Power economics and operations: levelized cost, the merit order, storage and the grid
Why financing decides the cost of solar, how the merit order sets prices, how batteries earn money, and the supply chain behind a power project.
Industry brief, with a one-minute summary: Power and renewablesKey takeaways
- A solar or wind plant spends almost all its money before it produces anything, and then its fuel is free.
- Cheap solar is not useful if it cannot reach customers.
- Development: find land, measure sun or wind, get permits and a grid connection.
- Contract and finance: win a tender or sign a PPA with a utility or a large company, then raise debt (often 70 to 80 percent of the cost) and equity.
- Procurement: most solar panels, and much of the equipment for batteries, are made in China.
Key idea
A solar or wind plant spends almost all its money before it produces anything, and then its fuel is free. So its cost per MWh depends mostly on the capex, the capacity factor and the cost of capital. A gas plant is the opposite: its cost per MWh depends mostly on the price of gas.
Levelized cost of electricity in plain words: take everything the plant will cost over its life (building, financing, running, fuel), and divide by all the MWh it will produce. The quick way in a case is to turn the capex into an equal yearly payment, like a mortgage, using a capital recovery factor. For a plant that lasts about 25 years with a cost of capital around 6 to 7 percent, the yearly payment is about 8 percent of the capex. Then add yearly running costs and divide by yearly MWh.
Worked case
Levelized cost of a solar plant, and why financing matters
The prompt
Solmira Power (a fictional company) plans a 100 MW solar plant in a sunny region. Capex is USD 60 million. Capacity factor is 25 percent. Yearly operation and maintenance costs USD 1.2 million. Assume a capital recovery factor of 8 percent per year. What is the levelized cost per MWh? Then recompute it if the capital recovery factor is 11 percent, as it might be in a country where investors demand a higher return.
The structure
- LCOE = (yearly capital charge + yearly running cost) divided by yearly MWh
- Yearly MWh = MW x 8,760 hours x capacity factor
- Yearly capital charge = capex x capital recovery factor
- Running cost = operation and maintenance (no fuel for solar)
Working it through
1. Yearly output
100 MW for 8,760 hours at 25 percent.
Yearly output (MWh):100 × 8,760 × 0.25 = 219,0002. Yearly cost at 8 percent
Capital charge of 8 percent of 60, plus 1.2 of running costs.
Yearly cost (USD million):60 × 0.08 + 1.2 = 63. LCOE at 8 percent
USD 6 million divided by 219,000 MWh.
LCOE (USD per MWh):6 × 1,000,000 ÷ 219,000 = 27.44. LCOE at 11 percent
Capital charge of 11 percent of 60 is 6.6, plus 1.2, is 7.8 million a year.
LCOE at higher cost of capital (USD per MWh):(60 × 0.11 + 1.2) × 1,000,000 ÷ 219,000 = 35.62
The recommendation
Solmira should secure low-cost financing before building, because the plant costs about USD 27.4 per MWh with an 8 percent capital recovery factor but about USD 35.6 at 11 percent. First, that is 30 percent more for the same panels and the same sun, since capital is USD 4.8 million of the USD 6 million yearly cost. Second, this means guarantees, stable contracts and a creditworthy buyer can matter more than cheaper panels. The risk is a capacity factor below the 25 percent planned. As a next step, test financing offers from development lenders.
Risks: A lower capacity factor than planned raises LCOE; LCOE ignores when the power is produced: solar power at noon may be worth less than power in the evening peak.
A gas power plant in the Gulf has a heat rate of 7 gigajoules (GJ) per MWh. Gas costs USD 8 per GJ. What is its fuel cost per MWh, in USD?
The merit order: how a wholesale price is set
In a wholesale market such as those in Europe, every plant offers power at about its running cost. Solar, wind and nuclear have very low running costs, so they are used first. Gas and coal plants follow. The grid operator takes offers from cheapest to most expensive until demand is met, and the last plant needed sets the price for everyone in that hour. On a sunny, windy afternoon, cheap plants may cover all demand, so prices fall, sometimes below zero. In the evening, when the sun sets, gas plants set the price again. That is why the value of solar power falls as more solar is built, and why storage matters.
Worked case
How a grid battery earns money by shifting energy
The prompt
A 100 MWh battery in Europe charges when power costs USD 20 per MWh and sells in the evening peak at USD 90 per MWh. It loses 15 percent of the energy in the round trip (85 percent efficiency). It completes 300 full cycles a year. What is its gross margin per cycle and per year, in USD?
The structure
- Margin per cycle = energy sold x peak price minus energy bought x off-peak price
- Energy sold = energy bought x round-trip efficiency
- Yearly margin = margin per cycle x cycles per year
Working it through
1. Revenue per cycle
85 MWh sold at 90.
Revenue per cycle (USD):100 × 0.85 × 90 = 7,6502. Cost per cycle
100 MWh bought at 20.
Charging cost per cycle (USD):100 × 20 = 2,0003. Margin per cycle
Revenue minus charging cost.
Margin per cycle (USD):7,650 - 2,000 = 5,6504. Yearly margin
300 cycles a year.
Yearly gross margin (USD):5,650 × 300 = 1,695,000
The recommendation
The owner should go ahead only if the price spread holds, because the battery earns about USD 5,650 per cycle and about USD 1.7 million a year before its running costs and capital charge. First, it sells 85 MWh at USD 90 for USD 7,650 against USD 2,000 to charge. Second, it needs 300 full cycles a year, which means the spread must be large and frequent. The risk is that new batteries narrow the spread. As a next step, check extra income from grid services or capacity payments.
Supply chain and operations
From idea to power on the grid
- 1Development: find land, measure sun or wind, get permits and a grid connection. In many countries the grid connection queue is now the slowest step.
- 2Contract and finance: win a tender or sign a PPA with a utility or a large company, then raise debt (often 70 to 80 percent of the cost) and equity.
- 3Procurement: most solar panels, and much of the equipment for batteries, are made in China. Wind turbines come from a few makers in Europe, China and the US. Transformers and high-voltage cables have long waiting times in many markets.
- 4Construction: an engineering, procurement and construction (EPC) contractor builds the plant. Solar can take about a year; wind, hydro and nuclear take much longer.
- 5Operations: clean panels (dust is a big issue in the Gulf and India), repair turbines, forecast output, and sell power. For thermal plants, secure fuel and plan maintenance outages.
- 6Grid operations: the system operator balances supply and demand every second, keeps reserves ready, and decides curtailment when lines are full.
Cheap solar is not useful if it cannot reach customers. In many countries the limit is transmission lines, grid connections, or the system's ability to handle output that rises and falls with the weather. When a case says "we cannot sell all our power", check curtailment and grid capacity before you look at the plant itself.
A regulated distribution company in India has a rate base (the value of its network) of INR 10,000 crore. The regulator allows a return of 8 percent a year. What profit is it allowed to earn each year, in INR crore?
Sources for this lesson (3)
- Recognized public explanations of case-interview concepts and frameworks
- IRENA, Renewable Power Generation Costs in 2024
- BloombergNEF, "Lithium-ion battery pack prices fall to $108 per kilowatt-hour", December 2025
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