The Levelized Cost Of Electricity (LCOE) is a common indicator used to compare the average cost per kWh of different generation technologies, and therefore their competitiveness. Whilst it is a simple and straightforward indicator, it ignores three relevant factors for a comprehensive competitiveness assessment:
- External costs
The LCOE is represented by the grey bars in figure 1, showing that hydro, geothermal and coal are the three cheapest electricity sources (with data of existing installations for Europe in 2013). The LCOE, however, does not capture the external costs of each generation technology, which we can divide into externalities derived from CO2 emissions and Climate Change (CC), and non-CC-related externalities, such as human toxicity, particulate matter formation, etc., represented by the green and red bars in figure 1 respectively. Since the present cost of climate change is uncertain, two cases are considered: a social cost of carbon (SCC) of 50 and 150€2015/tCO2 (the latter considered as a lower bound by van den Bergh and Botzen (2016)).
When we include these externalities we see that coal is not one of the cheapest generation sources, but indeed the most expensive due to its high environmental cost, being natural gas the second most expensive. Therefore, whilst considering the conventional LCOE only hydro, geothermal and onshore wind are competitive with respect to hard coal and gas, all the renewables become competitive when the external costs of each generation technology are taken into account.
Figure 1. Levelized Cost Of Electrcity (LCOE) including external costs for the European Union in 2013.
Source: own calculations based on Ecofys, 2014.
- Integration costs
However, non-dispatchable renewable technologies —photovoltaics and wind— create additional costs for the electricity system, which are also ignored in the conventional LCOE analyses. The integration costs caused by non-dispatchable renewables sources derive from the uncertainty (balancing costs), locational specificity (grid costs) and variability (profile costs) of this type of generation technologies (Hirt et al., 2015). Likewise, we can divide profile costs into three different categories: backup requirements, full-load hour reduction (of conventional generators) and overproduction costs (when generation is higher than consumption, considering no batteries).
Figure 2 shows the LCOE of photovoltaics (PV), coal and gas considering both externalities and integration costs at different penetration levels. We can see that the cost of PV increases as penetration rises, particularly from 15% penetration due to overproduction costs. Taking all these factors into account PV is cheaper than gas up to 10% penetration and than coal up to 20%, at 2013 PV system costs and 150€2015/tCO2.
Figure 2. Levelized Cost Of Electricity (LCOE) including external costs (EU average) and photovoltaic integration costs (estimated for Germany).
Source: own calculations based on Ueckerdt et al., 2013 (profile costs), Hirth et al., 2015 (balancing costs), MIT, 2015 (network costs), and Ecofys, 2014 (LCOE and external costs).
- Price and value
Another relevant factor affecting the competitiveness of different generation technologies is the time at which the electricity is generated, since electricity has different prices depending on the time. PV produces electricity during daytime when electricity prices are higher, so at low penetration the price per kWh received by PV generators would be higher than the average. However, the generation profile of PV derives from its non-dispatchable nature, which is actually a technological handicap in comparison with conventional dispatchable technologies that can produce whenever it is required. Conventional generators could be producing at this time as well, but since the marginal cost of renewables is virtually zero and storing energy is expensive, renewables have access priority to the electricity market. This handicap becomes therefore an opportunity at low penetration levels. However, dispatchability has indeed a value that should be considered when assessing competitiveness of different energy sources, although it is not clear how this value could be quantified.
Finally, the non-dispatchable nature of renewables becomes a handicap again as penetration increases, since zero marginal cost electricity displacing conventional generation causes the decline of wholesale electricity prices, undermining thus the revenues of the renewable generators themselves. This is the so-called merit order effect which causes a kind of “cannibalization effect” for renewable generators, since the electricity prices drop deeper at the renewable generation time. The market/remuneration design will be crucial to face the challenge of an electricity mix with high penetration of zero marginal cost generation technologies.
In conclusion, the competitiveness discussion should go beyond the conventional LCOE, including on one hand the external cost caused mainly by fossil fuels and on the other hand the integration costs caused by renewables. In that case, we observe that photovoltaics is competitive up to 10 and 20% penetration with respect to gas and coal generation respectively, in the current conditions and at 150€2015/tCO2. These penetration levels are expected to increase as PV system costs keep decreasing and storage capacity is implemented reducing therefore overproduction costs. Besides, if not only costs, but also the value of the output produced is to be considered, the value of dispatchability, the market/remuneration design and the merit order effect would also become relevant factors.
Hirth, L., Ueckerdt, F., Edenhofer, O., 2015. Integration costs revisited – An economic framework for wind and solar variability. Renew. Energy 74, 925–939. doi:10.1016/j.renene.2014.08.065
Ueckerdt, F., Hirth, L., Luderer, G., Edenhofer, O., 2013. System LCOE: What are the costs of variable renewables? Energy 63, 61–75. doi:10.1016/j.energy.2013.10.072
van den Bergh, J.C.J.M., Botzen, W.J.W., 2014. A lower bound to the social cost of CO2 emissions. Nat. Clim. Change 4, 253–258. doi:10.1038/nclimate2135
 125$1995/tCO2 is equivalent to 149€2015/tCO2 using the US GDP deflator between 1995-2015 (1.457) and the historical average exchange rate (1990-2015: 1.228$/€)