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What Influences Electricity Pricing?

  • May 11, 2018

When it comes to electricity pricing, there are many factors to consider.  The electricity market is affected by the fundamentals of supply and demand and can be extremely variable – especially in deregulated, competitive markets, where supply and demand have numerous outside factors influencing them.  While all markets and regions have different components that go into their retail electricity supply rates, it is important to understand what drives electricity pricing so you are able to develop a strategic procurement plan.  What follows is an overview of these factors, with links to more in-depth explanations.

Factors of Electricity Prices

The price of electricity generally reflects the cost to build, maintain, and operate power plants and the complex electricity grid.

electricity pricing

  • Generation – As the primary marginal source of electricity generation in the United States, the natural gas market has a large influence on electricity prices. Currently, natural gas is abundant and low-cost.  The increase in Natural Gas Combined Cycle (NGCC) plants, due to their relatively low cost and quick construction, results in highly competitive generation rates compared to coal, nuclear, and hydroelectric.  The increased use of natural gas in generation has kept the wholesale market prices for electricity low.  However, in periods of high demand, power plants may need to turn on electricity generators with higher costs, resulting in higher marginal prices.
  • Transmission & Distribution – Transmission, the overhead wires that transmit electricity over long distances, and distribution, either the overhead or underground wires that distribute electricity locally, are the backbone of the electrical grid. They have become a growing portion of our electricity costs because of aging infrastructure and the need to meet reliability concerns.  Investments in transmission projects have started and will continue, requiring customers to support these costs through their rates.  However, distribution and delivery rates remain regulated, meaning that utilities must file a rate case to ask for more money to then invest in their transmission and distribution infrastructure.

More specific to generation, there are factors that influence the electricity market and depend on the specific characteristics of your commercial building.

Market Drivers:

  • Natural Gas Prices – Natural gas is typically the price setting generator, meaning that the natural gas market is directly correlated to determining electricity prices. Market fundamentals must be considered such as production and storage levels, imports and exports, and demand relating to weather, economic conditions, etc.
  • Capacity – Utilities must ensure there is enough capacity to meet the peak demand for electricity at any given time. To do so, the capacity market incentivizes investment in the development of generating capacity.  Depending on the level of demand needed to be met and the capacity planning process used by the ISO, the capacity payment will vary by region.

Property Specific:

  • Peak Load Contribution (PLC) – Depending on your account’s contribution to the overall grid peak load, it is assigned a PLC or installed capacity tag (ICAP). Since the grid needs to be ready to meet your peak demand at any time, your capacity obligation determines the amount of capacity needed to be purchased to serve your load.  All else equal, a higher capacity obligation relative to overall kWh volume results in a higher $/kWh.
  • Contract Specifics – The product selection, timing, term length, and bandwidth provisions in your contract have a large impact on the $/kWh you will end up paying.

It is often difficult to find one cause driving your electricity rates up because usually there are several.  It is important to understand the different components to ensure you are billed accurately, and if not, be able to distinguish any discrepancies.  Working with energy market experts alleviates the hassle of keeping track of market changes, regulatory developments, and supplier contract terms, all necessary for securing a strategic procurement strategy.