Energy 101

The cost of energy services is one of the biggest line items on the corporate budget, yet many companies do not know how to take advantage of deregulated markets to reduce this cost, or roll back consumption to save even more.


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THE US DEREGULATED ELECTRICITY MARKET

An Overview of Structure and Pricing

There are three major components to the supply of electricity to a business: Generation, Transmission and Distribution.

ELECTRICITY GENERATION COMPETITION

In the 13 states and the District of Columbia that have fully deregulated their electricity markets (see map on right), only the generation (or supply) of electricity is open for competition. The local distribution company (LDC), such as PEPCO, BG&E, or PECO, still delivers the electricity to every home and business, and remains as the single point-of-contact to both bill for and service a user’s electricity requirements.

WHOLESALE MARKET / ISO

To accomplish deregulation, the electric power industry has restructured by separating the competitive generation sector from the natural monopoly functions of electricity transmission and local distribution.

Under this restructuring scheme, central authorities - on a regional basis, called independent system operators (ISO) - were given control over both the transmission systems and the wholesale markets for electricity.

The ISO for the Mid-Atlantic States and parts of IN, KY, IL, OH, TN and WVA is called the PJM Interconnection (PJM). PJM’s territory is outlined in the adjacent map with the colors representing the seventeen (17) LDCs.

LOCAL UTILITY SUPPLY PRICES

Immediately following deregulation by each individual state, customers were still supplied with power from their LDC, and could choose to stay with their LDC or, for the first time, opt to buy from a competitive supplier. Those customers staying with the LDC received the LDC’s price for electricity supply, called the standard offer service (SOS).

This SOS price is typically fixed for a few months in advance through regular wholesale auctions for residential and most commercial customers. In the case of many LDCs the SOS price changes quarterly. Conversely, larger commercial and industrial customers are charged a rate based on their actual hourly usage and the then current wholesale market.

Each LDC has a set of rules and processes it follows to set the SOS price - rules that have been established by its state’s public utility commission. These rules often include a ‘break-even’ rider, which allows the LDC to pass-on a true-up of actual costs or savings from the provision of this supply, and are published as its tariffed supply rates. As a result clients are never guaranteed an exact fixed rate.

FUELS USED TO GENERATE ELECTRICITY

The table (right) indicates the variety of fuels used to generate electricity in PJM. (1)

As prices for coal, oil, and natural gas change regularly and independent of each other, so do the costs to generate electricity from individual power plants. In addition, some power plants run all the time, while others are brought online only to supply peak demand, so peak rates will vary based on the cost to bring the latest plant online.

REGIONAL PRICING VARIANCES (PPG)

While the ISO creates the market for wholesale electricity supply, the price for electricity varies significantly by region due to the proximity of power plants, the fuels used by these power plants, local fuel costs, congestion on transmission lines, in addition to local pricing regulations and structures.

Therefore, the prices at one LDC (e.g., BG&E) can be different than those at another LDC (e.g. PEPCO), and these prices can change at the different rates.

As an example, in the following table note that American Electric Power in Ohio averaged $33.81 per MWh in 2009 and its rates increased by 15.7% in 2010, while BG&E in Maryland’s 2009 average rate of $42.04 per MWh increased 30.9% in 2010 to an average of $55.05 per MWh. (2)

Average Wholesale Electricity Prices, By Region, 2009 vs. 2010

WHY USE A COMPETITIVE SUPPLIER?

Opting for a competitive electricity supplier can help businesses meet their financial and business objectives as these suppliers can offer fixed rates on annual or multi-year contracts, variable rates, and hybrid solutions that differ from the SOS provided by the utility. This is important as electricity prices vary significantly over time.

In particular, electricity generation rates have been very volatile the last few years, and have doubled, on average, from a decade ago. The table on the right identifies the annual average price per megawatt-hour (MWh) in the PJM Interconnect since 1998. (4)


Footnotes

(1)  Table 3-24, Energy Production by Fuel Source, January through September 2010, All 17 PJM Interconnection Control Zones, State of the Market Report for PJM, Q3/2010, Monitoring Analytics, LLC.

(2)  Data from Table 2-60 Zonal real-time, simple average LMP (Dollars per MWh): January through September 2009 and 2010, State of the Market Report for PJM, Q3/2010, Monitoring Analytics, LLC.

(3)  Data is for a 9-month period through September 30, 2010.

(4)  Based on PJM real-time, simple average LMP (Dollars per MWh) for calendar years 1998 through 2010.