Electricity bills don’t make for terribly exciting reading, but as boring as they may look, there is much more going on beneath the surface. Whereas the price most people pay for electricity remains steady from month to month, electricity costs can change dramatically from one hour to the next for the utilities that send the bills. For example, weather can cause demand to spike, raising prices as well, and suddenly the cost of the electricity is much different from the price we see on our bill. It generally falls on utilities to manage this problem, and in our new report, Estimating the Value of Energy Efficiency to Reduce Wholesale Energy Price Volatility, we estimate the costs of the risks that come with this kind of volatility and show how energy efficiency can play a useful role in mitigating those risks.
Utilities have to make plans several years at a time, setting electricity prices (with approval from regulators) to make sure they bring in enough money to cover their costs. They know that the weather is going to be bad at some point, but they don’t know when or how bad. One option is just to pay high prices when they come, hope that they set prices right, and ask permission from regulators to cover the difference if they’re wrong. Alternatively, utilities can essentially buy insurance by entering into long-term contracts for electricity at a fixed price, or by using financial markets, buying options on futures or other markets that don’t deliver actual electricity but rather pay the utility a certain amount of money if electricity prices rise above a particular level. However, the price for electricity in a long-term contract is generally higher than current expected prices, and financial instruments cost money to buy. If electricity prices don’t rise high enough, the utility loses money.
In general, utilities tend to do some of both, but regardless of what they do, volatility in electricity prices imposes costs on the system, and the only question is how much.