If you are a NH resident buying your electricity from Unitil,
NH Electric Cooperative, or Liberty Utilities, you are most likely reeling from
the recent increases in winter electricity rates. This post begins a series
that takes a look at what makes up NH retail electricity prices and the reasons
behind the large increases that we are seeing for certain utilities.
Historically, electricity prices have been on the rise. The
chart below shows the 24-year historical average NH residential electricity
prices. In 1990, prices were about 10
cents per kilowatt hour (c/kWh) and then climbed to about 14 c/KWh in 1998.
Prices then experienced a slow decrease until about 2002, after which they
continued their increase to this past winter when we saw average prices of ~17
c/kWh. The trend from 1990 to 2103 represents a compounded average increase of
2.5% per year, which is the same as US inflation over the same period.
The next chart looks at residential electricity prices for a
shorter time period, and compares the NH prices (in green) to those of the NE
states (brown) and to the average US monthly figure (blue) since 2000.
NH has generally followed the NE average, but from 2006 to
2010 was quite a bit lower. However, over this period, our electricity rates have
been about 40% higher than the national average.
State-by-state comparison is always useful and interesting.
The figure below shows recent state rankings based on July 2014 retail
electricity prices. The NE states are all in the top 11, with Vermont and
Connecticut higher having higher prices than NH. Our electricity prices are the
7th highest in the US at 17.23 c/KWh − we can take some solace that the
price in Hawaii is more than double the NH average. On the other hand, Washington
state, which benefits from cheap hydroelectricity, has the lowest prices –
almost half of NH’s at 8.96 c/KWh.
All of the electricity prices I have presented so far are average
prices and include all the charges you see on your electrical utility bill. Looking
at an electricity bill is not unlike deciphering your cell bill. There are a
lot of bits and pieces and it takes effort to understand them. There are three basic
components. The first is the cost of power, which is usually a single line item
for the cost of electricity per KWh. The second is the cost of getting the
electricity to your home, i.e., the
cost of distribution and servicing your account, which usually involves several
line items, such a fixed account charge, a distribution charge, and perhaps
even a transmission fee. Finally, there are all the odds and ends, such as
taxes, charges for government-mandated programs, etc.
The reason for all these separate charges is, as I have
noted previously in What’s It
All About, Alfie?, is that there are three key parts to the electricity
business: the generation of
electricity, typically at a large power plant located in a central location;
the transmission of electricity over long distances from the generation point
to towns and cities; and the distribution of electricity through the community
via the sub-stations, wires, and transformers to individual homes and businesses.
Not all electrical utilities focus on all aspects of the business. Some, for
example, such as my local electrical company, just distribute electricity.
Others, such as the merchant wood-fired power plants or wind farms, just focus
on generation, whereas utilities like PSNH are fully integrated organizations
involved in all three aspects of the business.
The biggest line item in your electrical utility bill is the
cost of electricity. This is the focus for the rest of this post.
The electricity industry has been partially deregulated in
NH and retail customers can purchase their electricity from different competitive
suppliers. However, this electricity still has to run through the transmission
lines and electrical wires of their local electrical utility and so customers are
charged for the use of that distribution infrastructure. Should a NH resident decide not to purchase
electricity from a competitive supplier, the local electrical utility has the
responsibility to source and supply the electricity to the customer. The
utilities do so and apply their default electrical
service rate. Although there has been competition on the residential supply
side of electricity for a few years now, the majority of NH residential
customers still rely on their local electrical utility company to source and
supply their electricity. This is the reason that increases in default
electrical service rates are so important.
There has been a good amount of reporting lately about the
big increases in electrical service rates proposed by the utility companies and
approved by the NH PUC. The table below
summarizes the present default electrical service rates as well as some
information for previous years.
It is important to remember that these increases all relate
to electricity supply (and not to transmission
or distribution charges) so let’s take a closer look at the supply side of the
NH utilities. The rest of this post focuses on the three utilities, NH Electric Co-op, Unitil, and Liberty Utilities, with approved increases. PSNH's default rates - which are not yet approved by the Public Utilities Commission - will be the topic for my next post.
Expanding the supply aspect of the simple generation-transmission-distribution
diagram presented above, the picture quickly becomes complicated because, as
part of deregulation and the drive for competitive supply, we have introduced various
intermediaries and market participants.
The electricity supply to residences by three of the four NH
utilities (NH Electric Co-op, Unitil, and Liberty Utilities) is shown in the figure below. Competitive suppliers, shown in yellow,
purchase electricity directly from generators (red) or through wholesale
electrical markets (green). The second source of supply is from the utility
itself, shown in blue, which needs to procure electricity for its default
electrical service customers. The utility can purchase this electricity
directly from generators but the bulk of the purchases are through wholesale
electrical markets. There are two types of wholesale electrical markets – the
forward sales and the spot markets. Generators sell electricity into both of
these markets.
In order to supply electricity to their default customers,
the utilities have to forecast how much electricity will be required for a six-month
period and then lock in the price of the forecasted amount of electricity in advance. This is carried out in the forward sales segment of the wholesale
electrical markets. Although there is a cost associated with forward purchase
commitments, they offer the advantage of locking in the rate of electricity
purchases for the period. Should more electricity than forecasted be required,
the utility has to purchase this extra electricity on the spot market.
