The Failings of Levelised Cost and the Importance of System-Level Analysis

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The current debate on the future of the electricity sector can be broadly defined by both unity and discord; it is unified on the urgent need to decarbonise power generation in light of the 2015 Paris Agreement, and divided on the means by which it can best be achieved.

On the issue of the future composition of the electricity system, the division is notably acrimonious – the eager promotion of particular generation technologies is tied to vociferous calls to exclude others, often nuclear power. The principal means by which cases are argued relies upon producing estimates of the levelised cost of electricity (LCOE) that purport to demonstrate the superiority of one generation technology to another by virtue of lower generating costs. Unsurprisingly, a wide variety of contradictory LCOEs have been produced by different advocacy groups that often reflect more than a glimmer of vested interest. As a result, no one is left any the wiser.

However, there is a further criticism of a higher or - der to be made of the levelised cost method beyond the dubious motivations of some of its practitioners. Namely, that it offers an exceedingly narrow lens through which to assess the relative merits of different generation technologies. The LCOE, a financial metric in essence tells us the average price per unit of generation required if an operator is to balance their revenue and their costs. This project-level focus is unable to capture a number of meaningful variables, including whether or not generation is regulated by the operator or by ambient weather conditions, the relationships between technologies of different types and the consequences that they might have for the system as a whole, and the broader impact of use of the particular technology on society, the environment, and the economy.

Research Findings:

This report makes clear the importance of considering the value offered by different generation technologies in a holistic manner – to evaluate their system value – and illustrates the misconceptions that arise from use of the project-level, levelised cost method. Based on data from Europe and the United States, the report also provides a number of novel research findings:

  1. The annual change in the share of total generation accounted for by nuclear power has the largest (negative) impact on system carbon intensity – ahead of other low-carbon technologies such as hydropower and variable renewable energies. On a per-MW of installed capacity basis, nuclear power is associated with a 34% greater reduction in the carbon intensity of a power system than renewable energies.
  2. There exists a notable benefit of natural gas in terms of reducing system carbon intensity at low shares of variable renewable energies as the dominant motivation for expanding its use it to facilitate coal-for-gas switching, but the effect is notably reduced at higher levels of intermittent renewables as gas becomes increasingly entrenched as it is required to balance the electricity grid in times of low renewable generation.
  3. The expansion of intermittent renewable technologies is associated with a concurrent decrease in the capacity factor of the system as a whole, which has implications for the generation cost of the residual load as well as electricity price volatility.

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