Week 1 – Session 9

The issue of the cost

Sidney LAMBERT-LALITTE

MOOC ENERGY TRANSITION

IFP SCHOOL
Introduction
After we saw together how challenging it can be for a grid operator to integrate more and
more variable resources in the existing grid, the second key issue I would like to discuss with
you is the cost.

In this video, I will introduce you to the methodology of calculating the “Levelized cost of
electricity”, what makes the difference from one technology to another, and how these costs
have evolved for renewables in comparison with fossil fueled power plants.

The levelized cost of electricity

When we compare different means of power generation, one useful tool economists
frequently use is what we call the “levelized cost of electricity”, or LCOE.

This LCOE reflects a unit cost for a given technology or a specific power plant: it is generally
expressed in dollars per megawatt-hour of electricity produced. In the numerator of the
formula next to me, “I” reflects the initial investment of the installation (or what we usually call
capital expenditures), “O&M” corresponds to the operation and maintenance spending
throughout the lifetime of the plant (also known as OPEX), while “F” stands for fuel. All of
these costs are divided by the total electricity output of the asset over its lifetime, which is the
term “E” in the formula.

However, because different power plants incur costs at different moments in their operating
lifetime, and produce electricity differently from one technology or one site to the other, the

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LCOE discounts all the costs and megawatt-hours in present value. To put it simply: it
doesn’t only matter how much the power plant will cost, but also when these costs are going
to occur.

LCOE differences explained

So what makes the difference from one installation to another?

Well, for renewable sources, LCOE will vary from one site to another depending on each
site’s resource availability: for instance, a solar plant installed in a location with higher solar
irradiance will generate more electricity compared with the exact same plant set up in a place
where there is less sun. More electricity production, with the same costs, means a lower cost
of production per MWh.

A developer can also accept higher capital costs if they expect a higher electricity
production throughout the lifetime of the power plant. For example, this is the reasoning for
off-shore wind farms. Installing turbines in the sea requires much higher investment and
more complex technologies than an onshore plant: however, the plant will capture a stronger
wind resource and probably produce more electricity over the plant’s lifetime.

Will the LCOE be lower in the end? It depends on each project, because many other factors
have an impact on the costs throughout a plant’s lifetime. If you remember my colleague
Philippe Gilbert’s video, you now understand how technologically complex an offshore wind
plant can be.

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Two other elements have played a key role in reducing the LCOE of renewables in recent
years: economies of scale, and learning effects. Economies of scale are cost reductions
obtained by a technology due to a larger scale of operation. This is quite evident in the case
of solar PV: for instance, from a 10 MW to 100 MW PV power plant installed in the United
States, the CAPEX per unit will be reduced by 20%. This is due the fact that the project will
benefit from bulk purchasing, lower labor-cost per watt installed due to learning
improvements for larger systems and a lower developer cost per unit.

Learning effects, on the other hand, are inherent to any manufactured goods such as wind
turbines or solar panels. These effects are often measured by learning curves, a concept that
is often used to predict how the costs of a product or process may evolve based on historical
trends. Manufacturers, through time, become better at producing a good or offering a
service; this enhanced efficiency results in cost reductions.

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The idea of learning curves stems from empirical evidence, as cost reductions are observed
with each doubling of cumulative production. In the case of crystalline silicon PV modules,
the learning rate since 1975 is around 25%, meaning that each time the cumulative
production doubles, module prices fall by 25%. A PV panel used to cost $95 per watt 40
years ago. Today, a module costs 30 cents in terms of dollar per watt.

This learning effect is a key reason behind public support for renewables. Policy makers
agreed to pay a higher cost for solar PV or wind installations in the early years, because they
knew this would lead to cost reduction in the future.

This bet is about to pay off in several countries, as costs for wind and solar have been
greatly reduced in recent years, and are now competitive with traditional means of power
generation in many cases. Indeed, if you look at the graph next to me, which shows average
LCOE figures for various generation technologies, you can see that solar PV and wind are
becoming more and more competitive with fossil powered means of generation.

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 Conclusion
As we have mentioned, LCOE is different from one project to another. However, there is a
general cost declining trend in both solar and wind installations. When these technologies
reach grid parity, we enter into a whole different economic context for the electricity market.

To sum up what we have just mentioned here: LCOE is a useful tool to compare different
means of power generation. This LCOE is the ratio between the discounted costs and the
discounted electricity production over the full lifetime of the power plant. For each
technology, LCOE varies from one site to another, depending notably on resource availability
and capital costs.

Two elements play an essential role in the recent cost decline for solar and wind: economies
of scale (the bigger the project, the lower the cost per unit) and learning effects (getting
better at producing panels and turbines through time). Currently, wind and solar are
becoming competitive with traditional means of power generation, and this is about to trigger
an electricity revolution…

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