better understand how LCOE works, let's look at a semi-hypothetical example:


Using Victoria as a sample, Canstar Blue’s 2020 electricity customer satisfaction survey found that the average annual electricity bill for the average Victorian household was $1,490 (Downes, 2021). At the time of writing, Consumer Price Inflation (CPI) sits at 0.7% (Reserve Bank of Australia, 2020) (due to the economic effects of the COVID-19 pandemic), but let's assume a more historically average annual CPI of 2%. This would mean that over a twenty year period, you would pay approximately $36,203 for twenty years of electricity. Now let's say that a solar energy company offers you a twenty year solar PPA (Power Purchase Agreement) - an agreement that involves a business providing, installing and maintaining a solar panel system for a client at no initial cost. The client would then buy the generated electricity at an agreed price for an agreed period. The cost of this hypothetical agreement is $30,000. This figure includes all initial investment fees, the cost of capital and operations and maintenance (O&M) costs. By agreeing to this solar PPA agreement, a savings of approximately $6,203 could be realised along with a environmentally sustainable and responsible source of electricity.


How LCOE can help you

In the case of electricity generation, LCOE can help you to determine whether an energy generation technology like a solar energy system will help you generate electricity at a cheaper rate when compared to other energy generation technologies; taking into account all variables that may be involved in creating and delivering said energy to you, the consumer.


Given that there are essentially two main methods to access the supply of electricity as a regular consumer in Australia, using LCOE to distinguish between these methods can be a useful tool in ensuring you have the best energy for you and your circumstances. Let’s have a look at these methods.


The first of these methods is accessing electricity through an electricity retailer, where you receive little to no choice as to the source of that generated electricity. In the event that you are able to choose renewable energy as the source of electricity generated, this usually comes at a premium. The second method is to access electricity first-hand from a solar energy system installed on your roof via a Solar PPA. This gives you direct access to a renewable source of energy, avoids the usually associated premiums and allows you to pay no upfront costs all under a lower electricity bill. What more, as solar energy technology improves and becomes more efficient, the price of solar energy will decrease - allowing for even greater savings. As such, should LCOE indicate that you would be better off with a solar energy system, it might be worth some further investigation!


So if you would like to know more or are interested in utilising the benefits of solar energy under a solar PPA, contact Energy Terrain today to see how we can help you on your way to a cheaper, cleaner, more sustainable energy future.


References

Australian Bureau of Statistics. (2020, August 27). A third of businesses will face challenges paying bills. Available at: <https://www.abs.gov.au/media-centre/media-releases/third-businesses-will-face-challenges-paying-bills#:%7E:text=The%20Business%20Impacts%20of%20COVID,35%25%20compared%20to%2018%25)> [Accessed 17 February, 2021]


Foster, J., Graham, P., Havas, L. & Hayward J. (2019). GenCost 2019-20: preliminary results for stakeholder review. CSIRO, Australia. Available at: <https://aemo.com.au/-/media/files/electricity/nem/planning_and_forecasting/inputs-assumptions-methodologies/2019/csiro-gencost2019-20_draftforreview.pdf?la=en> [Accessed 17 February, 2021]


Downes, S. (2021, March 2). What is the average electricity bill? Canstar Blue. Available at: <https://www.canstarblue.com.au/electricity/average-electricity-bills/> [Accessed 17 February, 2021]


Reserve Bank of Australia. (2020, July 29). Measures of Consumer Price Inflation. Available at: <https://www.rba.gov.au/inflation/measures-cpi.html> [Accessed 17 February, 2021]

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