Degradation in Levelised Cost Calculation

Incorporation of adjustments to the levelised cost for degradation are addressed on this page. In some cases like solar and batteries, the entire plant degrades and you can adjust the recovery of the total capital cost. In other cases such as for hydrogen, the degradation applies only to one cost item — the purchase of electricity. On this page I show you how to apply both types of degradation. I emphasize again that the you should worry much more about getting the levelised cost number right and less about your financial model which just proves that the levelised cost numbers are correct.

Inclusion of Degradation in the Levelised Cost using adjustments to both Carrying Charges and O&M Costs

The formulas below evaluate levelised cost when the quantity of the units change. Different amount of units affects the weighting of the levelised price. For example, if the number of units is half of the units when the units start and if the price changes, then weighted average price changes. Without discounting, the screenshot below is 13.33. The price is not the average of 15.00 because you should give less weight to the price when there is less generation.

You should make changes to both nominal and real LCOE and you should make operating expense adjustments. The adjustments are represented by the following equations:

Adjusted Target IRR for Degradation = (1+Nominal IRR)/(1-Degradation)

Adjusted Real IRR for Degradation = (1+Real IRR)/(1-Degradation)

O&M Factor Nominal = PV(Real IRR,Life,-1)/PV(Adjusted Nominal IRR,life,-1)

O&M Factor Real = PV(Real IRR,Life,-1)/PV(Adjusted Real IRR,life,-1)

I have included degradation as the change in units after inflation because degradation can be modelled in a similar manner to negative inflation. In the example below I illustrate how the real and nominal discount rate (target project IRR) is adjusted for degradation. The formulas to apply when adjusting the carrying charge include an adjustment to discount rates:

When you think about things, the levelised nominal cost is a silly number. Think about a hydro plant than may last 80 years. The nominal levelised cost is the flat value over 80 (with a minor adjustment for inflation in O&M expenses discussed below). With even a minor rate of inflation like 2%, the real value in 80 years is a very small percent of the value in the first year (divide by 1.02^80) — 4.9 times. It would be much better to compute the current value that, when inflated, gives you the target return. In simple terms this involves using a real cost of capital as described below.

Degradation with for a Single Expense Rather than the Entire Project

As stated above, for an electrolyzer the degradation can be for the quantity of electricity purchased rather than for the entire project.