Beyond the Levelised Cost of Electricity: why policymakers need better metrics for the energy transition

The ‘Levelised Cost of Electricity’ has long guided investment and policy decisions, but its simplicity masks important realities about how electricity systems operate. A more comprehensive approach is needed to design a reliable, affordable and low-carbon energy future, write Shefali Khanna, Florencia Aguilera Zúñiga, Giles Atkinson and Massimo Marino.

For many years, the Levelised Cost of Electricity (LCOE) has been the main tool for comparing the cost of different power generation technologies. It summarises all costs associated with building and operating a power plant into a single figure that shows the average cost of producing one megawatt hour of electricity over its lifetime. Its simplicity has made it an attractive tool for policymakers, investors and analysts.

However, as electricity systems evolve and the share of renewable energy increases, the LCOE has become less reliable as a guide for planning. It does not consider when or where electricity is produced, how different technologies interact with the grid, or what additional costs they create for the overall system. Relying on the LCOE can lead to decisions that appear economically optimal but result in inefficient and less resilient energy systems.

What the LCOE leaves out

1. System costs and reliability

Two technologies may have the same LCOE but very different implications for the power system. For example, a wind farm and a gas turbine might both appear to cost £50 per megawatt hour (MWh), but only one can provide electricity whenever it is needed: the other may require additional investment in backup generation, energy storage or grid upgrades. These integration costs can reach US$25–30/MWh in systems with a high share of renewables.

As the LCOE does not account for these additional costs, it gives a misleading picture of which technologies are most valuable to the system. This can result in under-investment in sources that provide flexibility and stability.

According to a 2025 UNECE expert report, relying on LCOE alone “risks underestimating true system costs” by ignoring balancing reserves, network expansion, and other integration needs. Policymakers should adopt a Full Electricity System Cost approach that accounts for these factors to avoid surprises and disruptions.

Indeed, UNECE experts have developed a “System Cost Breakdown of Electricity (SCBOE)” framework that bridges the gap between plant-level LCOE and actual system costs by itemising grid integration, reserve capacity, and other requirements of each technology. This kind of holistic metric can guide planners in comparing technologies on equal footing, accounting for reliability impacts and infrastructure needs.

2. Environmental and social costs

The LCOE also ignores the environmental and health costs associated with electricity generation. Coal-fired plants can appear to be cost-competitive when only their direct expenses are considered, but they impose substantial costs on society through carbon emissions and air pollution. Accounting for these external costs would change how technologies are ranked, with wind, solar, geothermal and sustainable biomass appearing much more competitive.

Incorporating these costs through measures such as emissions pricing or lifecycle assessments would enable a fairer comparison of technologies.

This mirrors recent UNECE guidance, which insists that a ‘full cost’ evaluation include environmental externalities, ensuring that options like coal do not appear artificially cheap once their climate and health damages are accounted for. UNECE’s call for carbon-neutral energy systems implies robust carbon pricing or equivalent measures and we concur with encouraging policy instruments (like carbon taxes or emissions trading) that embed these external costs into investment decisions.

3. Reflecting the locational and temporal value of electricity

The value of electricity depends on where and when it is generated. Factors such as grid congestion, resource quality and hourly demand patterns can cause significant variation in the economic value of electricity. The LCOE assumes that these conditions are uniform, which is rarely true in practice. Policies that ignore this variation can lead to investments in regions where generation is plentiful but grid capacity is limited. Introducing locational marginal pricing, which reflects the cost of delivering electricity at different points in the grid, can help align investment decisions with system needs. In the UK, studies suggest that this could save as much as £30 billion up to 2035 by reducing congestion and transmission losses.

As the UNECE analyses note, the reliability and capacity of the network are integral to system costs: a cheap generator located far from demand or in a grid bottleneck can impose high transmission expenses. Ignoring these undermines true cost-efficiency.

These omissions matter – and they matter now – because the next decade will be decisive for global efforts to reach net zero. Governments and companies are planning to invest trillions of dollars in new energy infrastructure. If these choices are based on incomplete information, they could lead to systems that are inexpensive in the short term but unreliable and costly over time. Leveraging geographic diversity – for instance, linking areas rich in wind, solar, hydro and nuclear – can balance supply and demand across borders, reducing congestion and curtailment costs. Policies should therefore encourage not just optimal siting within a country, but also cross-border grid solutions where feasible.

Accounting for when power is delivered is equally vital. We recommend evaluating technologies by their contribution to system flexibility and stability – for example, a generator’s ability to deliver during peak demand or low-renewable periods adds value beyond its average cost. Adopting market designs (like locational or real-time pricing) that reflect this value aligns investment with actual system needs.

For decision-makers balancing the goals of affordability, reliability and decarbonisation, it is therefore essential to understand the limits of LCOE and possible alternative approaches – a few of which we present below. This is not a purely technical issue but a matter of economic efficiency and social wellbeing.

