The Hidden Costs of Power: Why LCOE Isn’t the Whole Story
As demand for power outpaces new supply, concerns about the rising cost of electricity are growing. While the majority of your monthly electric bill comes from factors like utility investments in transmission and distribution as well as federal and state policies, roughly 45 percent still comes from the generation of electricity.
That makes it critical that policymakers, grid operators, and industry players have an accurate understanding of how much different energy sources ultimately cost consumers.
One traditional metric that is commonly used to compare the price of generation resources is the Levelized Cost of Electricity (LCOE). But it’s not a complete picture.
A growing chorus of experts is cautioning that using LCOE alone severely understates many broader system costs of intermittent resources like wind and solar, making these resources seem artificially cheap.
That has not stopped policymakers from touting LCOE numbers to call for more intermittent energy resources and the retirement of dispatchable ones. But for any policymaker who is serious about keeping energy costs in check for their constituents, a more accurate system-wide picture is essential.
Understanding of how an individual resource drives overall system costs is complex, but newer metrics—including ones developed by FTI Consulting and EPSA—can help demystify these costs and show what a resource will really mean for the grid.
What is LCOE?
The levelized cost of electricity is used to determine the cost, per megawatt, of generating electricity from different resources. LCOE is a prominent metric and provides a valuable data point when assessing a single project’s costs. However, it’s essential that policymakers understand the limitations of LCOE as a metric.
Challenges when using LCOE
While LCOE can accurately offer a picture of how much it theoretically costs to generate a single megawatt (MW) of electricity, this doesn’t capture the real-world implications. One megawatt of an intermittent resource that is available when the sun shines or wind blows is simply not a one-to-one equivalent to a dispatchable resource that is available whenever needed. In order to equalize the two, grids need additional infrastructure, spare capacity, and more to ensure the power stays on. That comes with costs, which consumers ultimately have to pay.
Resources do not exist in isolation. But LCOE omits the costs of integrating resources and ensuring reliable service, even as resource adequacy remains a major concern across the country. A recent report from Jefferies on the growing challenges facing the LCOE metric found that “the core weakness of renewables is not the cost, but intermittency.” Customers expect around-the-clock access to power, something that intermittent resources are not able to provide without dispatchable generation sources providing a backstop.
This has profound implications. LCOE has long been the primary metric used to make the case for the cost competitiveness of intermittent resources. For instance, 2022 LCOE estimates from the U.S. Energy Information Administration found that the cost of a combined cycle gas plant was $37.05/MWh, while onshore wind was $37.80/MWh and solar was $36.09/MWh. But empirical evidence shows that these estimates reflect very little about real grid conditions.
While LCOE is useful in specific instances, there are better tools available that provide a more complete and accurate picture when assessing the costs of various resources. As a Clean Air Task Force report recently put it, “Solely using LCOE is not appropriate for long-term planning.”
Moving towards a full-cycle analysis
Unlike a traditional LCOE, a “full cycle” analysis of generation costs takes into account the need for backup generation sources, new transmission, curtailment, and resource adequacy measures that ensure reliable generation.
Variants of this method include the International Energy Agency’s “Value-Adjusted LCOE” and EPSA’s own Full-Cycle LCOE. EPSA and FTI Consulting developed a holistic analysis of generation resources in PJM, which also took into account the impact of subsidies, dual-fuel plants, intermittent generation, and other issues in PJM that are necessary to evaluate the true impact of various resources. To do this, the study considered factors like the effective load carrying capability (ELCC), a measure of how reliable each resource is.
The study found that the cost of providing resource adequacy services is more than 100% of the traditional LCOE cost of wind and solar units.
The study also found that while traditional LCOE is lower for wind and solar units compared to combined cycle (CC) natural gas units in PJM, analyzing the full system costs makes gas much more competitive.
When accounting for the full cost of connecting a resource to the system and providing resource adequacy services, natural gas plants consistently outcompete many other resources—a major reason why they are playing a key role in powering new sources of demand like data centers. Other dispatchable resources like hydro, nuclear, and battery storage also perform well by full-cycle metrics.
Bottom line
LCOE as a metric has significant limitations that can hide the true cost of generation. Reliability and resource adequacy remain essential, and policymakers should make decisions with complete information.
