To Investors,
The levelized cost of energy is a metric I’ve used many times to argue for the use of more renewable energy sources such as solar energy, over the use of coal in South Africa; but after learning more it makes sense that solar cannot easily replace coal power in South Africa. So today I wanted to share more about why the levelized cost of energy (LCOE) metric is a half-truth.
Firstly, what is LCOE?
LCOE is a calculation that determines the feasibility of a power plant, standardising all factors to better compare the cost of building and operating that power plant vs another type.
The formula considers the cost of building and operating a plant over the amount of electricity it will produce over its life-time.
In South Africa, multiple studies show that the LCOE for solar power (R0.62/kWh) and wind power (R0.62/kWh) is at or near the levelized cost for existing coal power (R0.65/kWh), with new build coal power even higher.
Still, we can’t take this lower LCOE for solar at face value because of two additional factors that must be considered.
One factor is that solar energy must be supplemented by battery-stored energy because while the sun might be up for 14 hours, it only provides peak power for a fraction of that. In South Africa, a world-class solar site typically has a capacity factor of 25% to 30%, not 58%. If you build 100MW of solar, you are actually only getting ~25MW of constant energy equivalent over 24 hours – highlighting why solar energy must be supplemented with BESS (Battery Energy Storage Systems).
If solar isn’t supplemented with battery energy, then the grid would have to call on energy peakers (energy sources that can remain idle until demand peaks) when demand spikes in the early morning or evenings in South Africa due to residential activity. If not adequately planned, this “last-minute” request can make the cost of electricity higher for consumers.
Another factor to consider is the integration cost of renewables like solar energy in South Africa.
Although this is now changing, the South African electricity grid was built on a model requiring a baseload amount of energy – energy that runs 24/7, with additional sources to support that baseload during energy spikes. South Africa’s energy infrastructure (generation sources and transmission infrastructure) is 50 to 100 years old, and struggles to accept additional energy running through the infrastructure.
That means that additional solar capacity being built in the country cannot easily be accepted on the national grid. This then requires the buildout of additional infrastructure.
Because of these two factors we then need to broaden the approach to LCOE by thinking about the metric through the lens of a value-adjusted LCOE, or a system LCOE since the cost of building and operating a solar power plant must also incorporate flexibility (battery storage), and/or backup (peakers) to manage the variability of solar.
That said, it may be best to standardise a requirement that solar buildout is supplemented with BESS to bridge the gap when the sun goes down, or when electricity demand spikes, as well as to take full advantage of the solar plant by storing energy when supply is abundant during the day but demand is too low.
One large consideration that warrants its own mention is that South Africa’s electricity system model that uses coal as a baseload source and has existed for a century, has also created a large value chain upon which many businesses and communities rely on for survival. This is why South Africa has implemented the Just Transition framework.
This framework is a strategic roadmap for shifting South Africa’s energy economy from a high-carbon, coal-dependent system to a diversified, low-carbon future while ensuring that vulnerable workers and communities are not left behind. It functions as a social license to operate for the energy sector, balancing the technical necessity of decarbonisation with the socio-economic reality that thousands of livelihoods currently depend on the coal value chain, particularly in the Mpumalanga province. For an investor, the framework is also a hedge against political and operational risk as it moves the goalposts from pure Green Finance (carbon reduction) to ESG-Integrated Finance, where the success of a renewable project is measured by its ability to stimulate local industrialisation, absorb displaced labor, and ensure that the “Levelized Cost of Energy” translates into affordable, inclusive access for the entire population.
I hope you enjoyed reading this letter.
On my journey to becoming a master capital allocator, one lesson down, a billion more to go.
I hope you all have a great start to your week!
-Mansa Wandile Sithole
Founder & Chief, Self-Taught MBA
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