Energy Costs are falling but my Electric Supply Cost is Rising.
Why is this happening and can I prevent it?
Your electric costs consist of several different components, some of which you have control over and others that you do not. Before you can begin to control these costs and plan for increases that are certainly on the way, you must first understand exactly how your electric costs are calculated.
Your electric utility costs are comprised of two major components; first is the local utility delivery charge, these rates are regulated by the state and are based on the amount of energy that flows through the meter. Historically, utility costs represent about 25% of the total expense but may range from a low of 10% to a high of 50% depending on electric supply costs and your utility rate class. The easiest way to control utility costs is by changing the amount of energy you consume or when you consume it. Generally speaking, the most economical way to alter these costs is by reducing your overall electric use through conservation and implementation of energy efficiency projects. The second major component is the supply cost. Unlike utility delivery costs, you have the ability to control these costs, or at least predetermine the cost based on open market bidding. Supply rates are based on a number of factors ranging from the actual cost to generate electricity, the capacity associated with energy consumed throughout the entire region, transmission costs, line losses, renewable portfolio standard (RPS) and other ancillary costs that go into generating energy and moving it from a power plant to the local utility.
See chart to the right for a breakout of the average historical percentage of cost associated with supply and delivery. What the chart to the right does not show is the various components that make up your supply costs today and into the future compared to what they were five or even two years ago.
More than 50% of all electric generation in New England is fired by natural gas compared to less than 20% fifteen years ago and as natural gas prices rise and fall, electric generation costs will rise and fall. From 2010 to 2018, energy has gone from being more than 60% of the overall supply costs to what is currently forecasted to be a little more than 40% of the overall costs. This represents a 33% reduction in energy generation costs when compared to the beginning of the decade. Another reason for the variation in overall electric supply costs is changing costs for things like capacity, renewable portfolio standard (RPS) and other ancillary costs. Over the past few years, electric supply costs have been as high as $.12 per kwh and as low as $.06 and are forecasted to be close to $.11 per kwh in next few years. Higher electric supply costs are occuring all at a time when prices for other energy related fuels like crude oil, heating oil, gasoline and natural gas are all falling to lowest levels in fifteen years. So why is electricity the exception when it comes to falling energy prices?
Below is a chart that shows the different cost components associated with your total supply costs between 2010 and 2018. As you will see, back in 2014, energy represented about $.085/kwh of your total supply costs while capacity and RPS were less than $.02/kwh combined. Compare this to what is forecasted to be supply costs in 2018 when energy may only represent about $.045/kwh of the total supply costs while capacity and RPS will balloon to a combined cost of more than $.05/kwh of the total cost. Why are we seeing this shift in the make up of your electric supply costs? First of all, as we discussed earlier, natural gas prices have been falling and the lower fuel input costs associated with generating electricity is having a direct effect in lowering these costs. However, MA mandated increases in a larger mix of renewable energy as part of the overall electric generation mix is causing RPS costs to rise. Going back a decade renewable energy made up less than 2% of the overall energy mix in Massachusetts but this percentage must be 15% by the year 2020! At a time when natural gas prices are falling and driving electric generation costs lower, a mandated requirement to purchase more renewal energy like wind, solar, biomass and hydro is causing this portion of your supply costs to rise. Overall, RPS costs have increased ten fold in the past fifteen years! These higher costs are paid by all consumers of electricity regardless of whom you buy your enrgy from.
To further understand electric supply cost we need to take a closer look at the next largest cost associated with electric supply, capacity. Capacity costs consists of two components, capacity rates (set by the market and already known for the next three years, you have no control over these costs) and your capacity tag. You have control over determining your capacity tag. Each of these items requires additional discussion.
Capacity Costs – These costs are set in forward market trading three years in advance. These are prices bid into the electric grid operator (ISO – NE) by power generators that assure that the region will have enough power to meet demand. You may think of capacity as your reservation between the power plants and the transmission lines to meet your electric demand. This space, reserved for you by your local utility, is determined by your capacity tag.
Unfortunately, generation capacity will be coming from fewer resources and future prices have already risen as a result of power plant closings. With previously announced power plant closings like Pilgrim and Vermont Nuclear as well as coal-fired Brayton Point, New England will see a reduction of more than 3,500 megawatts of power in the next couple of years (enough power to serve more than 2.2 million homes) and more plants may follow suit in years to come. As is the case with just about any product you are purchasing; as you reduce supply at a time when demand is rising prices will also rise and electricity is no different. Plant closings will not have any affect on ability to meet demand it just means we have to pay more for it.
Capacity Tag – Every consumer of electricity in the region is assigned a capacity tag. This number is the amount of capacity the utility has reserved for you to meet your peak demand. Your capacity tag is set every year and is based on your percentage of electric load consumed during the highest demand day of the year. Historically, this will happen on the hottest day of the year. Controlling the amount of energy, which you consume on the day that capacity tags are set will help lower your capacity tag and therefore lower this cost for you in the future.
Finally, there are a number of smaller components that make up the remainder of your final all in electric supply cost. This includes lines losses (amount of energy that is lost as energy travels from power generating facilities to your building), transmission, winter reliability (cost to meet peak demand in the winter time due to limited natural gas pipeline capacity) and other miscellaneous ancillary costs.
So what does this all mean?
- Electric generation costs are falling as a result of natural gas prices falling. We have seen a 50% reduction in this portion of your electric supply costs (dropping from $.08/kwh to $.04/kwh) over the past few years. However, keep in mind that energy prices will not remain low forever and a plan must be put into place to buy energy while these prices are near historic lows. Even if this means your overall supply costs will be higher!
- Higher capacity rates have already been bid into the market and accepted so you will start to see the impact of these costs starting in 2017.
- Controlling your capacity tag will help lower overall supply costs into the future.
- Reducing demand with conservation and energy efficiency programs or implementing a program with staff, engineering and facilities to keep demand lower on the hottest day of the year this summer will lower your supply costs for the entire following year. (Remember that you need to have a pricing program that will allow you to capture these savings).
- Utilizing energy efficiency programs and rebates will help you save money in two ways.
- Lower capacity tags.
- Lower overall energy use.
- Having control of as much as 75% of your total electric costs gives those that take an active approach to managing these costs the opportunity to plan ahead for increases or adjust purchasing plans and or energy use to limit these increases. Actively managing your energy supply costs will also give you the flexibility to take advantage of decreases in the market when they occur as well.
Given the complexity associated with buying energy and controlling costs, a team of energy professionals is needed to design, implement and monitor the results of your overall energy strategy. Your energy strategy must include everything from how you structure your supply pricing and implement procurement plans, down to how and when you consume your energy. Taylor Consulting has the resources and tools to assist you with your energy planning and to help you navigate this intricate marketplace. A sound plan today will not only help you control costs now but will also help reduce costs and minimize increases that are certainly going to happen over the next 3-5 years.
To learn more about how we may help you manage your energy costs, please contact your Taylor representative.