An electricity product seems like an arcane concept. We pay for electricity after we use it. And we can’t see it. So how can it be a product? This is a re-post of an earlier article, because energy and finance professionals keep asking us this question.

What do we mean when we talk about an electricity “product”? People want to know what is “in” an electricity product. Knowing what makes up your costs goes a long way to getting those costs under control.

Electricity Product: Cost Components

Take a look at the graphic, above. The largest components of your electricity costs are:

Electricity/Energy— measured in kWh at your utility meter. The largest component of your electricity cost is the power that runs the motors, lights the lights, and turns the meters. The wholesale cost of energy in deregulated markets is the known as the Locational Marginal Price (LMP), which is a market-based value that includes power generation costs and the costs of transportation and losses to a specific location. That location is your load zone. The LMP is defined each hour by an auction process administered by the Independent System Operator (ISO). The ISO is responsible for coordinating and directing the flow of electricity over the high-voltage transmission system in the State or group of states. The LMP prices are publicly available at your ISO/RTO, at the NYISO homepage, for example.

Distribution and transmission— The RTO or ISO administers the wholesale power markets and manages the flow of power over the transmission grid to insure reliable power at the lowest cost. Your utility (like Con Edison in NY City, for example) manages the distribution of electricity to your meter.

Capacity –The fact that electricity can not be stored cost-effectively has a big impact on how best to manage your energy costs. The ISO administers a market for installed generation capacity to insure that adequate generation resources are available to supply load. Each electric account has a capacity obligation. While the actual cost of capacity is determined system-wide through an auction process, a customer’s individual capacity tag for an account is established by that account’s electricity demand when the system is peaking. In New York State, the capacity tag that is assigned to a customer’s account is determined during the summer system peak, but then takes effect the following May. So the tag that is assigned in May of 2018 will be determined by an account’s coincident peak during the summer of 2017.

Each retail electricity supplier must purchase installed capacity to meet that obligation. The various ISOs use an annual/monthly auction process to set the capacity price. The rules differ among the ISOs. This cost will be the second largest component of your electricity cost. (There is no installed capacity obligation or cost in ERCOT.

For more information, take a look at MWh’s Resources page.

How should you think about your electricity product costs overall?

Supply comprises somewhere between 50 and 60% of your total electricity cost. Of that number, power/energy is the largest component (65%), capacity is next largest (20-25%), then ancillary services (7-9%), risk premiums (5-7%) and supplier/broker margin (2-3%).

The vast majority of delivery/distribution costs are made up of:

• demand charges (60% or more depending on the facility)
• energy-related delivery charges (20-30%)
• systems benefit charges and renewable portfolio standard fees collected on behalf of the state, and
• other taxes (GRT and sales tax) comprise the rest of your costs.

So what can you do about it? 

The biggest components of both supply and delivery costs are directly tied to your demand, particularly your peak demand. For example, your peak kW demand recorded at the time of the overall state-wide system peak sets your capacity obligation. Typically, peak demand occurs during the heat of Summer. If you can manage your demand to remain low at key points, for example at the time of the system-wide peak, that will lower both your supply and delivery costs. Get demand under control for your largest accounts, and you’ve gone a long way toward controlling your energy costs.

Bottom line for finance and energy professionals: Focus on your highest cost facilities– then hone your focus on what’s driving those costs. Energy is important, but so is demand. Finding ways to control peak demand will pay off by lowering both delivery and supply costs.