The most important things to know about LCOS in 7 minutes

To avoid an apples with oranges comparison of energy storage cost, LCOS - the “Levelized Cost of Stored Energy” - has become a well-established metric that is widely used in the industry today.

If applied and interpreted correctly, I like it for being a simple figure covering all cost influencers (not just CAPEX) helping to select the right energy storage technology in the targeted application or to make an educated investment decision on both the corporate or project level.

However, if blindly trusted or used in the wrong context, I have seen LCOS becoming meaningless or providing a distorted picture of the reality, potentially leading to poor decisions and expensive mistakes for the unaware user.

Therefore, let’s spend 7 minutes to revisit the three basic rules of LCOS and how to calculate it in the right way. 

Rule #1: Choose the right basis

Cost of energy storage is typically based either on the provided energy (i.e., kWh, MWh) or on the power capacity (kW, MW). LCOS is calculated on an energy basis and should therefore not be used for “power use cases”. Cost calculations for the latter should be done with a TCO (Total Cost of Ownership) approach instead.

LCOS is calculated on an energy basis and should therefore not be used for “power use cases”

As simple way to decide on the right basis for a use case (and whether LCOS should be applied) is the value that energy storage is adding in the specific use case, i.e., in many cases, the costs that are avoided through application of energy storage.

For example, if storage helps to save costs for power generation from gas peaker plants denominated in USD/MWh, the storage use case is based on the provided energy and LCOS represents a meaningful value. If the investment in a transmission line should be avoided by adding storage, the usual denomination is in USD/MW and the use case is based on power. Here TCO, not LCOS, should be applied.

Rule #2: LCOS comparison for same use cases only

In contrast to technologies for power generation, which have a single use case (i.e., the generation of electricity), energy storage technologies can serve a variety of use cases, both “in front of the meter” (e.g., renewable energy time shift) and “behind the meter” (e.g., increase of self-consumption of rooftop PV). Each use case features various applications (e.g., time shift for 2, 4 or 6 hours) and requires different operating parameters, which affect the LCOS. And each technology optimizes along these parameters differently according to its relative strengths and weaknesses.

A storage technology with higher costs than an alternative technology is not necessarily “worse” or “less advanced”, it is probably just meant for a different application.

Therefore, cost comparisons of energy storage only make sense for a common and clearly defined use case. Furthermore, only energy storage systems that were designed to serve the technical requirements of a specific use case should be compared: A storage technology with higher costs than an alternative technology is not necessarily “worse” or “less advanced”, it is probably just meant for a different application.

Rule #3: Know your cost influencers

The key to comparing apples with apples is to make sure that individual cost figures are calculated at the same level of detail and are based on comparable assumptions. The prerequisite for this is a deep understanding of the different factors influencing the costs of an energy storage system (ESS), i.e., upfront costs, O&M costs, charging costs, useable energy over lifetime, residual value and financing costs.

Upfront costs: Already at this basic level, a close look is required when comparing different energy storage solutions. Are all necessary investments for the complete and connected system included in the initial quote? Sometimes, for example, costs for the necessary inverters, safety engineering or for shipping and installation are not covered.

O&M costs: Like all infrastructure assets, energy storage requires periodic minor and major servicing. Depending on the components that need to be replaced, and how frequently, this can cause significant additional technology-specific costs. For example, a redox-flow battery features mechanical parts such as pumps that can require maintenance efforts not needed for other battery technologies.

Charging costs: The costs of charging the ESS should be taken into consideration, but are often left out. Efficiency losses during a complete charge-discharge cycle (i.e., low roundtrip efficiencies) mean that more energy has to be purchased at a certain price for charging the ESS than can be sold when discharging – often constituting a significant cost factor depending on the charging electricity price.

The costs of charging the ESS should be taken into consideration, but are often left out.

Also, energy consumption of the ESS is very different from technology to technology and should be included in the costs. For example, many Li-ion chemistries require power consuming air-conditioning to maintain favorable operating temperatures.

Usable energy over the lifetime: The cost of an ESS intended for energy-based applications should be put in relation to the energy output of the ESS expected over its lifetime. Lifetime can be determined by two factors:

1.     The calendar life, which is simply the elapsed time before a storage solution becomes unusable, whether it is in active use or inactive. For batteries, it mainly depends on the chemistry and manufacturing specifics of the ESS (e.g., life period of the electrolyte, quality of sealing rings and welded joints) as well as on the voltages applied and the battery temperatures – as a rule of thumb, calendar life drops by 50% for each 10°C increase above 20°C.

2.     The cycle life, which is the number of complete charge-discharge cycles a battery is expected to perform before its nominal capacity falls below 70–80% of its initial rated capacity as a result of continuous degradation.

It is important to understand that a very long cycle life is not necessarily an advantage: if there are only a limited number of annual cycles required to serve the intended storage use case(s), the end of the calendar life is often reached first.

A very long cycle life is not necessarily an advantage: if there are only a limited number of annual cycles required to serve the intended storage use case(s), the end of the calendar life is often reached first.

Finally, the useable energy of batteries greatly depends on the depth of discharge or DOD. For most chemistries, the lower the DOD applied, the higher the number of cycles and the roundtrip efficiency (see above) – but obviously the lower the amount of energy that can be discharged in each cycle as well. Consequently, cost figures should not only include the (relevant) number of cycles and roundtrip efficiency, but also the corresponding DOD.

Residual value: Even after an ESS has reached the end of its lifetime, it bears a certain residual value based on the achievable sales price for the individual components including inverters, switchgear and transformers. Obviously, the shorter the period of time an ESS has been used, the higher the residual value.

Financing costs: The time value of money dictates that time has an impact on the value of cash flows. In other words, future cash flows related to an ESS have a lower present value than cash flows generated today. Therefore a discount factor reflecting the financing costs, typically the weighted average cost of capital (WACC), needs to be applied to all outflowing (i.e., O&M and charging) and inflowing cash (i.e., the remuneration for the usable energy and residual value).

The Why and How of LCOS

In order to reflect all of the cost influencers explained above in a simple metric, it makes sense to assume a constant – or levelized – price per kWh over the applicable lifetime of the ESS. The resulting cost metric is called Levelized Cost of Stored Energy (LCOS). In other words, the LCOS is the constant and thus levelized price per kWh at which the net present value of the storage project is zero.

LCOS is the constant and thus levelized price per kWh at which the net present value of the storage project is zero.

Although a bit counterintuitive, it is important to “discount” also the useable energy (electricity discharged), as can be seen in the derivation of the LCOS formula below in Figure 1:

 Figure 1: Formula showing the calculation for levelized cost of stored energy

The LCOS formula can be structured along the individual components of CAPEX, O&M, residual value and charging costs in Figure 2:

Figure 2: LCOS reflecting individual components of CAPEX, O&M, residual value and charging costs

By applying LCOS, the significant impact of including or leaving out any of the described cost influencers becomes obvious.

Handle with care

It is most important to be aware of the various factors influencing ESS costs and how to apply them correctly depending on the individual use cases. In consideration of certain limitations as described above, LCOS can be an easily calculable, sufficiently detailed metric that enables a meaningful comparison of different storage technologies, as well as between storage and non-storage solutions, in energy-based applications.

Cost metrics like LCOS should be applied with caution, though. Even if the underlying assumptions of a cost comparison are clearly communicated (e.g., which ESS technology is applied, value of benefit stacking considered), the results might still “stick” – and are still quoted as a reference for the general viability of ESS in completely different, non-applicable situations.

As perception often creates reality, energy storage might be ruled out as a flexibility option before a detailed assessment related to the specific use case is done.