Unraveling the Electricity Pricing Mystery

Posted by: Lyman from the Shop My Power Team

Many people ask “How is electricity priced” and “What makes the price of Electricity move up and down so frequently and many times seasonally?” Without getting entirely too technical, we’ll try and explain this pricing and free market mechanism in Layman’s terms.

First of all electricity has been and always will be produced by a generator consuming some type of fuel source.  Today, numerous fuel sources exist that can be used to generate electricity.  All of these fuel sources; solar, wind, coal, natural gas, fuel oil, or lastly uranium in nuclear units, have differing costs.

 Wind Turbines

Wind that turns a wind turbine, the sun that heats a solar panel, or water that turns a turbine at a hydroelectric dam, we might call FREE sources of fuel.  BUT, these wind turbines, solar panels and dams have costs to manufacture, install and commission the equipment that must be paid back over time.  This capital is returned to the investors by the generator selling electricity into the wholesale power markets.  The idea is to hopefully sell the power above the cost it took to: produce the power and the other costs involved to keep the generator continually in good operating condition so it can generate and sell electricity.

The price of power in the wholesale market is determined by the demand for the electricity.

  This supply/demand relationship is why in the summer months in Texas, consumers tend to see higher electricity prices.

These higher electricity prices, in August versus March, are a direct result of the generators that are being called upon, or dispatched, into what is called the market generation stack.  In March there is not a great demand for air conditioning, but in August, the electricity demand to keep Texans cool is significant!  Also, as consumers, we use electricity differently during different parts of the day.  During the night we are sleeping and not demanding as much electricity but when we return home from work at 5:30 in the evening we may want the house cool, so our electricity consumption rises with the air conditioning load.

 

As the demand for electricity rises the stack begins to get taller as more and more units are called upon and dispatched.  Below is a graphic of a generation stack from a U.S. power market other than Texas, but the illustration applies to Texas, as well.

Market Price Graph_Lyman Wilkes

As the graph above shows, the greater the demand for electricity, the more generation units must increase output or come online as can be seen by the Peaking (purple) line adding to the amount of electricity generated and so the price of electricity will rise.  As the less efficient generation units that require higher prices for their generation and investment return to their investors come online, the market heat rate rises.  Simply put, heat rate is a measure of the efficiency of a generation unit to convert fuel into electricity.  A nuclear generator or a Qualified Facility (QF) are generators that are running almost constantly so they are what is called baseload and are some of the lowest cost generation in the stack and generation that cannot move up or down easily with changes in demand.

Being smart about how we use electricity and how we shop for electricity, is the best way to get the lowest electricity price.

In conclusion, it is the demand for electricity that affects the market prices whether it is the time of day or time of the year.  The graph above shows hypothetical prices for electricity occurring over a 24 hour period ranging from $28 to a high of $49 per megawatt hour.  As consumers, we buy electricity by the kilowatt hour, or 1/100 of a megawatt, so this equals 2.8 to 4.9 cents per kilowatt hour.  Also, the steepness of the valleys and peaks will also change during the different times of the year. We hope this blog helps you understand this component in the electricity market.  Stay tuned for more.

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