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How Does Electricity Pricing Work? Understanding Energy Costs

5 minutes
02/07/2024
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Electricity use is on the rise in many parts of the country. Sometimes, this increase in demand drives prices higher. The Energy Information Administration (EIA) says U.S. power generation totaled 4.24 trillion kWh in 2022, up more than 25% since 1990. 

Fortunately, more and more electricity is coming from clean, renewable sources. Most notable is the increased use of wind turbines and solar installations to generate power.

The Major Influences on Electricity Pricing

So, what’s driving energy prices? The cost of fuel and power plant operations are key factors. Rates also reflect the cost to transmit and distribute it.  On average, generating electricity accounts for 61.6% of the price. Distribution accounts for 26.3%, and transmission accounts for 12.1%. 

Fuel Costs

Fossil fuels still account for about 60% of U.S. electricity generation. In 2022, natural gas supplied 39.8%; coal 19.5%; and petroleum, less than 1%. Things are quickly changing, however. For example, coal accounts for less than half the electricity it supplied 15 years ago. An estimated 11 GW of capacity will retire in 2023-24 alone.

As the use of fossil fuels declines, the impact of fluctuating fuel costs does as well. By comparison, the sunlight and wind that power photovoltaic cells and wind turbines are free. Utilities look to renewable energy (and battery storage) to diversify portfolios. Getting energy from different sources insulates the utilities and their customers from sudden price spikes. 

As of 2021, the nation’s power plants consumed about 92% of U.S. coal production. Since most of it is supplied via long-term contracts, prices are relatively stable. However, a review of natural gas electric power prices reveals recent volatility. For example, the August 2022 price per thousand cubic feet was $9.33. This was more than double the $4.59 price twelve months earlier. Those who rely on electricity from natural gas are vulnerable to these price swings.

Meanwhile, costs associated with wind and solar energy are declining. From 2009 to 2017, the cost of harnessing wind power declined by 67%. During that same period, the cost of solar power declined an impressive 86%. 

Power Plant Operations

New power plants are expensive to construct and to finance. Nonetheless, natural gas-fired capacity continues to go on-line. For the two-year period 2022-23, 27 new plants will add 14.2 GW of capacity. The EIA predicts 20 new gas-fired plants to come online in 2024-25, adding another 7.7 GW of capacity.

It is also expensive to operate and maintain existing plants. Many coal-fired and natural gas power plants are aging, and maintenance costs are rising. The average coal-fired plant is 43 years old, and the average natural gas-powered plant is 24 years old. New emissions requirements also increase costs at fossil fuel-powered plants.

Transmission and Distribution

The electrification of America is a relatively recent phenomenon. In 1907, only eight percent of households had access to electric power. Today the entire population has access. Electricity gets delivered via a grid featuring 600,000 miles of backbone transmission lines. It also includes 5.5 million miles of local distribution lines.  More than 500 transmission and distribution utilities (TDUs) perform repairs following extreme weather events and other natural disasters. They must also invest in cyber security. All these costs get passed on to end users. 

As the New York Times points out, there is no single electric grid in the United States. There is one in the East, one in the West, and one that primarily serves Texas. Little power gets shared between them. This fragmented grid is an obstacle as utility-grade solar and wind power come on line. This requires another round of infrastructure investment as sources of renewable electricity proliferate.

External Factors Affecting Electricity Prices

When you ask, “Why does the price of electricity increase?” it is also important to note external factors. These include conflicts around the world such as extreme weather and global conflicts.  

Weather Conditions

Increasing extreme weather conditions and an aging infrastructure are an expensive combination. A NASA graph depicts atmospheric warming since 1960. Record heat waves strain electric grids, and Arctic cold does as well. Weather.com notes how heat waves are becoming hotter and longer lasting. Recent research suggests that hurricanes that strike the U.S. are getting stronger. Winds and floods damage infrastructure, raising repair costs.  

Global Events

Today’s energy markets are global in nature. One of the wild cards in energy pricing is the potential for disruptive events around the world. For example, the Middle East accounts for 31% of global oil production and 18% of natural gas production. Here and elsewhere, conflicts may disrupt production, causing prices to spike. 

Understanding the Fluctuations: Demand and Supply

Retail electricity rates tend to follow seasonal fluctuations in wholesale costs. Graphs prepared by the EIA illustrate seasonal fluctuations, year after year. Summer rates may spike as pricier  sources get added to meet higher demand. 

Peak Hours and Demand

Usage also tends to spike during the business day. To avoid brownouts and blackouts, a utility must have the capacity to deliver electricity in times of peak demand. To reduce such demand, utilities offer discounts to customers who agree to reduce consumption when demand is high. Since the higher-priced hours are often the most emissions intensive, those who cut their usage also help the environment.  

Energy Source Availability

In 2022, renewable energy generation surpassed coal-powered generation for the first time. Fourteen percent of total utility-grade generation came from wind and solar. As of early 2023, utility-grade solar capacity totalled 73.5 gigawatts (GW), while utility-grade wind power capacity totalled 141.3 GW. About 8.5 GW of utility-grade wind power capacity came online in 2022 alone.  

Renewable energy is now very cost-competitive with energy generated from fossil fuels. Areas that get more electricity from renewable sources face fewer challenges when fossil fuel prices spike. However, the intermittent nature of wind and solar power remains a problem. The sun doesn’t always shine, and the wind doesn’t always blow. Utility-grade battery storage addresses this concern. Batteries store renewable energy, delivering it when needed. 

The Role of Energy Choice in Pricing

In theory, deregulated electricity markets that foster competition should deliver lower energy prices. In deregulated states, energy brokers help both residential and commercial customers find the best rates. 

The Deregulated Energy Market

In regulated states, consumers must accept the designated utility’s choice of energy supplier. But, how does energy pricing work in deregulated states? Here, consumers may limit their energy costs by taking advantage of competition between multiple retail energy providers (REPs). Providers compete on rate, length of contract, rebates, and more. Competition among REPs  may also drive innovation. This may speed the deployment of new cost-saving technologies.    

Practical Tips for Consumers

How is electricity priced where you live? According to the EIA, the average 2022 residential retail electricity price was 15.12 cents per kWh. The average commercial rate per kWh was 12.55 cents, and the industrial rate was 8.45 cents. However, prices vary. In 2022, it was 8.24 cents in Wyoming, but 39.85 cents in Hawaii.

Some consumers pay less by taking advantage of time-of-use plans. You can also cut your bill by reducing your energy consumption.     

Time-of-Day Pricing

Time-of-use (TOU) pricing adjusts the rate you pay at different times of the day. Such plans consider two key variables: the cost to generate electricity and demand. Rates may vary by season, weekdays vs weekend, holidays, and time of day. For example, a TOU plan might charge the highest rates from 5:00-8:00 pm on weekdays. 

Consumers benefit if they can align their usage with the right electricity plan. For example, a TOU plan might be attractive to an EV owner who charges his/her vehicle at night. 

Energy Conservation

The easiest way to reduce your utility bill is to use less energy. You can switch to LED lighting, use cold water for laundry, and reduce “always on” settings on electronics. To use even less energy, invest in a smart thermostat, energy-efficient appliances, and better insulation. For more ideas, consider these energy-saving strategies

How Price to Compare Can Help

Price to Compare is a user-friendly, online energy marketplace. Check out our online comparison tool, or speak with one of our expert energy consultants today!