Industry 101 Electricity Market Alex Tao

Participants in the Energy Sector: Electricity Market

Industry 101

This post is part of our Industry 101 Series, an ongoing campaign to provide a foundation of knowledge about our unique industry. To learn more about this campaign, please click here.

Commodity – “A kind of thing produced for use or sale, an article of commerce, an object of trade,” as defined in the Oxford English Dictionary. In the context of the utilities market, commodities electricity, gas, and water are considered commodities. However, a utility company may also offer services such as sewage, waste management, and broadband internet services. This section, provides an outline of the various commodities and services that utility companies offer.

The development of technology in the past few decades has made electricity ubiquitous in residences. Even with the advancements of home electricity generation technologies, electricity at home is still generally supplied by utilities. Electric utilities often participate in both electricity generation and distribution. One thing that differentiates electric utilities from other utilities is demand management. Since storage of electricity is generally difficult and costly, electric utilities may provide related services and programs to assist the timing of a customer’s electricity usage.

The second major contender in the energy sector is natural gas. On the industrial side, natural gas is commonly used to generate electricity. On the residential and commercial side, it is mostly used for cooking and heating. In the United States, natural gas is deregulated in many states, so gas utilities tend to rely on suppliers for the sourcing and delivery of natural gas. In Georgia for example, natural gas is a deregulated market. A utility such as Gas South does not distribute gas to the consumers. Atlanta Gas Light is the distribution company that owns the gas pipelines, connects and disconnects gas service, but Gas South is the provider bills the customer.

Water and sewer service operate on very different grounds and are often billed to the customer separately. Water utilities provide clean drinkable water in large quantities, while sewer utilities handle the disposal of waste water with a complex network throughout cities. The cost of each type of service is based on its complexity. Clean water is delivered to the consumer in pressurized pipelines from a central location – elevated storage tank and booster stations –  and has regulations regarding the cleanliness of the water. A sewer utility must collect and treat waste water in accordance with pollution and safety regulations and develop sewer plans for sewer systems. Due to the non-pressurized system, this is a more challenging problem than water distribution.

Waste management, sometimes known as solid waste management, is the process of collecting, transporting, treating, and disposing of waste. In the modern era, waste management is not as simple as pure disposal, but includes sustainability such as recycling, composting, and re-use. Aside from undesirable landfill disposal option, it is common for utilities to offer recycling programs, divert reusable products to charities, encourage the reduction of junk mail, or promote backyard composting methods to their customers.  A good waste management utility will consider the waste management hierarchy thoroughly to minimize pollution in land, air, and water and to conserve natural, economic, and energy resources where possible.

1.1 ELECTRICITY MARKET

1.1.1 GENERATION

Energy Sources USAThe very first step into the electricity market is the generation of electricity. In the U.S., the main energy sources are coal (33%), natural gas (33%), and nuclear energy (20%). At a lower rate are renewable sources including hydropower (6%), wind (4.7%), biomass (1.6%), solar energy (0.6%), and geothermal energy (0.4%).

Electricity from these sources is primarily generated by some variations of turbine rotations. The most common medium for driving the turbines is steam. To create electrical energy with steam, water is boiled into steam to create mechanical energy to rotate turbines. Power stations generating power via steam are known as thermal power stations.

Once electricity is generated by the electric generator, the electricity is passed to a step-up transformer to increase the voltage for long distance transmission. By increasing voltage, the current can be kept low along transmission lines; this is a key factor to keep transmission costs low.

1.1.2 TRANSMISSION

United States Transmission GridThe basic goal of electrical power transmission is to transfer masses of electrical energy from a power generation site over a large distance to a substation. In the U.S., the network of transmission lines across the country is known as the power grid.

Electricity is transmitted at high voltages, 115 kV and above, to reduce the amount of energy lost in long-distance transmission. The two types of transmission are overhead and underground. Overhead transmission lines are commonly made from aluminum alloys because of its light weight, low electrical resistance, and low cost. Underground transmissions utilize cables, which consists of a conductor and an insulation layer which houses the conductor. The advantages of underground transmission are lower physical low visibility, less susceptibility to weather conditions, and low power loss. However, due to the high cost of underground transmission, overhead transmissions remains the more competitive method.

Before distributing the electricity to consumers, electricity is transmitted to a distribution substation.

The Continental U.S. power transmission grid is made up of about 300,000 km (186,411 mi) of lines. The lines are operated by approximately 500 companies, and the North American Electric Reliability Corporation (NERC) oversees all of these lines.

1.1.3 DISTRIBUTION

Electricity Distribution NetworkDistribution stations typically contain a step-down transformer to decrease the voltage from the transmission network to something much closer to a consumer’s required voltage. The first voltage drop at the distribution substation will take electricity to primary distribution lines. At this point, power is delivered to a busbar, a central location where power can be distributed in multiple directions. Closer to a customer’s premise, a distribution transformer further steps down a voltage to a consumers expected voltage. Here, the secondary distribution network will connect to a customer after going through a nearby service drop pole. In the rare case of large customers that require larger amount of power, a utility may decide to directly connect a customer to the primary distribution network.

In the past, the fine distribution network lines and the coarse transmission network lines may have been owned by the same company. Today, it is not uncommon to have separate ownerships due to the deregulated market conditions.

