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The Energy (Electricity) Economy


If you work in energy efficiency or any other energy field, it’s critical that you understand the economics of energy. For instance…


  • Why does electricity cost $0.44/kWh in Hawaii; $0.26/kWh in California; and $0.10/kWh in Idaho?

  • Why, in New York, does a residential building owner pay $0.24 per kWh while an industrial customer pays only $0.07 for that same kWh?

  • Why did average electricity prices in the United States increase by 22% in President Biden’s first two years in office; and only 8% in President Obama and President Trump’s 6-years?

  • If natural gas is the same price today as it was in 1994, and it’s the largest percentage of energy used to generate electricity, why are electricity prices double what they were in 1994?

  • Deregulation of the late 1990’s was supposed to reduce the price of electricity, why hasn’t it?

  • If wind and solar are free energy, why is the price of retail electricity increasing rapidly as we install more wind and solar?


Why does any of this matter to Energy Service Companies (ESCo’s) or energy efficiency engineers?


The fact is that most energy efficiency projects are supposed to pay for themselves over a specific period of time. If the energy economy is shifting over that same time period, don’t you think it’d be a good idea to share this information with your customer?


Think about it. A customer wants to replace a natural gas boiler with an electric boiler because the price of natural gas recently spiked to record levels. Wouldn’t you look like fool two years later when the price of electricity in your customer’s region doubles and the price of natural gas drops by 50%?


Rookie energy efficiency engineers can calculate the costs and savings of basic energy conservation measures. What your customers are looking for is an energy expert who can help them make the best decisions for the long term.


This post will help you understand energy price trends so that you can help your customers navigate our “energy economy”.


Natural Gas

The most critical energy price for building heating and cooling is natural gas. Natural gas is used for the majority of building heating needs in the U.S.; and it is also the fuel used to generate the majority of electricity in the U.S. Why? Because it is the cleanest burning fossil fuel we have and it has become abundant through innovative exploration tactics.

It may surprise you to learn that natural gas costs the same today as it did in 1994. As I write this post, the spot price for natural gas is $2.5751 per MMBTU. In 1994, the peak price for natural gas was $2.5540 per MMBTU.


The best way to characterize the natural gas energy economy is that it is volatile. Natural gas prices tend to follow the typical free-market supply and demand economy. When natural gas prices rise, gas companies are incentivized to explore and produce more natural gas. When natural gas reserves are high, prices drop. In recent years, natural gas prices have experienced spikes due to upheaval in Europe. The major natural gas supplier in Europe is Russia. When Russia invades another European nation, natural gas prices are bound to fluctuate.


Regardless of where the price of natural gas is while you do energy work for your client, please advise them of volatility and not a flat, up, or down trend. Us average natural gas rates for the past decade when you estimate natural gas savings or costs.


The Electricity Economy

The natural gas economy is relatively straight forward. The electricity economy has become very complex. That’s why most of this post is focused on the electricity economy. Electricity price is a byproduct economy of multiple different means of generating power, transmitting power, power distribution, government mandates, and consumption of electricity.


Energy Generation

The most common belief about electricity is that it matters what fuel is being used to generate electricity. If natural gas prices rise, then electricity prices will rise. If we use solar and wind energy, we get free energy from nature. Right? Wrong.

The chart above illustrates the percentage of fuel used for generation of electricity from 1950 to 2021. Coal is the cheapest form of fuel if you consider the cost per btu of heat generated. That is probably why coal has been the go-to fuel to generate electricity for most of our history. Coal’s energy price is only $0.032/kWh. Natural gas electricity generation prices range from $0.02/kWh to $0.08/kWh depending on the price of natural gas. Nuclear energy generation by uranium has a fuel price of $0.0015/kWh. The incremental cost of wind and solar energy is $0/kWh. I have not listed the capital or other environmental costs of each fuel source. If you want, you can find the Levelized Cost of Energy (LCOE) that attempts to include added costs associated with each fuel source.


The raw price of fuel does make a difference in the price of electricity. However, it makes such a small difference in the retail electricity rate that it’s not the main economic driver of electricity prices.


Electric Energy vs Capacity

In the 1990’s, it was common knowledge that electricity demand (kw) cost more than electricity usage (kWH). kWh is the measure of electricity energy being consumed; while kW is the rate at which that energy is consumed. A kW is a Joule per Second (yes, our electricity is measured in metric units). A common strategy by energy efficiency engineers was to look at creative ways to reduce the demand charge. The electricity demand charge was charged for the highest 15-minute period of consumption during each billing period. Us energy efficiency engineers were quite creative by using peak demand generators, ice storage cooling, and control systems to avoid paying a high demand charge. This was a great savings because demand charges were often 50% to 75% of the electric bill. The reason for the demand charge was two-fold: 1) the utility needed to recover the infrastructure cost of providing electricity to each customer; and 2) the cost of electricity during a peak period was much more expensive than in non-peak periods. The demand charge was their way of recovering these costs.


