Avoided cost is the marginal cost for the same amount of energy acquired through another means such as construction of a new production facility or purchase from an alternate supplier. For example, a megawatt-hour's avoided cost is the relative amount it would cost a customer to acquire this energy through the development of a new generating facility or acquisition of a new supplier.

Short run avoided cost refers to avoided cost calculated based on energy acquisition costs plus ongoing expenses. Long run avoided cost factors in necessary long-term costs including capital expenditures for facilities and infrastructure upgrades.

Avoided cost is typically used to calculate a fair price for energy produced by cogenerators and other energy producers that meet the specifications of the Public Utility Regulatory Policies Act of 1978. The use of avoided cost rates for cogenerated energy is intended to prevent waste and improve both efficiency and cleanliness by insuring that fair market prices paid for energy generated from renewable resources, small producers and others.

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