Industry 101 | Participants in the Energy Sector: Types of Utilities and Consumers
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1.4 TYPES OF UTILITIES AND CONSUMERS
Supply and demand is perhaps one of the most fundamental concepts of economics. Thriving in competitive environments, it is the idea that the price of goods sold or services provided is determined by what the market will bear. When applied to the market structure, utilities do not fit into this basic model. Alternatively, utilities tend to form monopolies, which determines how they are regulated, how ownership is handled, and how their rates are set.
A monopoly is “a market structure in which there is only one producer and seller for a product.” This market tendency can be credited largely to high operations costs. Utilities fall into this category because it is more cost efficient to have a single provider fulfill overall demand by territory. When many small entities competed in the utility space, they grew unstable and many were acquired over time by larger parent companies. Where competition does exist in the space, whether it is among energy providers or in utility billing, the infrastructure (e.g. transport and delivery facilities) is usually owned and operated by a single source. By nature, a monopoly leads to having one provider with the power to restrict output to specific territories and set price levels, regardless of what is economically justified. Hence, strong ownership and regulation are keys to success in the utility space.
1.4.1 OWNERSHIP AND OPERATIONS IN THE UTILITY INDUSTRY
Though utilities are often referred to as monopolies, ownership can take different forms depending greatly on location.
The most popular ownership structure is the investor-owned utility (IOUs). These companies are privately owned, yet still subject to state regulation. Companies that take on this form will generally be financed by a combination of shareholder equity and bondholder debt. IOUs tend to be financially large and have multi-fuel or multi-state operations. Though these companies represent only about six percent of the utility providers, they provide service to approximately sixty percent of all utility consumers in North America.
A second ownership structure is a municipal utility. Such entities are city-owned. These providers are utility-only government agencies which are controlled by a board of elected officials. The goal of a municipal utility is to improve reliability and keep money in the community.
Another ownership structure is a cooperative. Often cooperatives service more rural areas and are private, non-profit entities. Each customer is a member and owner of the cooperative with a vote equal to every other member. The idea of this structure is to bring the best service at the lowest cost. However, the high cost of maintaining the infrastructure needed to cover the rural areas causes prices to be high. This structure can be very cost effective though when a previously rural area becomes urban because of city growth.
1.4.2 REGULATION OF THE UTILITY INDUSTRY
Because utilities tend to operate as monopolies, governmental regulation plays an important role in the energy space with a goal of protecting the public interest. Regulatory bodies are responsible for providing operational oversight in the utility space, and play roles in the federal, state, and local government levels. The Federal Energy Regulatory Commission (FERC) governs Independent System Operators (ISOs) and Regional Transmission Organizations (RTOs). Entities such as these are ideally in place to ensure that utilities meet rules and regulations set for the good of the people.
Regulations on utilities cover a broad range of topics such as revenue and rates, resource acquisition, service standards, service quality, and the environment. Oversight of the generation of power (a producer of pollution), transmission infrastructure that has visual and physical impacts on land use, and noise levels are examples of topics covered under the environmental regulations imposed on utilities. Regulators design the pricing structures for collecting revenue and set the service quality standards and the consumer protection requirements. Regulators also oversee the financials of a utility such as reviewing and approving the utility capital investments and long-term plans, as well as have final ruling in disputes between consumers and the utilities.
1.4.3 RATEMAKING IN THE UTILITY INDUSTRY
As previously stated, utility rates are set by the regulators. The primary function is to address the cost of operation for utilities.
This will generally start with understanding the base cost of utility service. Here, items such as pipe and wire maintenance and the cost of owning and operating power plants are considered. Regulators would also address any fuel cost, purchased power supply, etc. depending on how the utility supplies energy to its customers. State and federal standards for environmental upgrades as well as any day-to-day operations cost are also factors. Examples of the day-to-day operations are any maintenance or repairs, service calls, meter reading, and billing.
In setting a rate, the regulator is attempting to factor in all needs of the utility as costs of operation. When the cost of doing business changes, rates will be changed to recover the costs.
In 2014, according to the U. S. Energy Information Agency (USEIA), the average price by type of consumer were:
- Residential: 12.50 cents per kWh
- Commercial: 10.75 cents per kWh
- Industrial: 7.01 cents per kWh
1.4.4 CONSUMERS IN THE UTILITY INDUSTRY
Electricity prices vary by the type of customer being served. Utility customers can be broken into three categories: residential, commercial, and industrial. In general, residential and commercial consumers will have higher rates because it costs more to distribute to them. Industrial consumers use more energy, yet can receive it at a higher voltage. Therefore, the transmission process is more efficient for industrial consumers making it cheaper to supply electricity to them.
The chart above provides the number of consumers by type over the course of ten years in the United States. Despite a significant differential, each is a part of the utility space in a unique way.
Residential consumers are the most common type of consumer and are the most studied for patterns. Residential energy consumption historically has been used mostly for space heating and cooling. In recent years, the chart below shows slight shifts in usage trends, which can be attributed to increased use of energy efficient homes (better insulation, efficient windows, energy efficient appliances, etc.)
Another factor that makes residential consumers unique is that they can quickly be motivated to alter their usage practices after they receive their bill. They do not mind making small changes in an effort to save money on their electric bill.
The commercial sector is slightly more complicated than residential because of the unique mix of small business owners with mid to large size businesses. Small business owners have the ability to be responsive to their bill. Their environment tends to be more flexible and open to shifts in habits to reduce costs.
Mid to large size businesses on the other hand have been historically less likely to allow their bill to influence their usage habits because individuals have not perceived control. Employees tend to experience a diffusion of responsibility to the point they believe changing their behavior will have little to no effect on cost. People also suffer from the notion that energy conservation equals reduced comfort, a serious obstacle. Overall, because so few are exposed to the cost of energy in a larger work environment, very few take strides to conserve energy.
Industrial consumers are the utility spaces’ largest consumer, and they use energy in multiple ways. They have process heating where they raise the temperature of components during the manufacturing process such as refining crude oil. They will heat a boiler to generate steam or hot water. Electricity powers their operations. The chemical, petroleum, aluminum, glass, and steel industries are just a few examples of industries which draw a large amount of energy.
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