Exploring the Factors Behind the Surge in Electricity Prices

In a deregulated wholesale market, prices for electric power generation are determined by competition. Power plant operating and maintenance costs and fuel costs factor into those prices.

However, each state determines end-user rates through a regulatory price-setting process that public service commissions oversee. These rates make up the bulk of a consumer’s power bill.

Global Gas Market

Electricity prices will likely continue rising rapidly as liquified natural gas, the fuel used for power generation remains in short supply, and companies’ operating costs rise. That’s why consumers need to understand what they can do to help lower prices.

Consumers can look to their utility bills for clues about the future of electricity prices. Most utilities, like electric company Grand Prairie, TX hold auctions to buy their customers’ electricity, and the price they pay for it can vary from state to state. While the warm winter has been a big factor in lower household energy costs this year, the global factors that affect natural gas supplies will play a major role in determining how much of a price increase you see on your next bill. The good news is that price increases should slow down as the market adjusts. But that’s no guarantee that the price spikes will end anytime soon.

Natural Gas Capacity

The price spike of natural gas, used for home heating and power generation, has directly impacted electricity prices. About 40% of US electricity comes from natural gas-fired power plants, and the fuel cost is a big part of the overall cost of running those plants.

As more coal plants closed or switched to burning natural gas during the COVID-19 pandemic, demand for that kind of electricity soared and drove up energy prices, pushing gas and coal prices.

These higher energy prices have ripple effects on household budgets, especially those of low-income households that are most sensitive to changes in their energy costs. We’ve decomposed the indirect impact of rising energy prices on household spending across 33 expenditure items for 116 countries.

The price increase in the industry PPI for electric power distribution reflects the higher costs passed on to consumers, as measured by sample bills that replicate monthly charges end-users pay to their utility companies. The charges in these bills are largely set by regulatory price-setting cases filed with state-level utility commissions, and most of the time, they remain the same for six months or longer. Those prices, in turn, reflect the prevailing wholesale electricity market rates. However, there is a lag in how quickly wholesale power prices drop and how much they affect the prices end-users see on their monthly power bills.

Renewable Energy

The cost of renewable energy has dropped considerably over the years, making it competitive with fossil fuels. But while solar and wind power are increasingly the cheapest options for power generation, they still need to be paired with other technologies that can provide backup and balancing capacity in case of intermittency or when prices drop too low.

These other solutions could include increased storage and more flexible conventional power plants. Power-to-heat options and other forms of onsite demand management also help reduce the risk of hours with negative prices. And while the energy market price fluctuations impact consumers in general, it’s important to remember that the cost of renewables can vary significantly among individual households.

State and utility programs that make it easier for lower-income people to invest in solar panels or energy efficiency can cushion these costs. In the long term, shifting to renewables could dramatically cut bills, even with higher energy market prices.

Electricity Demand

Power plants rely on multiple fuels to produce electricity, and the prices of those fuels—especially natural gas—can greatly impact wholesale and retail electricity prices. However, the current price surge is driven by many factors, including the ongoing Russia-Ukraine conflict and resulting economic sanctions on Russian gas exports1,2.

Demand for electricity changes from hour to hour and from day to day. It depends on weather and human activity patterns (e.g., people typically use more electricity in summer than winter to cool their homes). Demand also varies geographically, reflecting local weather and activity conditions and that some countries depend more on fossil fuels for electricity generation than others.

Changing electricity demand can significantly impact prices because utilities are required to keep sufficient capacity available to meet peak demand at rare times when demand is high. The cost of maintaining those capacities — and the price of power during the peak demand periods — is reflected in demand charges on residential and commercial customers’ electric bills.

Changes in households’ electricity costs tend to be the largest impact, but these change in different ways across countries depending on their reliance on fossil fuels for power generation, the overall level of household income, and the distribution of that income among households. Households in higher-income countries, for example, are less sensitive to price increases than those in lower-middle- and low-income countries.