In 2005, an interesting phenomenon took place. Electric utilities must have become wise to the demand shifting tactics and they started adding charges to the electric bill that had very little to do with demand or usage. In some cases, there were flat fees. In other cases, they’d create special names to the charge and add it to kWh usage. Average U.S. electricity rates rose from $0.10/kWh to $0.13/kWh from 2005 to 2009.

The challenge for energy efficiency engineers with this new tactic by the utility company was that it became difficult to help your customer reduce their utility bill by saving units of energy (kWH). Why? Because added fixed fees could not be reduced through energy savings.


From 2008 to our present day, this added capacity charge has become the majority of any building owner’s electric bill. This capacity charge rose from 8% of the electric bill in 2008 to 80% of the electric bill in 2018. While the cost of fuel to generate electricity is dropping, the capital costs of generation, transmission, and distribution has been increasing.


Think about it. If a utility spends the money to provide a 1,000 kVA service to a building, they do not save money on infrastructure when you reduce that building owners peak electricity usage from 900 kW to 500 kW. Right? They still must recover the cost of the 1,000 kVA service.


The Over Capacity Problem

So, now you’re aware that electric utilities charge for capacity. But did you know that our electricity usage has remained flat since 2008. Even though capacity charges have been going up, we have not needed more electrical capacity. All of the new electric cars, economic growth, and somehow our electricity demand hasn’t changed since 2008 (see chart above). The reasons for this flat utility electricity consumption are a mystery. As I’ve searched the internet, many believe this flat demand are improved efficiency, outsourced manufacturing, increased site generation, and occasional economic recessions.


One other possible contributor is the reduction in the use of coal. As coal has been used less and less for electricity generation, coal mining operations have used less and less electricity to mine coal. Mining is one of the most electricity intensive industries. It is responsible for consumption of 10% of the world’s electricity. By reducing coal to produce electricity, the amount of electricity needed to mine and deliver coal is also reduced.


You may think that since we don’t need added capacity, capacity charges on our electrical bill will disappear. Wrong! When electric utilities build more capacity then needed, they still must pay for that capacity whether you use it or not. This means that your electric bill will increase even when your usage stays flat.


Renewable Energy Effect

We have added a substantial amount of renewable energy to our electricity generation fuel sources. Wind energy has become quite popular and has grown at a steady pace from 2005 to the present day. Solar electricity generation started its growth spurt in 2012 and is continuing to become a larger part of the renewable energy mix for electricity generators.


While this is exciting for those who desire carbon free electricity generating resources, it doesn’t help your electric bill. Remember I said that we have not increased our usage of electricity since 2008? In a traditional free-market, price drops when demand drops and supply increases. The opposite happens in the utility marketplace. When you overbuild electricity infrastructure, you increase the cost to deliver electricity to the marketplace. Consumers have no choice but to buy from your marketplace because it’s the only game in town. What about deregulation? Deregulation only helps with the energy portion of the electric bill. If you save 10% on 20% of the energy portion of your electric bill, it’s only a 2% savings. It’s not worth picking an electricity provider when competition is neutered like it is in the electricity industry.


In addition to unused electricity generating capacity, wind and solar electricity can only be generated when the sun is shining or the wind is blowing. This means that you must have reserve capacity to generate when these renewable energy sources are not available. This means capacity costs continue to rise.


With all of this going against it, there is one more thing that is increasing the capacity cost of electricity. Many state governments have created aggressive carbon emission reduction mandates. An example of such a mandate is California’s “carbon neutral by 2045” initiative. This means that capacity must grow, and expensive battery storage must be used to help wind and solar generate power during non-sunny and non-windy periods. This capacity cost will ultimately be borne by California’s electric rates.


Electricity Rate Trends

While we have been reducing the cost of generating electricity, our electric rates continue to rise because of the capacity costs that I described in the paragraphs above.


The chart below shows how electricity rates have increased over the past six presidential administrations in the U.S. Electricity rates dipped in the late 1990 when many of these utilities felt they needed to get competitive with electricity deregulation. As deregulation was demonstrated to be more difficult than originally thought, electric rates continued to rise slightly until 2005. Electric utilities were allowed to recover many stranded asset costs by their respective Public Utility Commissions (PUC’s). Electricity rates grew slightly from 2008 to 2020. In 2021, electric rates increased substantially. In states that have aggressive Renewable Portfolio Standards (RPS), electric rates have grown faster than the national average.

As you can imagine, recent dramatic increases in electricity rates may create a high stress on those who are already struggling to pay their electric bill. This has resulted in the addition of government programs to help disadvantages and non-profit organizations. In some cases, these programs are funded by rate payers who are able to pay the higher energy rates…. Which means that their electricity rates will increase further.


Electricity Rates by State & Type

Each state has adopted different energy policies that tend to be reflected in the retail rates their customers pay.

Industrial vs Residential Electricity Rates

It’s important to understand that in some states, industrial energy users are subsidizing low energy prices for residential customers (Florida). In other states, it’s the other way around (New York). In a free-market economy, those who purchase large amounts of a product have leverage to reduce prices. In the energy economy this also holds true. In every case, commercial and industrial rates are less than residential rates. There are many reason for this price disparity: 1) lower distribution costs; 2) competitive options; and 3) negotiating clout.


