LEVELIZED COST OF ELECTRICITY: KEY DRIVERS AND VALUATION METHODS

Abstract

The aim of this paper is to propose an improvement over traditional approaches to the levelized cost of electricity (LCOE). Basically there are two methods available. The first one considers a yearly timeframe, so it yields a yearly estimate of the LCOE. The second one, instead, keeps the whole lifetime of the facility when computing its LCOE; it thus results in a life-cycle estimate. This said, they share some features, for example, their reliance on the net-present-value methodology and the scant use of market prices. Unfortunately, they also stumble on some common issues, such as the proper way to account for risk. The focus here falls on two power generating technologies from renewable sources, namely wind and solar. Section 1 gives a quick overview of their widespread deployment across the world. Section 2 provides a thorough review of the two approaches to the LCOE at a theoretical level. It also includes some remarks about their underlying assumptions and pinpoints some of their limitations. Section 3 shows numerical estimates of LCOE for different technologies and countries following the two approaches. It also looks at recent trends of LCOE estimates over time. Then Section 4 presents a proposal for an improved LCOE, one that uses public information available on the markets and deals with the discounting of risk more properly. There is also a numerical application to a standard wind park. Section 5 concludes. Key Words: Electricity generation, renewable energies, solar farms, wind farms, investment valuation, futures markets