Must-know: Cost structures based on fuel choice


Sep. 9 2014, Updated 9:00 a.m. ET

Cost structures based on fuel choice

As we discussed in the previous part of the series, the setup of a power plant and the operation costs vary. The setup and costs are determined by the selected technology and fuel. To understand each plant’s competitive advantage, you have to understand the levelized cost of electricity (or LCOE). LCOE is a normalized economic assessment of the energy-generating system’s cost. It includes all the costs over its lifetime. The LCOE is the initial investment, operations and maintenance (or O&M), cost of fuel, and cost of capital.

LCOE is one of the most important metrics for companies in the industry like Duke Energy (DUK), Southern Company (SO), Dynegy Inc. (DYN), and Dominion Resources (D). The LCOE helps the companies make decisions about setting up their new plants.

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In the conventional space, coal-fired power plants run on lower operation and maintenance (or O&M) costs. However, their total LCOE are among the highest. This is because of the higher cost of capital. Natural gas powered plants offer the best LCOE—compared to all the other electricity generating sources. Understanding the cost advantage of natural gas powered power plants, explains the decrease in coal power plants. Coal power plants decreased as a source of electricity from 57% to 37% in two decades.

Wind powered plants have the lowest LCOE among renewable technologies. However, the scarce availability of free flowing wind limits the technology to certain geographic locations. Solar photo-voltaic (or PV) is one technology that has seen a tremendous decrease in LCOE. The decrease is a result of research and development in the technologies.

Cost structure is a major research area for all electric companies in the Utilities Select Sector SPDR (XLU).


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