The levelized cost of energy (LCOE) is one of the most widely used metrics in energy economics. Governments, investors, and analysts frequently rely on it to compare the cost of electricity generation technologies such as wind, solar, natural gas, or coal. The appeal of LCOE lies in its simplicity. It reduces the complex economics of building and operating a power plant into a single number that represents the average cost of producing one unit of electricity over the facility’s lifetime. However, while LCOE is a helpful starting point for comparing technologies, relying on it alone can lead to misleading conclusions about the real cost and value of electricity generation.
Understanding both the usefulness and the limitations of this metric is therefore essential for evaluating energy investments and policy decisions.
What the Levelized Cost of Energy Measures
In its simplest form, LCOE represents the total lifetime cost of building and operating an electricity generating asset divided by the total electricity it produces over its lifetime. These costs include the initial capital investment, operating and maintenance expenses, fuel costs where applicable, and financing conditions such as discount rates. The calculation effectively spreads all costs over the expected energy output of the project, producing an average cost per unit of electricity (Lotfi et al., 2016).
Mathematically, the metric is derived from the net present value of all project costs divided by the total discounted energy generation across the project lifetime. This framework allows technologies with very different cost structures to be compared using a common unit, typically expressed as cost per megawatt hour (Pawel, 2014).
Because it incorporates both investment and operating costs, LCOE is often interpreted as the minimum electricity price a project must receive in order to break even financially. If the expected market price of electricity exceeds the calculated LCOE, the project is generally considered economically viable.
This simplicity explains why LCOE has become a standard benchmark in energy policy discussions.
Why LCOE Became So Widely Used
The popularity of LCOE comes from its ability to standardize comparisons between technologies that operate very differently. Electricity generation technologies vary widely in capital intensity, operating costs, fuel requirements, and lifetimes. For example, solar and wind projects have high upfront investment costs but almost no fuel expenses, while fossil fuel plants require ongoing fuel purchases but often have lower initial capital costs.
By converting all these cost components into a single cost per unit of electricity, LCOE allows analysts to compare technologies that would otherwise be difficult to evaluate side by side (Pawel, 2014).
Another advantage is that LCOE can be compared directly with electricity prices in the market. When the levelized cost of a technology falls below the retail electricity price, the technology is said to reach grid parity, meaning it becomes economically competitive with conventional electricity supply (Lotfi et al., 2016).
For these reasons, LCOE has become a common tool used by governments, energy agencies, and investors to evaluate generation technologies.
However, despite its usefulness, the metric has several important limitations.
Electricity Does Not Have the Same Value at All Times
One of the main weaknesses of LCOE is that it treats every unit of electricity as equally valuable regardless of when it is produced.
In reality, electricity prices fluctuate throughout the day and across seasons. Power generated during periods of high demand, such as summer afternoons when air conditioning use peaks, can be far more valuable than electricity produced during low-demand hours.
LCOE does not account for this difference in timing. Two technologies may have identical levelized costs but deliver electricity at completely different times. This matters because electricity generated during peak demand periods contributes more to system reliability and market value than electricity produced when demand is low.
Solar energy illustrates this issue clearly. Photovoltaic systems generate electricity primarily during daylight hours. When solar capacity becomes widespread, midday electricity supply can exceed demand, reducing market prices. Meanwhile, evening hours may still experience supply shortages. LCOE cannot capture this mismatch between production and demand.
As a result, technologies with low LCOE values may still provide electricity that has lower economic value in the market.
System Integration Costs Are Not Included
Another important limitation is that LCOE measures the cost of generating electricity at the plant level but does not account for broader system costs.
Electricity systems must continuously balance supply and demand. Some technologies contribute to this balance more easily than others. Dispatchable generators, such as gas or hydroelectric plants, can adjust their output when needed, helping maintain grid stability. Intermittent renewable sources such as wind and solar depend on weather conditions and cannot always produce electricity when demand is highest.
When the share of variable renewable energy increases, power systems often require additional investments in storage, backup generation, or transmission infrastructure to maintain reliability. These costs are typically not included in LCOE calculations.
Therefore, while renewable technology might appear cheaper based on its levelized cost, the broader system may incur additional expenses to integrate it effectively.
Ignoring these system-level costs can lead to incomplete comparisons between energy technologies.
Utilization and Operational Assumptions Matter
LCOE calculations are also highly sensitive to assumptions about how frequently technology operates.
Power plants that operate more frequently can spread their fixed investment costs over a larger amount of electricity generation, lowering their levelized cost. Conversely, technologies that operate intermittently or only during peak periods may have higher LCOE values even if their capital costs are moderate.
Energy storage systems demonstrate this challenge particularly well. Unlike conventional generators, storage does not produce electricity but instead stores energy and releases it later. Calculating its levelized cost requires considering the cost of charging electricity, system efficiency, and operational cycles.
Research shows that factors such as charging duration, electricity price, and round-trip efficiency significantly influence the resulting LCOE of storage technologies (Lotfi et al., 2016). Additionally, underutilized storage capacity inevitably increases the cost per unit of delivered energy because fixed investment costs are distributed across fewer operating cycles (Pawel, 2014).
These operational dependencies highlight that LCOE values are strongly influenced by usage patterns.
LCOE Does Not Capture Revenue Streams
Another conceptual limitation of LCOE is that it measures costs but does not account for potential revenue streams.
In electricity markets, generators may receive payments not only for producing energy but also for providing additional services such as capacity availability, frequency regulation, or grid balancing. These services can generate significant revenue, particularly for flexible technologies such as storage systems or fast responding power plants.
Because LCOE ignores these additional revenue sources, it cannot fully represent the economic value of a technology within a functioning electricity market.
For this reason, project evaluations often complement LCOE with financial metrics such as net present value or internal rate of return to better assess overall project viability (Pawel, 2014).
Results Depend on Assumptions
A further complication is that LCOE estimates depend heavily on underlying assumptions. Discount rates, fuel prices, technology lifetimes, and capacity factors all influence the final result.
Small changes in these parameters can significantly alter the calculated levelized cost. For example, a higher discount rate increases the weight of upfront capital costs, making capital-intensive technologies appear more expensive. Similarly, different assumptions about operating lifetimes can change the amount of electricity used to distribute fixed costs.
Because different studies often use different assumptions, LCOE values from separate reports may not always be directly comparable.
Understanding the assumptions behind any LCOE estimate is therefore critical before interpreting its results.
A Useful Metric, But Not the Whole Story
Despite its shortcomings, LCOE remains a valuable analytical tool. It provides a standardized way to compare the cost structure of different electricity generation technologies and offers a useful first approximation of project economics.
However, electricity systems are complex networks in which reliability, timing, and flexibility all influence economic value. Evaluating technologies solely on the basis of LCOE can therefore produce incomplete or misleading conclusions.
A more comprehensive analysis often requires additional metrics that account for system integration costs, operational flexibility, and market value.
In short, LCOE is best understood as a starting point rather than a final verdict on the economics of electricity generation.
References
Lotfi, H., Majzoobi, A., Khodaei, A., Bahramirad, S., & Paaso, E. A. (2016). Levelized cost of energy calculation for energy storage systems. Grid of the Future Symposium.
Pawel, I. (2014). The cost of storage: How to calculate the levelized cost of stored energy (LCOE) and applications to renewable energy generation. Energy Procedia, 46, 68–77.