Lower Distribution Costs : The last leg of electricity getting to your facility is the distribution leg. Electricity is transmitted across the country in very high voltage lines. The voltage is then reduced and distributed by substations to distribution systems in urban centers. Each residential area requires transformers to step down the voltage to a safe level by the time you use it in your house. Industrial and commercial electricity users often own their own step-down transformers and can eliminate some or all of the distribution costs associated with electricity. This results in a lower retail rate for electricity.


Competitive Options: If a customer consumes a lot of electricity, most electricity companies will trip over themselves trying to get this large account. This means they will give a much better rate to a large energy user than a small user. In deregulated states, retail electricity companies compete for these large contracts. Even in deregulated markets, large energy users get better rates.


Negotiating Clout: I’m sure you’ve heard of states giving sales tax concessions for large companies to locate businesses in their state. The same thing happens with utility negotiations. Another tactic is for large industrial customers to self-generate. If you are using 10-Megawatts of electricity, you can easily justify building your own power plant. Why pay for all of the added capacity costs for electric utilities? Just generate your own power. Often times, the threat of this self-generation capability is enough to convince the local utility to give a large industrial client a deal on electricity.


You will notice from the chart above that no matter what the electricity rate is for residential customers, most industrial customers pay the same low rate. This is because industrial customers can leverage electricity rates from state to state. If one state charges too much, that industry will move out of state; or out of country to manage its manufacturing costs.


State Electricity Rates

I’ve tried to layout the cost drivers for electricity in the previous sections. You can see that these capacity challenges show up with each state. The lowest cost electricity is in the Pacific Northwest due to the large availability of hydro-electric dams. The next lowest rates are the sparsely populated Midwest and Southern states who have more traditional electricity generating sources. Many of the Midwestern states are also taking advantage of the abundant availability of wind energy. Urban centers and densely populated states are paying higher rates for more aggressive renewable energy goals and congestion of electric distribution systems.


The one outlier is Hawaii. Hawaii has extremely high electricity prices. This is because Hawaii must ship in oil, propane, and liquid natural gas (LNG) to generate power. They have improved from 8% to 30% renewable energy in the past decade; but still pay a very high rate for electricity.


How can you help your customers?

I’ll admit it, I geek out about economics and energy; and when it comes to electricity economics, I get carried away. As an energy efficiency engineer, it’s important to know what you can do to help your customers make their best decisions with energy efficiency projects.


Given our current electricity economy, you can count on electricity rates rising faster than the rate of inflation to build duplicate capacity. You can also count on the notion that utility companies need to get their customers to pay for these capacity increases regardless of how much energy they use.


My best advice is to pay close attention to the electric utility bill of your customer. See how they pay for electricity. See how the utility is charging for capacity in kWh and kW rates.


Get Off the Grid

Getting off the grid used to be advice you’d get from “preppers”. Preppers are the folks who are convinced the world is going to end and they need to be 100% self-sustaining. The reason I suggest generating as much electricity as you can on site is to avoid the added capacity charges from your electric utility.


I’m not sure how many of you are old enough to remember what it cost to make a long-distance phone call in 1975. It was expensive. The reason was that phone companies needed money to pay for their gigantic infrastructure. Long-distance phone calls seemed to be the way to get the money. Eventually, cell phones were invented, and we were charged by the minute for all calls. Then some innovative companies started installing fiber networks when the internet became all the rage; cell towers were added everywhere, and voice communication was very cheap with this broadband infrastructure. Today, you can pay $30/month and make phone calls to anywhere.


The electricity market is becoming a behemoth with government regulation forcing prices up and up. The only way to alter the trajectory of electricity costs is to self-generate. Your customers can add peak generation or solar panels to start. However, for large clients, it’s a good idea to consider an off-grid strategy. This strategy can improve electricity reliability, and dramatically reduce electricity costs if it’s done right.


Consolidation

Another tactic to reduce prices is to move your client into a better commercial or industrial rate structure. The best way to do this is to consolidate as many buildings as possible. If your customer is a college campus, a military base, an industrial complex, or neighborhood; you can take on the responsibility of electric distribution and save a substantial amount on your electric bill for distribution costs. In some states, you may gain the privilege of purchasing wholesale power.


Aggregation

If buildings are not in the same geographic location, building owners may have the ability to aggregate all of the buildings to buy natural gas and electricity in a more competitive way. The ability to aggregate will depend on regulatory requirements in your state, and the utility company’s policy on such tactics.

 

I hope that this very long discussion on energy economics gives you insight into how energy prices and electricity prices are set in the marketplace; and how you can reduce the cost of energy for your customers now and in the future.

 

About me. I have been actively engaged in the energy efficiency, renewable energy, and energy conservation industry all my professional career from 1987 until now. I was a licensed Professional Engineering in six states and a Certified Energy Manager (CEM). I worked as a sales executive, energy engineer, sales manager, and entrepreneur. I started, grew, and sold my own Energy Service Company (ESCo) called Ennovate Corporation (1997 to 2013). I am now a certified professional business coach for business owners, engineers, and business development executives.



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