How Electricity Rates Are Determined

To have an understanding of changes in electricity rates it is necessary to understand the factors which affect the production of electricity.

You may have noticed that electricity rates constantly vary. The variations in the price of electricity is due to a multitude of factors. The price of electricity is determined by the cost to construct, maintain, finance, and operate the power plants, electrical grid, and power lines.

The factors which affect the price of electricity are:

Price of Fuel

The price of fuel is one of the deciding factors for electricity rates. The price of fuel would depend on the method that is being used to produce electricity. Natural gas is a popular way of generating electricity as its price has dropped and is lower than its alternatives. Other options for generating electricity are through the use of solar, wind power, and coal, though these options are not as popular as natural gas. Fuel costs are based on per unit cost. Natural gas’ cost would therefore be determined per thousand cubic feet.

Power plants

Power plants require construction, operating, and maintenance costs in order for them to continue operating. These costs, which may be expected or unexpected, will have an impact on electricity prices.

Weather

Weather conditions impact electricity production and the cost of electricity. Harsh weather conditions, such as heavy snow or rain coupled with wind can damage power lines and transportation routes. When damage occurs to the electrical grid there will be added costs in order to fix the damage. Although, rain and snow can provide water for hydropower production.

Transmission and Distribution

There is of course a cost associated with delivering electricity from the power plant to businesses and homes. These transmission and distribution systems require maintenance and operation costs which contribute to the price you’re paying for electricity usage.

Generating electricity is by far the largest part of the price of electricity as it on average constitutes 58% of  electricity rates. Distribution accounts for 31% of the price and transmission composes 11% of the price.

Electricity prices are always changing

The price of electricity changes so rapidly as the cost of producing electricity reflects the real time demand for the resource. This is why prices for electricity are highest in the afternoon and evening as these are the hours when the most electricity is used. Peak times in the summer are from 11 AM to 5 PM, and in the winter are from 7 AM to 11 AM and 5 PM to 7 PM.

Although, the price of generating electricity is always changing, the rate you pay on your electrical bill is based on a seasonal average cost of electricity. Prices for electricity are highest in the summer when demand is at its highest and it becomes more expensive to generate electricity to meet the demand on the market.