How it works
LCoE divides the present value of all lifetime costs by the present value of all lifetime energy. In symbols, LCoE = [Σ (I_t + O_t + F_t) / (1 + r)^t] ÷ [Σ E_t / (1 + r)^t]. Here I_t is capital spending in year t, O_t is operating and maintenance cost, F_t is fuel cost, E_t is energy delivered in MWh, r is the discount rate and t runs from 0 to the end of life. Energy is discounted as well as cost. That makes the result the constant price per MWh that would give investors exactly the rate r.
Solar and wind have no fuel, and most of their cost is spent before the first MWh. Their LCoE therefore depends mainly on capital cost, capacity factor and the discount rate. The measure ignores when the energy arrives. A MWh at midday from solar and a MWh in the evening peak carry the same weight, though they are worth different amounts. It also leaves out grid connection, balancing and curtailment unless they are added. Storage is usually measured with a related figure, the levelised cost of storage, which includes charging cost and round-trip losses.
Why it matters
LCoE is the first screen for a site or a technology. If it sits above what buyers will pay, the project fails before any detailed modelling. Developers use it to find the lowest tariff they could bid. Buyers use it to judge whether an offered PPA price leaves the seller a margin it can live with over twenty years. It hides timing and risk, so it starts the analysis and the full cash-flow model finishes it.
A worked example
A 100 MW solar plant costs $80 million to build and $1.2 million a year to run. At a 25% capacity factor, with flat output, it delivers 100 × 8,760 × 0.25 = 219,000 MWh a year. Over 25 years at 7%, the annuity factor is (1 − 1.07^−25) / 0.07 = 11.654. The annual capital charge is 80 ÷ 11.654 = $6.865 million. Adding operating cost gives 6.865 + 1.2 = $8.065 million a year. LCoE = 8,065,000 ÷ 219,000 = $36.8/MWh.
Illustrative figures.
Across markets
The formula is the same, but the inputs differ enough to change the ranking of sites and technologies. Indian solar has low capital cost per megawatt and strong sunshine, but a higher cost of capital, so the discount rate moves the result more. US figures are often quoted both with and without federal tax credits, which can change the answer substantially. In northern Europe, weaker sunshine raises solar LCoE, while cheaper finance pulls it back down.