1.1.4 THE ELECTRIC MARKET, WHOLESALES, AND RETAIL MARKET

Economically, electricity is similar to other commodities; it can be bought, sold, and traded. The electricity market exhibits a dynamic supply and demand model due to factors such as weather, major televised sporting events, and holidays. However, electricity differs from traditional commodities because it cannot be stored easily, usually eliminating surplus in stock, rationing, and customer queuing.

A wholesale electricity market exists when competing generators offer electrical output to retailers. The retailers then re-price the electricity and take it to market. While wholesale pricing used to be the exclusive domain of large retail suppliers, increasingly markets are beginning to open up to end-users. In the U.S., wholesales are often made across states and require interstate regulations. The wholesale market can be entered by any company that passes various approvals, can generate electricity onto the power grid, and secure sales. Trading is open to organization or individuals interested in buying or selling electricity in the wholesale market. The trader is not required to have any association with any part of the electricity generation, transmission, distribution or consumption.

Electricity is ultimately sold to a consumer by the electricity provider; the act of the sale is electricity retailing. Broadly speaking, monopoly supply or supply by choice – depending on whether a consumer is based in a regulated or deregulated electricity market – are the two types of retailing. As opposed to a regulated electricity market, in a deregulated market, consumers may choose electric providers based on pricing, services, maintenance, etc.

A retail electricity market exists when end-use customers can choose their supplier from competing electricity retailers; one term used in the United States for this type of consumer choice is ‘energy choice.’.A separate issue for electricity markets is whether or not consumers face real-time pricing (prices based on the variable wholesale price) or a price that is set in some other way, such as average annual costs. In many markets, consumers do not pay based on the real-time price, so have no incentive to reduce demand at times of high (wholesale) prices or to shift their demand to other periods. Demand response may use pricing mechanisms or technical solutions to reduce peak demand.

Generally, electricity retail reform follows from electricity wholesale reform. However, it is possible to have a single electricity generation company and still have retail competition.

Deregulated or not, residential consumers are generally charged a fixed service fee and a separate charge based on the amount of energy consumed over a period of time, usually one month. For commercial and industrial customers, more complex pricing tariffs could depends on more variables such as peak demand, time of use, or reactive power.

1.1.5 INDEPENDENT SYSTEM OPERATOR (ISO) AND REGIONAL TRANSMISSION ORGANIZATION (RTO)

As mentioned above, regulatory bodies are responsible for providing operational oversight in the electric market. These organizations are known as ISOs and RTOs and are governed by the Federal Energy Regulatory Commission (FERC); currently nine ISOs and RTOs operate in North America, serving over half of Canada and two-thirds of the U.S.

RTO and ISO Council, IRCRTOs may be responsible for a larger geographical area than ISOs, but they serve similar purposes: plan for the electric industry’s infrastructures across service areas, regulate fair and open trading in the electricity market, and ensure reliable and efficient transmission systems. RTOs and ISOs will coordinate generation and transmission across regions to keep a healthy balance between supply and demand, which protects both electricity providers and the consumers by lowering the risk and cost involved in the electricity market.

Creating a reliable power grid often requires different regions of service areas to work together. RTOs and ISOs will engage separate markets to work together and extend networks, provide back up to the regional grids, cut excessive overheads, and ultimately provide more reliable and low-cost electricity to the consumers.

1.1.6 PUBLIC UTILITIES AND PUBLIC UTILITY COMMISSION (PUC)

Public utilities maybe be publicly owned or privately owned. In both cases, PUC is required to regulate various business operations and services conducted by the public utility.

One example of regulation is the process of ratemaking. Any adjustments made to rates by the public utility must be proposed to a PUC so it can be thoroughly examined to ensure electricity is charged at a reasonable cost to consumers. To support a rate case proposal, a public utility typically justifies an increased rate by providing evidence of operating expenses and the efficiency and reliability of service delivered to consumers. Since electricity is deemed such a necessity in the modern world, the rates placed by a utility can become political as the rate needs to be fair and equal across all socioeconomic groups.

Some other examples of a PUC’s realm of responsibility may include: infrastructure and reliability, metering standards, recording and reporting, transmission and distribution, and sourcing of energy.

To continue your journey, click here to access the next installment of our Industry 101 guide.

 

Here is a list of relevant reading material our expert identified as sources for additional information:

www.oed.com/view/Entry/37205?redirectedFrom=commodity#eid
www.nytimes.com/2015/02/27/technology/net-neutrality-fcc-vote-internet-utility.html?_r=0
www.gru.com/MyHome/ProductsServices/InternetServices.aspx
www.eia.gov/tools/faqs/faq.cfm?id=96&t=3
www.gas-south.com/residential/faqs-atlanta-gas-light-company.aspxhttp://mrsc.org/Home/Explore-Topics/Public-Works/General-Utility-Topics/
www.tucsonaz.gov/water/distribution-system
www.epa.gov/smm/sustainable-materials-management-non-hazardous-materials-and-waste-management-hierarchy
blog.opower.com/2013/01/will-the-super-bowl-save-the-planet-how-americas-most-watched-tv-event-reduces-home-energy-usage/
www.epsa.org/industry/primer/
www.isorto.org/