Understanding Electricity Rates

The retail price of electricity is affected by multiple factors. According to the U.S. Energy Information Administration (EIA), electricity prices generally reflect the costs to build, finance, maintain and operate power plants and the electricity grid, which includes all power transmission and distribution lines.

Factors that impact electricity rates

In order to understand why electricity rates change, you must know the factors that play a role in the production of electricity. Many factors contribute to electricity prices, including:

  1. Fuel – Fuel is one of the main factors that determine the price of electricity. The price of fuel is relative to what kind of source is used to generate electricity. Coal, natural gas, solar and wind power all generate electricity, however, they generate it at different costs and vary in popularity. Natural gas, for example, is becoming a more popular option as prices have dropped. Fuel costs vary based on per unit cost, such as dollars per thousand cubic feet for natural gas or dollars per ton for coal.
  2. Weather conditions – Weather impacts energy consumption and the cost of electricity because different conditions affect electricity generation. Rain and snow, for example, can provide water for low-cost hydropower generation. On the other hand, in severe weather conditions such as heavy rainfall and wind, transportation routes and power lines can be damaged, resulting in added costs to fix the electricity grid.
  3. Power plants – In order for power plants to operate properly, they incur construction, maintenance and operating costs that affect energy prices.
  4. Transmission and distribution system – The transmission and distribution system is responsible for delivering electricity from power plants to residences and businesses. Maintaining and operating this system to deliver electricity contributes to the overall price of the commodity.

In 2013, the EIA reported that generating electricity was the largest component of the price of electricity. Generation was responsible for 58 percent of the average retail price of electricity, whereas distribution was responsible for 31 percent and transmission was responsible for 11 percent.

Electricity prices vary minute by minute

The EIA suggests that wholesale electricity prices change every minute. The price changes so frequently because the cost to generate electricity reflects the real-time demand for electricity. Demand is usually highest in the afternoon and early evening, when usage is at a peak. This means during these hours when electricity usage is at its highest point, prices are also high.

Despite the constant change in prices, most consumers pay rates based on the seasonal or average cost of electricity, not as the cost of generating electricity changes. Prices change per season and are usually highest in the summertime when total demand is high and when more expensive generation is needed to meet the demand of the commodity.