Levelized Revenue of Electricity (LROE) - Part 1

I introduce a new term, the levelized revenue of electricity (LROE), an analogue of the levelized cost of electricity (LCOE). It is a financial instrument to discount the flow of revenue from a renewable or non-renewable source of electricity. Like the LCOE, the LROE is vital for comparing the revenue from different energy sources in different markets. It is needed, especially for renewable projects, because revenue includes several time component variables such as the retail or wholesale electricity rates, tax breaks, and government incentives.


There is no easy answer to the question of how much energy costs. Utility scale projects are complicated, incredibly expensive, and contain many variables that affect the cost over the lifetime of the project.  
Many of the conventional sources of energy (coal, oil, and natural gas) are a good example of this last point. There is a large initial investment to build the plant, and then additional money over the lifetime is needed to buy the fuel to produce energy. Many renewable projects, on the other hand, require one incredibly large upfront investment, but then have very little operating costs. This difference in cash flow, along with differences in financing from project to project, variable fuel prices, uncertain weather conditions, different time lengths of operation, variability in energy production, and numerous other factors are reasons why comparing the total cost of each type of energy can be very difficult.  An established method which incorporates all the costs over the lifetime of the plant, is called the levelized cost of electricity (LCOE).

I will argue that calculating the revenue from a specific type of generation, especially renewable sources, is equally as complicated since it involves the continual stream of money from the sell of electricity, but can also involve different one-time or reoccurring incentives or tax-breaks. I will introduce the levelized revenue of electricity (LROE), an exact analog of the LCOE.  Before doing so, however, it is important to understand the LCOE.


The LCOE is a calculation of the life-cycle energy cost. It captures capital, ongoing maintenance, fuel and all other costs. The LCOE is the net present value of the total life cycle costs of the project divided by a discounted quantity of energy generated over the system life. 

Since the costs are time-dependent and vary drastically from project to project, it is important to incorporate the time value of money (also see note #1). By discounting the costs and future output of energy, it allows different technologies to be compared even if they have different scales of operation, investment, or operating time periods.
Let's take a look at a sample expression of the LCOE.²

where r is the discount rate and n is the year. Initial costs are self-explanatory. The second term includes deprecation and how that affects taxes. The third term, Annual Costs, are the maintenance costs and fuel costs if they exist. In the denominator, we have the discounted energy output of the module. Often LCOE is calculated over a 20-25 year period. The power of the LCOE is it allows costs of various projects to be compared with a common metric: money/energy (most often, $/kWh)

Below is a list of the LCOE for different technologies:

Figure 1. LCOE for a variety of technologies.  Source of image can be found on the web here.

You might be surprised with how well some of the renewables compete with conventional sources of energy (and it is important to point out that there are approximations needed in these calculations so people will often report different numbers). That said, the costs represented in the table are in ideal situations (you can't find a good wind or solar resource everywhere) and in nearly every situation coal, gas, and nuclear will be lower in cost. Renewable sources of energy are also intermittent which effectively gives the non-intermittent conventional source a premium.

We've seen that finding the cost of a energy source is complicated. It seems natural to apply the same reasoning to the revenue side of cash flow. Revenue from the construction of a renewable energy source can come from a variety of sources. First is the sale of the actual electricity. These often come in three forms: 1. retail rate, 2. wholesale rate, or 3. power purchase agreement (PPA). The first two are variable market rates that depend on whether the power is in-front of the meter like on a residential roof-top (retail), or behind the meter like in a large utility scale project whose electricity is fed into the grid (wholesale).  Power purchase agreements are contracts where a utility or load will promise to buy the electricity from the generator, but at an agreed upon and usually constant price. In addition to the sale of electricity, there are often incentives and tax breaks that provide additional sources of revenue at different times during the lifetime of the project. (We will illustrate some of these incentives in Part 2 of this post) 

To determine the total revenue from a project, in an analogous fashion to the LCOE, we calculate the net present value of the revenues and divide by the discounted energy production. 

We can use the LROE with the LCOE to determine if a project will be profitable. This is especially important for policy makers. Incentives must be designed in such a way that LROE > LCOE, otherwise it's unlikely projects will be built.

In part 2 of this post, I'll calculate the LROE for some specific examples and show how some markets are not sufficiently funded to encourage growth of renewable sources of energy.


Sources and Notes:
1. For you financial types this is trivial, but encase you haven't heard this concept the basic idea is that we must take into account that money (or energy) you gain in the future is not as valuable as money or energy you have now. Why? Because money you have now could be invested and you could gain a return (the average return you could get, is what we'll call the discount rate). With the same logic, costs that you offset until the future are better (since that's money you don't need to pay now, and you can use to invest).
2. Here's a nice resource about the calculation of LCOE for solar: http://fr.sunpowercorp.be/downloads/SunPower_levelized_cost_of_electricity.pdf