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What Energy Efficiency Engineers MUST Know About Wholesale Electricity


To be honest, I rarely thought about the supply side of electricity until I started consulting with electric utilities. After all, I’m an energy efficiency engineer. I worked to save building owners electricity costs. Why should I worry about the source of electricity? All I cared about was the total usage (kWh), monthly peak demand (kW), and the rates associated with each of these numbers. The reason that I started working with utility companies in 1998 was that they were facing the threat of deregulation. Electric utilities were convinced that they needed to develop alternative business strategies as competing for customers on the sale of electricity would diminish profits.


I remember clearly one time I was looking over the shoulder of a staff member of one of our utility customers and saw what looked like a sine-wave on his computer screen. As a curious engineer, I wanted to know what he was doing. He said that he was trying to predict the capacity of power generation they needed for the next day. I was fascinated. The utility needed to generate exactly the amount of power needed for each period of the day. If they ran out of generation capacity, they needed to purchase that power from an another electricity generator on the grid.


At this same time, electric utilities were trying experimental retail electricity rate structures to larger commercial customers called Time of Day Pricing. If the customer could shed peak or turn off electric load at a moments notice, they’d be able to save a ton of money on their electric bill during these peak periods. I suppose this is where I got a glimpse of what was happening on the supply side.


Fast forward to today (2023) and there are some interesting movements in play.

The first movement is the move to reduce carbon emissions. This movement has resulted in pressure to use solar and wind energy as a clean energy source that doesn’t emit carbon.


The second movement is states adopting Renewable Portfolio Standards (RPS) that set targets to generate a certain percentage of their electricity with renewable generation. For instance, California has set a goal to be carbon neutral by 2045. This means no electricity generated by coal, natural gas, or oil.


The third movement is electrifying buildings, automobiles, and anything that currently uses natural gas, gasoline, coal, or any other form of hydrocarbon fuel.


The Heart of Wholesale Electricity is the ISO

Independent System Operators (ISO’s) and Regional Transmission Organizations (RTO’s) are responsible for coordinating electricity supply generation to match electricity demand. To give you insight into how an ISO operates, here is a snapshot of the screen of the California ISO on a slow Sunday. You can see this any day at https://www.caiso.com/TodaysOutlook/ . This image is available to anyone on the internet.

Let’s think about what is happening in this graph. The ISO is trying to accomplish two goals: 1) the lowest cost per MW; and 2) Eliminating transmission/distribution congestion. When I say lowest cost per MW, I mean lowest “marginal cost”. Marginal cost is the cost it takes to generate an additional MW of energy for that specific energy source. It is not the total cost of generation for that electricity source. As it happens, the lowest marginal cost will always favor renewable energy generation like solar, wind and hydropower. Wind and solar energy sources only generate when the wind is blowing, or the sun is shining. Hydropower is more flexible.


When renewable energy increases in capacity, natural gas generation declines; battery banks switch from discharging to charging, less water is released through hydro-electric dams, and imports are reduced. An import is electricity purchased from another region. Nuclear and coal generated electricity stay constant supplying the base load of electricity.


On the demand side of the equation, the California ISO is looking at a picture that looks like this:

The teal-colored line is the electric demand. The purple line is the amount of non-renewable energy generation. The yellow line is the amount of solar energy, and the blue line is the wind energy available. The teal area of the graph is the amount of electricity demand currently being generated by renewable energy sources.


In effect, the ISO tries to maximize the use of renewable energy, minimize the amount of imports, and ensure that electricity demand is met by electricity supply.


Wholesale Electricity Market

The utility companies are purchasing electricity through the ISO through four different methods: 1) Capacity; 2) Baseload; 3) Day-ahead; and 4) Intraday. Capacity is the overall generation capacity a retailer believes they need for their territory. Regardless of whether or not they use this capacity, they must pay a price to have this capacity available. The rest of three markets are for marginal cost that is paid above the capacity cost. The baseload market is a long-term purchase at a price that will serve the baseload of customers regardless of fluctuations in demand. This electricity is often purchased at a relatively low price in a long-term contract. The day-ahead market is a bid and purchase made a day before the electricity is needed. This is where sophisticated algorithms are used to predict how much power is needed. Retailers bid on electricity on an hourly basis. The intraday market is based on payment to provide power in 15-minute increments. The cheapest marginal cost power is purchased in baseload. The day-ahead market is more expensive. The intraday is the most expensive.


