FacilitiesNet published a four-part article for its July 2015 issue that aims to explain what drives power costs. The first part provides an overview of the market changes brought on by deregulation and the creation of wholesale power markets. Retail energy prices are driven by two primary components: supply and delivery.
Delivery costs represent traditional utility expenditures related to power lines, electrical substations and other utility infrastructure necessary to build and maintain the grid, as well as other utility operations expenses. The costs covered under delivery are based on a “cost of service” model, as explained by the Edison Electric Institute. Under this model, utilities are allowed to recoup long-term capital investments plus a profit margin through rates paid by customers. The rates also cover any short-term fuel and operational costs on a dollar-for-dollar basis. These costs are less volatile and more predictable than supply costs and tend to vary little from year to year.
Power supply costs are designed to cover the costs of investing in power plants, buying fuel and operating and maintaining the facilities. Unlike delivery costs, supply costs do not directly correlate with the cost of providing electricity service; they are driven by market prices. This means some plants enable their owners to earn substantial gains, while other plants earn a minimum profit margin or even operate at a loss. Due to the nature of wholesale power markets, prices are volatile, which is why many retail buyers insulate themselves from price fluctuations through the use of fixed-price power contracts.
Retail Energy Buyer provided a more in-depth explanation of wholesale power markets in February.