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Electric Utilities: Update Model for Wholesale Energy Pricing

Last week, we took a deep dive into the wholesale cost of electric energy, including pricing methodologies and marginal pricing determinations. Though it is important to understand these methodologies when considering developing offshore wind farms, they need to be updated for electric utilities and independent power producers to continue to be profitable. This is especially true as we embrace a future with climate change and expanded renewable energy sources.

Within the next 5 years, electric utilities and independent power producers would benefit from updating their pricing method to be based on the yearly costs of energy production and delivery, rather than based on hourly costs as they are today. Before taking a closer look at this change, it is important to understand the typical daily and seasonal load demands, as well as different pricing structures in deregulated and regulated states.

Daily and Seasonal Load Demands

Energy producers base their production schedules on daily and seasonal demands for electric energy. In most of the United States, peak load demand occurs in August, due to air conditioning usage, and minimum load demand occurs in April. However, in some areas, peak load occurs in January. Generally, minimum demand is about 50% of peak demand. As consumers transition to electric vehicles and electrically heated homes, peak load demand will shift to occur in January in more areas. As more and more consumers install rooftop solar panels, minimum demand in April will be less than 30% of winter peak demand.

Wholesale energy providers typically price the energy they deliver in terms of hourly costs. Figure 1 shows PJM’s marginal pricing of energy production broken down by hours; this is a typical breakdown of energy costs for most wholesale energy providers. Figure 2 shows an hourly breakdown for wind energy production within PJM. Wholesale energy providers will be challenged to remain profitable in deregulated areas in the future, if they continue to use the marginal cost variations illustrated in Figure 1.

Figure 1 shows PJM’s forecast for the marginal pricing of wholesale energy in the typical hourly breakdown. Find today’s forecast here.

Figure 2 shows PJM’s hourly forecast for wind energy. Find today’s forecast here.

Wholesale Energy Costs in Deregulated States

Before deregulation, all electric utilities were vertically integrated: each electric utility owned generation, transmission, and distribution assets. In deregulated areas, electric energy producers compete on price and market conditions. This means that bus bar costs are confidential, and the configuration of the energy grid is broadcast (note: bus bar is industry lingo for cost of energy at the energy production facility).

Wholesale prices are available to the public in deregulated states, such as New York, California, and PJM territory; we took a closer look at pricing within these states in our last article.

Within PJM, before deregulation, electric energy was centrally dispatched using a “split cost savings” approach. This meant that if one electric utility could produce energy at $20 per MWH and a second utility could produce energy at $30 per MWH, the first utility would sell energy to the second utility at $25 per MWH, or half the cost difference.

Wholesale prices are production costs with margins. Energy production costs are a function of capital costs, operating and maintenance expenses, fuel costs, and capacity factor. Typical values for a variety of energy sources are displayed in Table 1. For utilities to earn a profit, energy production costs must be lower that the selling price most of the time.

Values in Table 1 are estimates based on typical values; actual values are proprietary. Values for nuclear and coal fired production facilities are for existing facilities. Bus bar prices for newer nuclear plants, such as Vogtle Electric Generating Plant in Georgia, are much higher. Bus bar prices for natural gas fired production facilities vary with market conditions. Costs are higher during winter when demand for natural gas increases.

Regulated States: No Price Available

In some states, electric energy production, transmission and distribution is regulated by state entities. In regulated areas, independent energy producers, that is, energy producers not owned by a host utility, compete on price and market conditions that are not published in the same manner as in deregulated states.

In Oregon, a regulated state, the price of electric energy is negotiated between franchised electric utilities and independent power producers. The price is not made available to everyone as it is in New York, California, and PJM.

In regulated states, price spikes are absorbed by host utilities rather than by independent power producers, as they are in deregulated states. In deregulated states that sign “time of use” contracts, such as Texas, consumers take the brunt of price spikes.

Yearly Pricing Models: A Better Path Forward

Generally, energy is available at a reasonable cost for most of the year. Costs are typically only excessive for less than 30 days each year. However, costs can become so excessive during high cost times that quarterly and yearly profits are erased. In fact, Liberty Power Holdings, an electricity retailer that had customers in 14 states and Washington DC, filed for bankruptcy in April 2021 after a record-setting mid-February freeze in Texas produced crippling losses from price spikes.

To prevent price spikes from decimating profits and impacting the reliability of electric service, wholesale prices need to be based on yearly production levels, capital costs, and operating and maintenance costs. A yearly price model would levelize costs so that energy producers are reimbursed for both energy production and standby energy capacity.

In other words, electric utilities and energy producers need to develop price structures that mimic electric vehicle pricing, rather than continuing to use price structures that mimic gas station pricing. In our next article, we’ll present an updated wholesale pricing strategy based on a yearly pricing model.

Interested in discussing wholesale energy pricing at greater lengths? Reach out to us and share your thoughts!

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