A better way to measure and value electricity

Adopt system-based metrics

Several newer approaches provide a more realistic understanding of costs and value:

• System LCOE includes the balancing, grid and profile costs that reflect the total cost of integrating each technology into the power system.
• Value-adjusted LCOE (VALCOE) compares generation cost with the market value of electricity at the time and place it is supplied.
• Levelised Avoided Cost of Electricity (LACE) estimates the cost that would be incurred if a new generation project had to be replaced by another source, thereby capturing the avoided cost to the system.

Using these measures together can guide policymakers towards selecting the right combination of technologies that meet national objectives for cost, reliability and sustainability, and a move towards system-aware valuation.

International bodies are converging on such metrics. UNECE’s recent analysis similarly calls for system-level cost metrics that capture integration needs and reliability factors, not just project costs. Their proposed SCBOE metric (System Cost Breakdown of Electricity) is one example of how to standardise accounting for grid, backup and flexibility requirements alongside generation costs.

Include environmental and social externalities

Economic assessments should always include the costs of carbon emissions, air pollution and water use. Instruments such as carbon taxes or emissions trading systems can ensure that these costs are properly reflected in investment decisions. Doing so helps align energy planning with climate objectives and creates a level playing field between fossil fuels, renewables and nuclear power.

Encourage flexibility and resilience

As renewable generation increases, the ability to store energy, adjust demand and provide a rapid response becomes more valuable than ever. Market structures and regulations should encourage investment in technologies that enhance flexibility, including energy storage, demand response programmes and advanced low-carbon generation. These measures are critical for maintaining system reliability as the energy mix becomes more diverse.

Design support that reflects system value

Support-policies that treat all technologies as equal can unintentionally disadvantage innovative solutions that strengthen the power system. Instead, policy design should differentiate support according to the maturity and system value of each technology.

Updating market and regulatory frameworks to explicitly reward contributions to grid flexibility and stability. This means creating revenue streams for energy storage, fast-ramping plants, and demand response – so that investments in these crucial resources are financially attractive and aligned with system needs.

This approach would help encourage innovation in areas such as advanced nuclear power, hydrogen-based generation and long-duration energy storage. Adding firm, dispatchable low-carbon capacity (e.g. nuclear or gas with carbon capture) and technologies like green hydrogen is critical for a resilient grid. These resources provide insurance against intermittency – a point policymakers must weigh up alongside raw cost figures.

Moving forward: identifying the best policy mix

The Levelised Cost of Electricity remains a useful communication tool, but it is no longer suitable as the main basis for energy planning. Modern electricity systems are complex and interconnected, and they require more than a single-number comparison.

Policymakers should develop a dashboard of metrics. The next step is thus evaluating options across multiple dimensions – e.g. economic competitiveness, energy security (import dependence and critical materials), environmental impact (lifecycle emissions), grid infrastructure needs, system flexibility, and operational reliability. This broader scorecard ensures that a technology’s value is judged not only by cost but also by its contribution to energy security and stability.

The focus should be on identifying the best mix of technologies rather than the cheapest individual option. By integrating system costs, environmental impacts and locational value into decision-making, governments can avoid costly mistakes and design power systems that are both sustainable and secure. In practice, this means that a slightly more expensive technology may be favoured if it adds strategic value (e.g. it improves energy independence or grid reliability) – a trade-off that single-number metrics would overlook.

We encourage transparent modelling and stakeholder dialogues around new metrics. When industry and the public understand the broader rationale (why a seemingly ‘costlier’ mix may actually be optimal once system benefits are counted), it will be easier to implement forward-looking policies. Shifting the policy focus from ‘lowest cost per MWh’ to ‘highest system value mix’ is essential for a successful clean energy transition. By doing so, countries can avoid the false economy of seemingly cheap options that carry hidden costs, and instead investing in portfolios that are truly cost-effective when judged on whole-system outcomes.

Thus, the key question is not ‘What is the cheapest source of electricity?’ but ‘What combination of technologies will best deliver reliability, affordability and sustainability?’ No single technology delivers sustainability, resilience and competitiveness alone.

Shefali Khanna is LSE newcleo Fellow in Energy Economics and Policy, Department of Geography and Environment, LSE. Florencia Aguilera Zúñiga is a Research Assistant at the UN Economic Commission for Latin America and the Caribbean. Giles Atkinson is Acting Director of the Grantham Research Institute and Professor of Environmental Policy, Department of Geography and Environment, LSE. Massimo Marino is Chief Education and Academic Relations Officer at newcleo.

This commentary was prepared during the LSE-newcleo partnership project. The authors gratefully acknowledge the support of that project. The views expressed do not necessarily reflect those of LSE or newcleo ltd.