Understanding hydropower’s LCOE calculation

Hydropower remains one of the least-expensive energy sources. This remains true even despite recent cost increases. Since 2010, hydropower’s global weighted average levelized cost of energy (LCOE) has increased by 27% to around USD 47 per MWh in FY2019. This uptick is due to rising installation costs, which in turn are largely due to new projects being located in more challenging locations. 

This post expands on ideas we presented in the article “LCOE’s to Compare Energy Investments”, looks more deeply at details of the LCOE of hydropower calculation and analyses past and current costs trends as well as factors that contribute to installation cost changes. 

Even though the global weighted average LCOE of hydropower has seen an increase over the past decade, this does not mean that hydropower is no longer competitive. Nearly 90% of new hydro installations still undercut the costs of new fossil fuel-fired alternatives. As a low-cost, mature and reliable renewable energy technology, hydropower ranks as the most deployed renewable energy source. As such, it meets more than 16% of the world’s electricity demand.^[1]

One essential factor when comparing levelized costs across generating resources is each plant’s performance requirement. This factor can complicate any calculation and result in considerable volatility and variation between the LCOE’s of different projects.

To illustrate this, imagine two scenarios:

Scenario 1: A power plant that is designed to run at a constant and continuous capacity to ensure baseload electricity.

Scenario 2: A power plant that is designed to meet peak power demands, provide spinning reserve and help balance the grid. 

Can you spot the problem? Let’s look at the general LCOE formula to understand the issue: 

LCOE = [S^t_n=1 (I_t + M_t + F_t) / (1+r)^t] / [S^t_n=1 E_t / (1+r)^t] 

Where (i) I_t is the invested capital in period t, (ii) M_t are the costs of maintenance in period t, (iii) F_t is the cost of fuel in period t, and (iv) E_t is the energy output in period t. 

Scenario 1: The higher average capacity factor for this plant increases the denominator in the formula; hence, the LCOE of hydropwer will be lower for this example; at least assuming that all other input parameters remain the same. 

Scenario 2: Because this plant is used for meeting peak demands, stabilizing the grid and providing spinning reserve, it offers both a high installed capacity and low average capacity factor; consequently, its LCOE of hydropower is higher. However, hydropower may offer the lowest-cost option to deliver ancillary services, due to higher correlating power prices. 

Planning and building a hydropower plant is a lengthy and expensive process. Civil construction work, including the construction of the dam itself along with tunnels, canals and the powerhouse, accounts for the largest share of installation costs. By contrast, O&M costs, ranging between 1-6% (latter for smaller projects because of fewer economies of scale)^[2] are lower than for comparable fossil-fueled plants. Typically, long lead times that are caused by extensive site surveys, inflow data collection, environmental assessments and permit acquisition, cause the cost of ownership to play a significant role. 

Despite its maturity as a generating technology, cost reductions remain possible for hydropower, especially when it comes to civil engineering techniques and process optimization. Additionally, hydropower’s unique ability (at least when compared with other renewable energy options) to provide grid stability adds value and enhances both the use and importance of hydropower plants.^[3]

Hydropower’s maturity means that the general formula for calculating its levelized costs produces little error and accurately estimates actual costs. However, the cost of environmental impacts and hydropower’s extensive land use requirements are not yet included in the calculation. These potentially expensive effects remain a challenge to reliably quantify. 

To be sure, hydropower has enjoyed low LCOE’s for a long time. This has contributed significantly towards the technology’s high penetration rate even as deployment costs have risen over the past decade. Despite these difficulties, hydropower remains an attractive power source through its added value as a rapidly available resource for a variety of ancillary services. 

What are some other factors (in addition to those listed above) that could drive down LCOE’s in the short- and long-term for hydropower projects? 

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^[1] https://www.eia.gov/outlooks/aeo/pdf/electricity_generation.pdf

^[2] https://www.irena.org/documentdownloads/publications/re_technologies_cost_analysis-hydropower.pdf

^[3] https://www.irena.org/costs/Power-Generation-Costs/Hydropower

https://irena.org/publications/2020/Jun/Renewable-Power-Costs-in-2019