Increasing Electricity Costs

I was impressed with the California ISO website. However, a nagging question arose, “If California is so diligent about ensuring their territory gets the cheapest power, why is California power so expensive?” In 1998, the average price for electricity was $0.106 per kWh. In 2022, the price has risen to $0.26 per kWh. This is 37% greater of an increase than the cost of inflation.


The answer to this question is quite complicated. Wholesale electricity buyers and sellers are participating in the California ISO market. Retail energy users are paying the retail electricity price.

A building owner buys electricity from a reseller or retailer. The retailer will add several fees and costs to the bill to that are allowed by the Public Utilities Commission (PUC). Every mistake the utility companies have ever made are included in the bill to a residential customer. In addition to that, the capital cost for new generation or stranded utility assets are often recovered in the bill to the customer.


Is it any wonder that the retail electricity bill is starting to get very confusing? Here is an example of a Southern California Edison electric bill from 2018.

As you can see in this bill, this customer is paying more for electricity that has exceeded their usage patterns in the previous year. Why? Because the retailer is buying electricity based on expected consumption. When they need to buy more electricity than expected, they pay a higher price on the day-ahead or intraday market.


So what?

Let’s get back to the main question, what is causing the rise in electricity prices? There are three main causes: 1) Renewable Portfolio Standards (RPS); 2) Duplication of Generation; 3) Electrification; and 4) Monopoly Control.


Renewable Portfolio Standards

As you can see by the California ISO chart, renewable energy from wind and solar can only happen wind is blowing or the sun is shining. Because California has invested mostly in solar power, this power is only available, on average, 8-hours per day (if it’s not cloudy). This means that the most renewable could contribute to electricity consumption is 33% (8 hrs ÷24 hrs/day). This is if solar can provide 100% of the electricity demand for a given territory. California has a Renewable Portfolio Standard of 100% (0 Carbon Emissions by 2045). The only way they can accomplish this goal is by purchasing very expensive battery banks to store power for solar generation. They will then need to purchase double the solar they currently have in order to charge the added batteries. This will not be cheap.


Duplication of Generation

Let’s say that you have a home in Minnesota. You don’t like cold Minnesota winters, so you buy another home in Florida. You live in your Minnesota home in the summer months, and your Florida home in the winter months. No one can rent these homes from you when you’re not there; and you won’t be able to sell either home to a buyer in the future. Your cost of home ownership will be quite high indeed. Now, let’s say that some philanthropist will pay for your cost of home ownership no matter how you live. You pass on the cost of your two homes to the philanthropist and live the good life.

This story is very whacky. No one would do that. Right? In this story, the philanthropist is the electricity rate payer; and the home owner are the utilities who are being forced to provide two sources of electricity generation. As the rate payer, you have to pay for both generation assets. This is showing up on your utility bill in the form of added fees.


Electrification

I don’t mean to pick on California, but they are leading many energy and climate policies in the United States of America. California is banning the sale of gas-powered vehicles by 2035. Similar bans are being put in place on heating and other gas appliances. These regulations will put more stress on the electric grid. Charging electric cars, cooking, lighting, air conditioning, and home heating will occur when renewable energy generation is at its lowest. This means that this electricity will need to be provided by non-renewable sources. If California sticks to its zero emissions goals for 2045, it’s difficult to understand what this added power generation will come from unless it is imported from adjacent regions at a high cost.


Monopoly Control

We are in a difficult position with utilities. The system is so complicated that we need a central planner and few companies to reduce the complexity to a level of manageability. Some markets still have vertically integrated monopolies where the utility provides generation, transmission, and distribution. They are regulated by PUC’s. Even in deregulated markets, most of the costly part of your utility bill is not under your control.

