Renewable Energy · Intermediate level · 3 min read ·
What is LCOE (levelized cost of energy)?
LCOE, or levelized cost of energy, is the average cost of producing each kWh over a project's whole life. It adds up what it costs to build (CAPEX) and to run (OPEX) and divides that by all the energy it will produce. It is used to compare that cost with the price the energy sells for.
In 30 seconds
- LCOE says how much each kWh costs to produce, on average, over the project's whole life.
- It includes CAPEX, OPEX and the time value of money.
- If LCOE is below the energy's selling price there is a margin; if above, there isn't.
Why should you care?
A solar project sells energy. To know whether the business makes sense, you need to know what producing it costs.
- You compare the cost of producing with the price it sells for.
- You understand why good design and a good location matter so much.
- You read a solar project's financial models section with judgment.
Think of it as the cost of each arepa
If you set up an arepa stand, each arepa's cost isn't just the dough: the griddle, the stall and the gas count too, spread across every arepa you will sell. LCOE does the same with energy: it spreads all of the project's costs across every kWh it will produce.
How does LCOE work?
- 1
Add up the cost to build
CAPEX: panels, inverters, structure, connection and engineering.
- 2
Add up the cost to run
Each year's OPEX over the useful life, O&M included.
- 3
Estimate lifetime energy
Annual production times the years of useful life, allowing for panel degradation.
- 4
Divide and discount
Costs over energy, both brought to today's value with a discount rate.
The formula
LCOE = Σ discounted costs ÷ Σ discounted energy
- Σ costs
- = CAPEX plus each year's OPEX, at present value
- Σ energy
- = kWh produced each year, at present value
An example with numbers
As simplified arithmetic, without discounting and unrelated to any project: a system with a 25-year useful life.
| CAPEX | 550 million pesos |
|---|---|
| OPEX over 25 years | 200 million pesos |
| Total cost | 750 million pesos |
| Energy over 25 years | 3,750,000 kWh |
| Simplified LCOE | 200 pesos per kWh |
If that energy sells above 200 pesos per kWh, there is a margin. The full LCOE is calculated with discounting, so it usually lands above this simplified version.
Where do you see it at Circular Urban?
On solar project sheets, the Financial Models section shows the project's nominal LCOE, and Risks & Mitigants compares it with the market tariff. It is an estimate built on the project's assumptions.
- Each solar project sheet, in Financial Models: LCOE (nominal).
- Each solar project sheet, in Risks & Mitigants.
What changes in your finances once you get it
You compare cost and price
You know an energy project's margin comes from the gap between its LCOE and the selling price.
You see why design matters
More production for the same cost lowers LCOE: location and equipment count.
You run the numbers at home
With your panels' cost and estimated output, you compare your own kWh with your bill's.
Common mistakes
- Myth
LCOE is the price energy sells for.
- In reality
It is the cost of producing it. The selling price is another figure, and the margin is the gap between them.
- Myth
LCOE only counts the cost of the panels.
- In reality
It includes everything it costs to build and run the system over its useful life, divided by all its production.
- Myth
With a low LCOE, the project's outcome is settled.
- In reality
It is an estimate built on assumptions. The outcome depends on actual production, prices and operation.
Test yourself
A system costs 420 million pesos over its life and produces 2,000,000 kWh. What is its simplified LCOE?
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This content is educational. Every participation carries risks inherent to the project, including the possibility of partial or total loss, and results are subject to each project's actual performance.
