Levelized Cost of Energy
Definition
The levelized cost of energy (LCOE) is the present value of a plant's lifetime costs divided by the present value of its lifetime output, giving an average cost per megawatt-hour. EIA describes it as 'the estimated costs required to build and operate a generator' over 'a specified cost recovery period.' It reflects capital cost, operating cost, financing, output and tax credits, but not what the power is worth where and when it is produced.
Why it matters
LCOE is widely quoted to show a technology is cheap, but an investor is paid revenue, not avoided cost. A low-LCOE project in a market where its output is worth little can lose money, while a higher-cost project with a strong contract can earn well. Investors should compare cost with realized or contracted price, and check the assumptions (output, financing rate, life, tax credits) behind any LCOE quoted.
Common misconceptions
- •LCOE is not a price; it says nothing about what the output sells for.
- •LCOE comparisons across technologies ignore when and where power is delivered.
- •An LCOE with tax credits differs from one without; check which is quoted.
- •A lower financing rate lowers LCOE without changing the project's physical cost.
Technical details
Formula
LCOE = present value of lifetime costs / present value of lifetime output (MWh).
Costs: capital, fixed and variable O&M, fuel, transmission, financing; minus tax credits where included.
Output: capacity x capacity factor x hours, after degradation.
Inputs to check
Capacity factor and degradation assumed.
Discount rate or weighted average cost of capital.
Asset life and residual value.
Whether tax credits are included.
How investors apply the term
Investors usually apply this term by tying the definition back to the controlling documents and then asking which cash flows, rights, restrictions, or valuation assumptions it changes. A useful review looks at the term alongside fees, leverage, liquidity, reporting frequency, and manager discretion rather than treating it as a standalone concept.
The practical diligence test is simple: identify who benefits if the assumption is wrong, who has control when conditions change, and what evidence the investor receives after closing. Terms that cannot be reconciled to documents, cash movements, and monitoring data should be treated as marketing shorthand until proven otherwise.
Frequently asked questions
- Does a low LCOE mean an energy project is profitable?
- No. LCOE measures cost; profit depends on revenue. EIA states that 'LCOE is limited because it only reflects the cost to build and operate a plant, not the value of the plant to the grid,' and pairs it with the levelized avoided cost of electricity (LACE), 'an estimate of the revenue available to that generator.' Projects with LACE greater than LCOE are 'more economically attractive to build.'
- What did solar cost and earn in 2024?
- Berkeley Lab found generation-weighted utility-scale solar LCOE rose 25% since 2022 to $60 per MWh without tax credits, or $41 with them, while solar's market value fell to $32 per MWh. National average net value for projects that began operating in 2023 was minus $7 per MWh after tax credits, ranging from minus $34 in NYISO to $17 in SPP.
- Does solar cost less than gas?
- On EIA's estimates for plants entering service in 2030, 'Solar PV LCOE is lower than natural gas combined-cycle LCOE on average and, in most regions, even without the tax credit.' That comparison is on cost alone; the two produce power of different value.