LCOE stands for Levelized Cost of Electricity
, although sometimes it is referred to as Levelized Cost of Energy, and is a robust measure for estimating the cost of the electricity that is produced over the life of a generating plant. It allows for the comparison of different technologies (e.g., wind, solar, natural gas) of unequal life spans, project size, different capital cost, fuel costs, operation and maintenance (O&M) cost, risk, return, and capacities. LCOE is defined as the sum of all expenditures over the life of the asset discounted to present value divided by the sum of electrical generation over the life of the asset discounted to present. Figure 1 shows a simple version of the calculation accounting for capital investment, O&M costs and fuel costs. LCOE can (and should) include all applicable incentives and credits.
LACE stands for Levelized Avoided Cost of Electricity, and is a measure of what it would cost the grid to generate the electricity that is otherwise displaced by a new generation project, i.e., it is a measure of the market value of that electricity. LACE is defined as the sum of the annual economic value generated over the life of the asset (including both generation and capacity payments) discounted to present value divided by the sum of electrical generation over the life of the asset discounted to present. Estimating avoided costs is more complex than estimating levelized costs because it requires information about how the local or regional electrical system would have operated without the asset under evaluation.
When the LACE of a proposed asset exceeds its LCOE at a given time and place, that asset would generally be economically attractive to build. And, although investment decisions in the real world are more complex than a simple LCOE to LACE comparison, at a high level the difference between LACE and LCOE provides a reasonable measure of economic viability.
An interesting study from the NREL: An Assessment of the Economic Potential of Offshore Wind in the United States from 2015 to 2030
demonstrates how LCOE and LACE can be used. They evaluated the variation in economic potential of offshore wind facilities across more than 7,000 US coastal locations by computing LCOE and LACE and extrapolating results into the future. Figure 2 shows the results for the Atlantic coast at three snapshots in time - 2015, 2022, and 2027. Based on this evaluation offshore wind only becomes profitable in 2027 for certain stretches of the coast from Virginia northward.
Although LCOE is a powerful tool for evaluating projects and making business decisions, as used today, it does not include a number of critical items. The costs associated with intermittency of generation (for renewable resources) and environmental damage, health care, climate change, water usage, etc., (which arise through electricity generation using fossil fuels) are also real costs paid by society outside the narrow definition of power cost, either directly or through taxes and insurance. At this point in time, renewables are approaching parity with traditional fossil fuel power generation in the absence of many of these considerations. (See OWOE: What is the cheapest method for generating electricity today in the US?