Let’s face it, when the power goes out in a major weather event, you don’t want to deal with all of the complexity. You just want your power to come back on as soon as possible. So, we tend to be okay with monopolies as long as they work.

Nevertheless, this monopoly control means that consumers do not have much choice but to pay the price they’re told. Best case, they can get competitive prices on 5% of their utility bill in a deregulated market. That’s not much of a savings… is it?


Regulation vs Deregulation – The Phone Company Example

For any of you old-timers, you remember when the regulated monopoly AT&T was broken up into regulated baby-bell companies which eventually got broken by deregulated phone service; and is now almost extinct as cell-phones have taken over the phone market.


The electricity market is on a similar path. In fact, one symptom of this path is the confusing electric bill shown above. The phone bill in the 1990’s was similar. Phone companies used regulators to allow them to pass on fees to customers. The justification was that: 1) phone companies made costly mistakes that they needed to have customers pay for or they’d go away; or 2) regulators forced phone companies to bear certain costs that needed to ultimately be paid by rate payers. The cost of phone service became so high that it was easy to justify lower cost alternatives in later years. As competition took over in the wireless phone market, consumers benefitted by eliminating high long-distance fees; and fixed monthly fees to use a phone.


What does this mean for building owners?

Most businesses I help are focused on saving money and energy for their customers. Challenges with supply side economics may not be apparent at first to building owners. The reason I wrote this article was to illuminate why building owners and energy efficiency engineers must pay attention to movements on the supply side of electricity.


As an energy efficiency engineer, you may be wondering how you can use the information I’ve presented in this article. By understanding how electricity is priced in the wholesale market, you’ll be well on your way to understand how your customers can better match their usage pattern with lowering the cost of retailers and wholesalers. Remember, the key for wholesalers and retailers to reduce their costs is “predictability”. If they can predict demand, they will pay the least amount for power by avoiding intraday prices. Here are a few tactics that may work.


Alternative Rates

Because retailers and wholesalers are navigating the complex world of buying power, they offer creative rates that help them reduce their risk and save money. Investigate what rate structures are available to your customers and what they will need to do in order to qualify for better rates. This is changing all the time.


Peak Load Management

One of the rate structures that has become popular with residential, commercial, and industrial customers is the Time-of-Day pricing. This pricing structure provides low prices when demand is low; and high prices when demand is high. In order to benefit from this rate structure, you must have the ability to shift peak load for your customer. This can happen with ice storage cooling, onsite peak generation, night-time electricity charging, or other peak load strategies.


Site Generation

As fixed costs of utilities continue to rise, ratepayers can justify the cost of installing site generation to provide their own electricity. This can range from off-grid solutions to peak load generation to proportional generation like rooftop solar panels. As of the writing of this article, some large commercial solar installations will result in 2 to 4-year paybacks. This is substantially better than the 20-year paybacks in the early 2000’s.


Wholesale Power

Large utility consumers can participate directly in the wholesale electricity purchasing marketplace. This means that they must have the ability to make bids on an hourly basis for their power demand. They may also have to maintain their own power distribution system with step-down transformers for their own facilities. Such clients as college campuses, military installations, and energy intensive factories are good candidates for direct wholesale power.


Conservation & Efficiency

The best way to avoid high energy costs in any form is to not use energy when you don’t need to use it. Even many of the fixed costs transferred to customers are charged by electricity usage (kWH) or electricity demand (kW). This means that if you reduce electricity consumption and demand, you will avoid paying these high charges for fixed and variable costs at the same time.


De-electrification

To the extent allowed by local regulations, your clients may benefit from use of natural gas appliances to avoid the high cost of electricity. This was a common strategy in the 1990’s when the price of natural gas was at an all-time low. With the high cost of electricity, even more expensive natural gas is a lower cost alternative.


Conclusion

I hope that this article gives you insight into how electricity is purchased on the wholesale marketplace and how you can help your customers reduce their electric bill.

 

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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