Avoided costs are the incremental costs to an electric utility of electric energy or capacity or both which, but for the purchase from the qualifying facility or qualifying facilities, the utility would generate itself or purchase from another source.

These are costs that a utility avoids by purchasing power from an independent producer rather than generating power themselves, purchasing power from another source or constructing new power plants. A Public Utility Commission calculates avoided costs for each utility, and these costs are the basis upon which independent power producers are paid for the electricity they produce. There are two parts to an avoided cost calculation: the avoided capacity cost of constructing new power plants and the avoided energy cost of fuel and operating and maintaining utility power plants. The minimum amount an electric utility is required to pay an independent power producer, under the PURPA regulations of 1978, equal to the costs the utility calculates it avoids in not having to produce that power (usually substantially less than the retail price charged by the utility for power it sells to customers).