The Hidden Costs of Delivered Renewable Energy

Why LCOE Underestimates the True Expense to the Consumer

Renewable energy has become a crucial component of the global energy transition, providing cleaner and more environmentally and economically sustainable alternatives to traditional fossil fuel-based power generation. One commonly used metric for comparing the cost of different energy sources is the levelised cost of electricity (LCOE). Although LCOE has been instrumental in assessing the competitiveness of renewable energy technologies, it fails to capture the full picture of costs associated with their integration into the grid, leading to the paradox that consumer electricity prices remain high despite the falling LCOE of renewable energy. Figure 1 plots the LCOE of solar, wind, and coal on the left-hand axis against the average UK consumer household bill on the right-hand axis. One observes that the LCOE of solar and wind have plummeted, whereas household energy bills have continued to climb, despite renewables making up an ever-greater share of the generation mix.

Figure 1

Sources: Lazard, 2023 LCOE+ report v.16 2023 Levelized Cost Of Energy+ | Lazard;

Department for Energy and Net Zero Quarterly Reports on Energy Prices Quarterly Energy Prices - GOV.UK;

Office for National Statistics, RPI electricity prices RPI:Percentage change over 12 months - Electricity - Office for National Statistics

This analysis suggests that LCOE misses some key costs that are passed through to consumers. In particular, LCOE often underestimates the expenses related to balancing costs, which are directly correlated with the penetration of renewable energy sources in a given electricity grid. This article explores the limitations of LCOE for renewable energy and sheds light on the externalities that are overlooked in its calculations, highlighting the importance of a comprehensive approach to evaluating renewable energy costs.

LCOE is a widely utilised metric that calculates the average cost of generating electricity over the lifetime of a power plant, taking into account the initial capital investment, operating expenses, fuel costs, maintenance, and decommissioning. LCOE is often considered a key factor in determining the economic viability of different energy sources, enabling policymakers, investors, and energy experts to compare the costs of various technologies on an equal basis.

Although LCOE provides valuable insights into the cost competitiveness of renewable energy, it falls short in accounting for certain externalities and system-wide costs. For example, there is already an existing literature pointing out that LCOE calculations often fail to consider the environmental externalities associated with conventional energy sources. Fossil fuel-based power generation emits greenhouse gases (GHGs) and air pollutants, contributing to climate change and negatively impacting air quality and public health. Air pollution-related externalities have profound societal costs, including increased healthcare expenses and reduced productivity. The omission of these externalities from LCOE assessments creates a distorted perspective on the true societal cost of fossil-fuel based energy sources.

There are likewise externalities associated with integrating large amounts of renewables into the grid. One major omission is the balancing costs required to ensure grid stability and reliability. Balancing costs refer to the expenses incurred by grid operators to match electricity supply with demand in real-time. These costs increase non-linearity as renewable energy sources are added to the grid. This is because renewable energy sources, such as solar and wind, are characterised by their intermittent nature. The availability of these sources fluctuates with weather conditions, time of day, and seasonality. This intermittency poses challenges for grid operators who must balance the supply-demand equation continuously. The frequency of the AC signal, which must be kept within +/- 1% of target at all times, is a result of the supply-demand balance. Excess supply leads to rising frequency, while insufficient supply leads to falling frequency. As renewable energy penetration increases, challenges associated with grid integration become more prominent. This constrains the ability to connect renewables to the grid. As shown in Figure 2 below, balancing costs in the UK alone have increased from £1.8 billion to £4.2 billion over the last three years.

Figure 2

Source: National Grid ESO

Economic externalities related to renewable energy integration include:

1.    Grid Flexibility: Integrating renewable energy into the grid requires substantial upgrades and investments in grid infrastructure to accommodate the variability and distributed nature of renewable sources. These grid enhancements and smart grid technologies come at an additional cost that is often overlooked in LCOE analyses.

2.    Backup Power: As renewable energy generation is uncertain, backup power sources, often fuelled by fossil fuels, need to be available to compensate for any shortfall. The cost of maintaining and operating backup power plants is not accounted for in the LCOE calculations.

3.    Curtailment: In situations where the grid cannot absorb the available renewable energy, curtailment occurs. Excess renewable energy is deliberately wasted or diverted, representing a significant economic loss. Curtailment costs, which are often disregarded in LCOE calculations, encompass the forgone revenue from the unused electricity and the associated maintenance and operational expenses.

4.    Ancillary Services: Grid operators rely on ancillary services such as frequency regulation and voltage control to maintain stability and reliability. As the penetration of renewable energy increases, the demand for these services also rises. However, the costs incurred by grid operators in procuring ancillary services are typically not included in LCOE estimations.

5.    Harmonics and Noise: Thermal generators are inductively coupled to the AC waveform in the network, so the mass of the generator’s turbine physically reinforces the quality of the waveform, absorbing distortions introduced to the signal by equipment downstream. Renewable generators, however, are connected to the network with inverters, complex switches that create a simulacrum of the AC signal and then inject it into the network. As such, renewable generators increase the level of noise and harmonics in the system, both because they introduce distortion and because they cannot absorb distortion as thermal power stations do. Harmonics and noise power reduce the percentage of power generated that can be used and reduce the carrying capacity of power lines. In systems with high levels of renewable energy, it is estimated that ~8% of generated electromotive force is lost as noise and harmonics.

To accurately assess the costs of renewable energy, it is crucial to adopt a more comprehensive approach that includes all relevant factors. Simply relying on LCOE can lead to misleading conclusions and undervalue the true complexity and expenses associated with integrating renewables into the grid, especially when externalities such as balancing costs are ultimately paid for by the consumer.

The underestimation of balancing costs in LCOE calculations has important policy implications. Governments and regulatory bodies play a significant role in shaping the energy landscape through incentives, subsidies, and regulations. By not considering the externalities associated with renewable energy integration, policymakers may inadvertently provide inaccurate signals that undervalue the true costs of renewable energy and overstate the grid’s ability to absorb it, potentially distorting investment decisions and hampering the transition to a sustainable energy future. This can lead to unrealistic targets for renewable energy, with the risk that climate policy may be undermined if they are not met. Fortunately, whereas limited progress has been made to resolve the environmental externalities of fossil fuel-based power, technological innovation can resolve the system balancing externalities associated with renewables.

To conclude, we note that although the levelised cost of electricity (LCOE) has been an influential metric in assessing the economic viability of renewable energy sources, its limitations have become increasingly apparent. By disregarding the externalities and balancing costs directly correlated with the penetration of renewables in the generation stack, LCOE underestimates the true expenses of renewable energy. To gain a comprehensive understanding of the costs involved, policymakers, investors, and energy experts must adopt a more holistic approach that considers the entire real delivered cost to consumers. Only by acknowledging and properly accounting for these costs can we make informed decisions that accelerate the transition to a cleaner and more sustainable energy future.