Top 5 Drivers of Retail Power Prices

So, what are the biggest factors driving retail energy prices? And, more importantly, what is it about these factors that inform shifts in retail energy pricing? We've got the low-down.

Many factors play a role in driving retail power prices – so many factors that most energy companies, and many end users, employ teams of analysts to track all the moving parts that so greatly affect their costs and exposure to risk.

So, what are the biggest factors driving retail energy prices? And, more importantly, what is it about these factors that inform shifts in retail energy pricing?

In our 50+ years of experience working with the wholesale and retail power markets, we have identified the key drivers that should be in the minds of every energy marketer, and a part of daily discourse for retailers, wholesalers, traders, and end-users alike.

Here are TRUELight’s Top 5 Drivers of Retail Energy Prices:

1.) Demand

The primary driver for retail power prices is demand. It is demand that requires generators to supply power, and transmission/distribution lines to deliver power from the point of generation to the point of demand. More generally, demand for electricity drives the necessity of the entire power system apparatus. Demand boils down into two key areas – long term trends and seasonal trends.

In the long term, population and industrial growth/decline defines the exact amount of energy needed. Generation developers then respond by investing in and developing new generators if necessary. In the short term, seasonal patterns drive demand. Take ERCOT for example: the heat of a Texas summer will result in increased air conditioning use that collectively guzzles up electricity and drives up power prices in the wholesale market, which translates into the retail market. Similarly, the cold weather associated with a New England winter will drive up demand for space heating in the same way.

2.) Supply

Supply of electricity is the second most important driver for retail power prices. Supply and demand together form the backbone of any organized market, and power is no exception. While demand defines how much power needs to be generated, the cost to generate power is what ultimately determines how expensive or cheap that power is. Traditionally, large baseload thermal power plants supply the bulk of power around the clock. However, numerous factors have disrupted this paradigm across the country, including natural gas and renewable (wind and solar) generation. The proliferation of renewables and cheap natural gas provides stiff competition to traditional baseload coal and nuclear generators, resulting in an economic retirement for these larger supply units.

The changing supply stacks ultimately result in increased price volatility, as an increasing portion of power supply is either subject to wild swings in the natural gas market or is unresponsive to real-time price signals due to the intermittent nature of wind and solar generation. Finally, increasing Renewable Portfolio Standards (RPS) across most states in the US drives even more development of wind and solar generation by requiring load severing entities to purchase RECs (Renewable Energy Credit) and/or SRECs (Solar Renewable Energy Credit) as a portion of their portfolio.

3.) Transmission

Though supply and demand are the most important drivers of retail power prices, they don’t tell the complete story. Ever since electric utilities shifted towards large-scale centralized generation, high-value investments into transmission infrastructure has been necessary to transport power from where it is generated, often in remote areas, to where it is most needed in urban load centers. The explosion of renewables highlights this growing disconnect, as wind turbines are developed in the windy plains that are far from larger power demand. In order to both maintain the current network and recover costly investments in building out new infrastructure, transmission charges are passed along to retail customers as a necessary component of the electric bill.

4.) Capacity (or lack thereof)

In the Northeast ISOs, structured forward capacity markets enable generation developers to secure revenue needed to build new power plants or upgrade online assets that are aging. Capacity prices also act as signals that communicate how much new generation is needed in a given area. A region with low capacity prices is unlikely to attract significant new power plant development, and vice versa. Through these forward auctions, money moves from the load side to the generation side. As a result, capacity costs move downstream to retail electric customers. ERCOT is different from the other ISOs in that it does not have a forward capacity market, instead relying on forward wholesale power prices to provide the economic signals that dictate power plant investment.

5.) Peak Load Contribution (PLC)

While this comes in different forms depending on the ISO, the fundamentals are the same: The ISO measures a customer’s peak load contribution during periods where overall system demand is highest. In other words, the PLC represents how much power a customer consumed during the highest peak demand periods of the year. If the load user’s contribution to demand is relatively small compared to other customers, they’ll experience lower PLC charges the following year. Conversely, if a load user’s contribution to the peak demand is relatively high compared to other customers, then they’ll experience higher PLC charges the next year. Both ISONE and NYISO call this the Installed Capacity tag, or ICAP. PLC is an important driver for retail energy prices and requires proper management to ensure future savings.

These 5 top factors can have a significant and dynamic impact on any firm’s energy costs, which is why incorporating them into one’s energy strategy is so fundamental.

We track these essential elements and more to maintain our proprietary pricing models, which are market-tested for proven accuracy. It is in this way that we are able to provide unparalleled transparency to our industry. Make sure that you are accurately capturing this dynamic power pricing landscape!

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© 2019 by TRUELight Energy LLC

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