How should we calculate electricity costs?

Introduction

Like most other goods and services, electricity prices depend largely on the market forces of supply and demand. These, in turn, are shaped by geographic and climatic factors as well as the availability of competing alternatives. Because of the nature of electricity (difficult to produce in advance and store), demand is often far more elastic than supply. This means that sudden upticks in consumer demand are more likely than not going to result in higher prices all around.

The Current Electricity Grid

At present, customers are billed for their electricity based on their total monthly consumption. Meters found at most homes aren’t equipped to deliver detailed reporting of energy usage such as the time of day power is consumed. Thus, consumers pay a monthly average of what it costs the utility provider to deliver power to its customers during that period.

When demand is high, the utility company may take costly measures to meet customer needs. Such measures might include things like firing up an additional power plant that is used during only part of the year or bidding on pricey energy contracts. Even if this is only necessary for part of a billing cycle, the costs will be factored into the average consumers see on their utility bills for that month.

One implication of this scenario is that even consumers who aren’t drawing on the power grid during peak periods will pay more overall.

Interestingly, Federal Energy Commission reports reveal that total energy demand hasn’t changed all that dramatically in recent years. What has changed, in fact, is peak demand. This owes largely to the increasing numbers of homes equipped with central air conditioning as well as a steady increase in their frequency of use. What’s more, the use of cooling systems depends largely on weather patterns which equally affect nearly everyone within a given region at the same time.

Demand response and time-based pricing

One alternative to the average-based pricing model is the time-based plan being advocated by consumers, public interest groups, and policymakers alike. Under the time-based plan, consumers would be able to decide how much electricity they would like to consume during peak demand hours when it is most expensive. Likewise, customers would be billed at close to real time rates for their usage.

As we mentioned earlier, utility companies are least efficient during peak demand hours and pass all of those extra costs along to end-users. So, the extra capacity freed up by users deciding to switch off their appliances and air conditioners during peak hours may not only benefit these customers, but also the ones that are consuming during peak hours.

Obstacles

In many if not most residential areas, utility companies still deploy vast numbers of meter readers to visit homes and record data on monthly consumption. And, as one might assume, shortening the intervals at which this information is delivered to the provider is crucial to changing the way rates are calculated.

On this front, smart metering technologies are aiming to bridge the information gap between consumers and utility companies. By enabling two way communications about pricing and usage, smart meters allow utility companies to better allocate their resources and consumers to cut back during the hours when it’s most costly to consume energy. Essentially, we would be allowing energy customers to do what we already deem perfectly logical in many other areas of life (i.e., choosing to go to a matinee movie instead of paying more during the busy evening rush or paying premium rates to go on vacation in September instead of the widely traveled summer months).

However, utility providers and entrepreneurs are currently lacking a set of universal standards with which to approach a full-fledged smart metering solution. While various states and localities have successfully rolled out limited trials for smart metering technologies, no industry-wide platform has been introduced to make these solutions available to mass markets.

One possible fix for this nagging problem is to build devices capable of communicating via an existing standard: broadband internet. With this in mind, plenty of companies are building devices capable of delivering complex energy usage data over the internet. Yet this solution is only a partial fix as not every residential energy customer is equipped with a broadband internet connection.

Conclusions

In order to meet the swelling peak demand seen in many regions, utility providers are faced with several options. They can expand output capacity by building new power plants, reinstate those that have been placed out of use, or incorporate new ways to manage peak demand.

The latter seems like the most scalable, most efficient solution, and one that may actually end up reducing overall demand. When consumers begin to switch off lights and appliances during peak hours, they won’t necessarily compensate during other parts of the day. Choosing less air conditioning during the day, for example, will likely result in a net reduction because temperatures are naturally cooler during the morning and evening hours.

For consumers, smart metering may require some getting used to, but it poses a fairer option for calculating energy costs: billing the end-user based on how and when they consume.

Average rates by region, state, and end-user are available from the U.S. Energy Information Administration.

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