Where Do The Prices Of Electricity Come From?

Our electrical grid is a massive, constantly moving machine. Here we break down how it works, and why we pay what we pay for power.

Matt Duesterberg
April 26, 2018
Home Energy

Some say the electrical grid is the biggest engineering feat of humankind, and as you uncover each layer of the electrical onion, most people agree.

In some places, the operation of the grid is blind to the public; OhmConnect generally works in places where the electrical grid is operated by a “market” that provides transparent prices to reflect the cost of electricity in each location.

Today we’re talking about that market price of electricity.

What is the true cost of electricity?

The electricity bill that you pay is an “assumed” cost of electricity multiplied by the amount of electricity you consume.

In reality, the cost of electricity is usually (99% of the time) cheaper than what you are paying for.

However, in that last 1% of the time, the cost of electricity is so high, that it increases overall costs substantially. Your bill reflects an assumption that you are using just as much electricity during the 1% of very high electricity prices as you do during any other time.

“What is included in the price of electricity that I pay?”

Electricity has a couple of primary costs which goes into the price (Generally thought of in $/MWh).

The most obvious cost is “generation”, or the creation of electricity. This is often done by power plants, which have a cost to generate one kWh (unit of electricity) directly dependent on the cost of fuel. For coal and gas power plants, the cost is for the coal or gas being burned to create one kWh.

For solar and wind power plants, the cost is $0.

The other cost component of electricity is “transmission”. 

Transmission refers to the movement of electricity from the power plants to areas of load. For example, in Southern California, a large amount of power gets imported from Nevada through a direct transmission (DC) line; transporting that power over those lines create additional cost (often dependent on how far that electricity is transported).

Prices of electricity are publicly available and downloadable (For example, CAISO prices can be found here.). These prices (Referred to as Locational Marginal Prices or LMPs) fluctuate frequently - every 15 minutes - and by location. It costs a bit more money to move electricity to places that are farther away from the power plants.

The prices are represented by three components - the cost of generation, the cost of transmission and distribution, and the cost of congestion.

Wait you say! What is the new cost? What is congestion? Congestion is the biggest driver of price fluctuation, yet it is hard to define.

What is congestion?

Congestion occurs when certain parameters in the electrical grid makes it hard to deliver electricity into a certain location.

A good example of a place where congestion frequently occurs is New York City. New York City is an island and has a large number of transmission lines to allow cheap power to enter New York City from the outside region. Power coming over these transmission lines are generally reflective of the cost of power on the entire New York system, which usually hovers around $50. However, during extremely hot days, everyone in New York starts running their air conditioning all at once, and the power to run the air conditioning starts requiring more energy than the transmission lines can handle.

In these cases, the grid operators will turn on peaker plants that sit on barges “inside the city” (they are actually located near Brooklyn). By turning on these power plants, the grid operators are protecting the transmission lines going into New York from melting. These peaker plants are functionally like jet engines, with very low efficiency in comparison to combined-cycle power plants in the rest of New York, and as a result, the cost of these peaker plants can be $500.

When those plants are turned on, the energy price remains $50 in the rest of New York state, but specifically in New York City, the energy price is $500 because those peaker plants had to be turned on. Those peaker plants will run for maybe an hour at a time, in which electricity prices have increased from $50 to $500.

Congestion can create enormous increases in price, which ultimately contribute to higher costs for everyone.

Your bill assumes that you consume as much energy during the time of those high congestion costs and therefore you pay a higher overall price in your electricity bill than what you generally would have to pay if those “congestion” events never occurred.

Matt Duesterberg

Matt is the Co-Founder and CEO of OhmConnect.

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