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Updated Electric Energy Pricing

Updated: Apr 26, 2022

This is part two of a series on the fourth generation (4Ge) electric power system.

Last week we discussed the pivot points that will lead to major change within the electric utility industry. Climate change is the driving factor behind multiple changes, including increased dependence on electric vehicles and distributed renewable energy sources, as well as intensified consumer demand for environmentally sustainable energy.

Climate change will also lead to more frequent and severe storms, which will test utilities’ ability to continue to provide reliable electricity at a reasonable cost to consumers. Cost pricing fiascos, like that which occurred in Texas in February 2021, should be a wakeup call to investors, regulators, and electric utilities that now is the time to pivot towards updated energy pricing structures.

Maintaining the status quo for energy pricing will force energy suppliers to choose short-term profits over long-term effectiveness. Without updating energy pricing structures, energy shortages and high prices will occur more frequently when risk factors align to create worse case conditions.

In this article we outline the current cost of electricity based on energy production costs and consumer demand for energy. Later, we’ll present cost restraints, market caps and production incentives as necessary steps to guarantee the availability of electric energy while reducing the production of greenhouses gases.

The Basics of Electric Energy Costs

Electric energy wholesale costs vary by state and energy source as well as by time of year. Examples of some typical electric energy production costs are listed in Table 1.

Customer willingness to pay also varies by energy source and time of year. Customers are willing to pay more to cool down on extremely hot days and to warm up on extremely cold days. Table 2 outlines the average amount customers are willing to pay for energy during peak heat in August, peak cold in January, and average temperatures in April.

Energy Production Costs

Energy production costs vary with plant efficiency, capacity factor, and fuel costs. For example, nuclear power plants are cost effective operated at 100% power with a capacity factor above 92%. Wind turbine generators are cost effective when operated at 100% power with a capacity factor above 60%.

On the other hand, gas, combined cycle, power plants are cost effective whenever gas is available at reasonable costs. During cold weather conditions, natural gas can be reserved for residential heating rather than to produce electric energy. Diesel generators are cost effective when used in central heat and power applications with fuel costs less than $2.50 per gallon.

Generally, customers are willing to pay a premium for renewable energy, hydropower and wind power that is converted to electric energy. However, this may not be the case going forward as renewable energy replaces fossil fuel-based energy production systems. This is especially true as the U.S. works towards its goal of becoming carbon neutral before 2050.

Consumer Energy Demand

Energy demand is a function of economic conditions, ambient temperature, and consumer awareness. Maximum demand occurs when robust economic conditions coincide with heat waves or cold snaps. Utilities try to prepare for extreme temperatures before they occur by maintaining excess energy production capacity, in reserve, so that unscheduled energy production facility shutdowns do not adversely impact the power grid, like they did in Texas in February 2021.

Currently, most consumers are unaware of their energy costs until the bill arrives. During the Texas winter storm, while a majority of consumers lost power, others saw power bills in the thousands of dollars once their bills arrived. To address this issue, some utilities now offer alerts to consumers when peak demand leads to increased cost of electric energy. This allows consumers to curtail their electricity use to reduce their electric bill.

Table 3 lists monthly peak loads and excess energy production capacity for areas in the northern United States. Energy production facilities and the electric power grid are designed to accommodate peak load conditions that occur a few days each year.

During peak load demand in August, 15% excess energy production capacity should be available. During April and May, excess energy production capacity can appear to be as high as 65% as the number of energy production facilities remains the same, but demand for energy decreases.

Balancing Profitability and Effectiveness

Buying electric energy at any price to avoid energy shortfalls is an outdated concept that needs to be revised. Today’s method of billing via KWH consumption should be replaced with flat rate monthly billing, where energy production facility profits are based on long term performance.

Utilities should use algorithms to quantify risk factors, such as inflation, fuel costs, economic activity, or weather conditions, and then refer to those risk factors to determine monthly rates for the next calendar year. With modern analytic capabilities, consumer energy costs and consumption can be accurately modeled.

Energy rates should include base rates and consumption charges with optional upgrades, like many other subscription or leasing services. Incentives, market caps, and cost restraints can help to eliminate the risk of sky-high energy bills and guarantee reductions in greenhouse gas emissions. Follow Prescient’s blog to learn more about these potential solutions, and contact us with questions.

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