Energy Economics, LCOE & Energy Policy

What energy really costs. Learn capital and operating costs, the capital recovery factor, levelised cost of electricity (LCOE) and its sensitivity to discount rate and capacity factor, system costs of variable renewables, tariffs and power purchase agreements, merit order and electricity markets, subsidies and carbon pricing, energy policy in India (renewable targets, PAT, green hydrogen mission) and energy access — with Python comparing solar and coal LCOE.

Energy choices are ultimately investment decisions. Solar has no fuel cost but high upfront cost; coal is the opposite. Levelised cost of electricity (LCOE) puts them on a common per-kWh basis over the plant's life.

But LCOE isn't the whole story: when and where electricity is produced, the cost of integrating variable renewables, fuel price risk and carbon costs all matter. Energy policy shapes these through targets, auctions, markets and prices.

An analogy

LCOE is like comparing buying a car versus taking taxis by working out the average cost per kilometre over years: the car has a big purchase price but cheap trips; taxis have no upfront cost but you pay every ride.

Cost components

Capital (equipment, construction, land, grid connection), fixed O&M, variable O&M, fuel, decommissioning, and financing cost. Capital-intensive technologies (solar, wind, nuclear, hydro) are sensitive to interest rates; fuel-intensive ones (gas peakers) to fuel prices.

Beyond LCOE

LCOE ignores:

Electricity markets and tariffs

Merit-order dispatch runs the cheapest marginal-cost plants first; zero-marginal-cost renewables lower wholesale prices. India uses long-term PPAs from competitive auctions (SECI), power exchanges (IEX day-ahead, real-time, green markets), regulated retail tariffs with cross-subsidies, and time-of-day pricing. Net metering and open access let consumers buy renewables.

Policy instruments

Targets (India: 500 GW non-fossil capacity by 2030, net zero by 2070), renewable purchase obligations, production-linked incentives for manufacturing, viability gap funding for storage, carbon markets (CCTS), efficiency schemes (PAT, S&L, ECBC), and energy access (Saubhagya, clean cooking). Policy design balances affordability, reliability, sustainability and industrial development.

Formulas

Worked example: CRF

Given: r = 8%, n = 25 years

Find: CRF.

Answer: 0.0937/yr

Worked example: Fuel cost per kWh

Given: Heat rate 2400 kcal/kWh, coal ₹4000/t at 4000 kcal/kg

Find: Fuel cost.

Answer: ₹2.40/kWh

Worked example: Carbon adder

Given: Coal 0.95 kg CO₂/kWh, carbon price ₹2000/t

Find: Extra cost.

Answer: ₹1.90/kWh

Solar vs coal LCOE and discount-rate sensitivity

# Levelised cost of electricity (LCOE) for solar vs coal (simplified, real terms)
def lcoe(capex_per_kw, om_per_kw_yr, fuel_per_mwh, cf, life, r):
    crf = r * (1 + r) ** life / ((1 + r) ** life - 1)
    mwh_per_kw = cf * 8760 / 1000
    return (capex_per_kw * crf + om_per_kw_yr) / mwh_per_kw + fuel_per_mwh
solar = lcoe(45000, 600, 0, 0.21, 25, 0.08)          # Rs/kW, Rs/kW/yr
coal = lcoe(90000, 2500, 2400, 0.65, 30, 0.08)
print(f"solar LCOE Rs {solar/1000:.2f}/kWh, coal LCOE Rs {coal/1000:.2f}/kWh")
# Sensitivity: solar at 6% and 10% discount rate
for r in (0.06, 0.10):
    print(f"solar at r={r:.0%}: Rs {lcoe(45000, 600, 0, 0.21, 25, r)/1000:.2f}/kWh")
# solar LCOE Rs 2.62/kWh, coal LCOE Rs 4.24/kWh
# solar at r=6%: Rs 2.24/kWh
# solar at r=10%: Rs 3.02/kWh

New solar is cheaper per kWh than new coal in India (auction tariffs of ₹2.5–2.8/kWh confirm it). Because solar is almost all capital, its cost is very sensitive to the cost of finance — lowering the discount rate from 10% to 6% cuts LCOE by 26%. Coal's cost is dominated by fuel. (Illustrative inputs.)

Common mistakes

Applications

Key takeaways

Going further