by Michael S. Payne, JD, LLM
Historically low electricity and natural gas prices are making headlines, but what lies ahead for theUnited Statesenergy market? In this two-part series, we’ll describe the factors impacting electricity and natural gas prices nationwide. Electricity prices closely track natural gas prices, but the two are not completely synchronized. And, natural gas is used to generate a significant portion of the electricity consumed in theUnited States.
What determines electricity prices?
Electricity prices change constantly—literally every five minutes, every day. A multitude of factors affect prices, some modestly, some dramatically. Some factors have a short term impact while others are long lasting. For example, weather conditions, natural disasters, and consumer demand influence electricity prices from one day to the next. Legislation, regulatory changes, generation efficiency, and electricity grid and infrastructure costs impact electricity prices on a long-term basis. Commodity investors and speculators have been a dominant force in electricity pricing. Remember in 2008 when oil prices were at $140 per barrel? Electricity prices peaked then, as well.
Disasters. In 2005, the hurricane season produced destructive storms, most notably Rita and Katrina, and the cost of electricity skyrocketed. Since 2005, hurricane seasons have remained relatively calm and had minimal influence on electricity prices. Of course, hurricanes, earthquakes, winter storms, and other major weather events cause price volatility.
In addition to causing prices to spike, natural disasters have ripple effects through the energy industry. For example, when an earthquake and tsunami devastatedJapanin 2011, a nuclear meltdown ensued at Fukushima Daiichi Nuclear Power Station. In theUnited States, the Nuclear Regulatory Commission reviewed the ability of domestic nuclear reactors to withstand natural disasters. As a result, several nuclear facilities were taken offline, and some new nuclear projects were abandoned at substantial economic loss to facility owners and local communities.
Disasters are felt on a political and governmental level too. Democrats and Republicans often disagree in response to disasters, such as theFukushimanuclear meltdown and the BP oil spill in theGulf of Mexico. This causes delayed responses and additional costs to consumers. A bipartisan approach is needed to implement a national energy plan.
Legislation/Regulations. A cohesive, harmonious energy strategy between government and the private sector on a nationwide level is pivotal for theU.S. to advance its energy markets. The Smart Energy Act of 2012 (H.R. 4017) and the Environmental Protection Agency’s Cross-state Air Pollution Rule both demonstrate the need for bipartisan legislation. Prudent regulatory measures must be developed and set into play to enhance growth and address environmental concerns. In the next decade, electricity pricing will continue to be affected by energy efficiency standards and power plant emissions restrictions. Opportunities exist for innovations and the creation of new products and services to meet these challenges.
Infrastructure. Who will pay for smart technology and necessary upgrades to our grid systems? Comprised of millions of individual meters and thousands of local networks, our electricity infrastructure is expensive, challenging to maintain, and rapidly aging. Trillions of dollars must be invested nationally in the next few decades to upgrade from the current infrastructure to a modernized, fully interactive, self-healing Smart Grid. As utilities are required to rebuild transmission systems to ensure reliable delivery of electricity to homes and businesses, consumers will see electricity delivery costs rise to cover necessary expenditures. Just a few of many needed upgrades include reclosers, capacitor banks, voltage regulators, automated switches, smart meters, substation transformer monitors, distribution management system platforms, volt/VAR optimization applications, and fault location, isolation, and service restoration applications. Some utilities are spending tens of millions per year. While federal stimulus funds have been issued to some utilities for upgrades, most utilities will continually increase delivery tariff rates to cover costs.
Environmental effects. The environmental consequences of coal mining, gas drilling, and power plant emissions affect electricity prices. In February 2012, the Nuclear Regulatory Committee approved two new nuclear power reactors for the first time in the USA since the partial meltdown at Pennsylvania’s Three Mile Island plant in 1979. Green or renewable generation, including solar, wind, and hydro, continues to slowly grow. Most of our nation’s electricity is generated from coal-burning power plants. The EPA has cracked down on air pollution, imposing strict limits on environmental emissions from coal-burning plants. (See how the EPA’s Cross-state Air Pollution Rule impacts power plants.)
Meanwhile, natural gas-fired power plants are less expensive to build and often less expensive to operate than coal-burning plants. In the last 5 years, natural gas drillers have produced an abundance of shale gas, which is now in storage and ready to be consumed. (See the impacts of gas drilling in PA.) As electricity prices plummet, more power plants convert from coal to natural gas for electricity generation. Lower electricity prices also have the effect of slowing implementation of renewable generation because the costs of installing a green system remain high relative to the cost of traditional electricity.
Weather. Across most of theU.S., the 2011-2012 winter season was exceptionally mild. Demand decreased for electricity to heat homes and businesses as outdoor temperatures were several degrees above normal. Lower demand pushed prices down. In situations when winter weather causes an increase in heating demand, electricity prices tick up.
In the summer of 2011, record high temperatures plagued parts of the U.S. Texas was particularly hard hit. Hot weather significantly increases electricity demand as consumers operate HVAC units to cool homes, churches, schools, businesses, and other buildings. The summer is when consumers participating in Demand Response programs are most likely to be notified to reduce consumption during peak usage periods. At peak times, the grid system can become overwhelmed by consumer demand, which causes electricity prices to drastically climb and be extremely volatile.
Consumer demand. Ultimately, electricity prices are affected most by the amount of consumer usage, and the time of day and season that electrons are consumed. Every day, grid systems across theU.S. work constantly to provide reliable supply to all consumers. Imagine the ever-increasing demand for electricity for schools, institutions, individuals, businesses, government, and other consumers. It makes sense that electricity prices are highest during times of peak demand in the late afternoon, and lowest overnight when demand drops. In any case, usage is likely to steadily increase.
Coming soon… Energy Outlook, Part 2: What affects natural gas prices?
About the author
Michael S. Payne, JD, LLM, is Executive Vice President & Corporate Counsel of Affiliated Power Purchasers International LLC (APPI Energy), an independent consulting firm that is endorsed by 140 affinity groups. Since 1996, APPI Energy has assisted more than 3,300 organizations with locations across the United States to reduce and manage energy costs. For unbiased advice, at no upfront cost to you, contact APPI Energy at 800-520-6685.