Three NH utilities (NH Electric Co-op, Unitil, and Liberty
Utilities) have just gone through the round of forecasting for this winter electricity
supply. The utilities have estimated the number of default service customers and
their total electricity consumption, and have gone out to markets and solicited
bids for supplying this forecasted electricity through the winter months. The
bids for Unitil and Liberty were reviewed, documented, and submitted as part of
their default electrical service rate application to the NH Public Utilities
Commission (PUC). The costs associated with these forward purchases of
electricity are then included, without any mark-up by the utility, in the
calculation of a single rate for winter months. The NHEC Co-op (NHEC) is unregulated
and is not required to submit its rate adjustment calculation to the PUC.
The problem for default electricity customers is that the
future prices for electricity for the next six months are high, as shown in the
chart below. As the utilities lock in their supply and prices for the winter
months, they are buying right into the winter price spikes.
The difficulty with this approach is that the utilities are
trying to forecast in September what their electricity sales in the winter will
be. This is an enormous challenge because they have to forecast how cold the
winter will be, how many customers they might have and their consumptions. They
must then commit to purchasing that electricity in advance. However, if the
winter is mild, the spot price could be lower. Of course, the opposite could
happen: it could be a brutal winter, natural gas consumption could be sky high,
and electricity prices could skyrocket like last winter. This is the challenge that the utilities and
their regulators face. Is it better to lock in the price now – called “hedging”
– or subject your customers to the gyrations of the spot markets where prices could
be higher or lower than the forward market, or should some balance be struck
between committing to a 100% hedge or a partial hedge? This is exactly the same
decision we face at home. Do we commit to a fixed price for oil or natural gas
over the winter months, or do we take our chances and hope it will be a warm
winter and that oil and natural gas will be cheaper than that fixed-price
contract. What would you do?
The regulators currently require Unitil and Liberty to hedge
100% of their six-month forecasted amounts and commit to the high winter prices.
This has lead to the higher winter default service rates posted by these
utilities.
This brings us to the question of why future prices for
electricity are so high in winter. In
two words: natural gas. As we have closed down nuclear and coal-fired power
plants in NE, we
are now generating 46% of our electricity using natural gas. Depending on
your viewpoint, that could be a good thing: it is a domestic fuel, cheap, and less
polluting than coal. It does, however, make us very dependent on the natural
gas market and fluctuations in natural gas prices. Natural gas is also used for
heating and cooking and, in winter, we do not have the pipeline infrastructure
to bring in enough natural gas for heating and electricity generation. During
winter, the natural gas utilities and electricity generators suck very hard on the
end of the natural gas straw and when demand increases, markets do what they
are wont to do and prices increase accordingly. When natural gas prices
increase, so do the prices of electricity. NE has experienced price spikes for
both natural gas and electricity during the past two winters, as shown in the
chart below.
Source: ISO-NE
Sam Evans-Brown, in a recent NHPR report, does a great job of summarizing the natural gas situation in New England. The political cartoon by Bob Englehart of the Hartford Courant points to the irony of
situation: there is an enormous amount of natural gas available in the US, but NE
is at the end of the pipeline and that causes problems for us in the high-use
winter months.
Bob Englehart
Hartford Courant
Dec 19, 2013
The future electricity prices are joined at the hip to the future
natural gas prices. In the figure below, the leftmost chart shows the future
prices of electricity and natural gas for the next three years, as provided by
the forward markets. (The forward price of natural gas is calculated for the
Boston Algonquin Citygate, which is a good proxy for NE natural gas pricing.
See The
Price for a discussion of natural gas citygate prices.) The winter spikes
in forward electricity prices match the winter spikes in forward natural gas
prices. Should you need convincing, the right-hand figure shows a direct and
very strong correlation between future electricity future natural gas prices. In fact, the
correlation coefficient is 0.966, which indicates a super-strong correlation.
(Correlation coefficients vary between 0 and 1. A coefficient of 1 indicates a
perfect correlation, whereas a value of zero indicates no correlation.) Although
correlation does not necessarily mean causation, in this case we can indeed be
comfortable in concluding that high
future natural gas prices lead to high future prices for electricity.
Returning now to the table that shows the default service
rates for the four utilities, we note that Unitil, Liberty, and NHEC reflect
increases of 59%, 76%, and 71%, respectively, over last winter’s rates. Although
NHEC also shows a large increase, their winter rates are substantially lower.
Based on what I have been able to learn, these lower rates are due to diversification
in the way NHEC purchases its electricity. NHEC does not hedge 100% of its
forecasted needs just six months ahead. Instead, it commits to forward
purchases many years out and to some just a few months out. It also purchases
electricity directly from generators through long-term (20-year) power purchase
agreements and will also purchase some of its power on the spot market where it
is able to take advantage of lower spot prices at times. As an unregulated
utility, NHEC clearly has more discretion than the regulated organizations and
some might suggest that these direct comparisons are unfair. I disagree, because
comparisons of these different approaches are important in trying to figure out
what works best for NH ratepayers.
The Co-op model has a lot of attractive features. The
customers are the shareholders and they are not incentivized by returns on
capital or dividends. They want reliable supply and the lowest possible prices
for electricity and the whole organization is focused to deliver this. With the
other utilities, I don’t see the same incentives to keep down electricity
prices. The regulated utilities, Unitil, Liberty, and PSNH, are required to
pass on the costs of electricity to their customers without any mark-up so
there is little motivation for them to search out alternatives to minimize
energy prices.
NHEC has a long-term view of electricity prices and, to my
mind, the “next six months” approach at Unitil, Liberty and PSNH, as required
by regulation, is far too short-term. Wholesale reliance on short-term forward
markets does not seem to be the best approach. There is certainly merit to the diversification
and flexibility of supply model used by NHEC and I wonder whether consideration
should not be given to incentivizing the regulated utilities to develop a
longer-term view of electricity supply. One way to do this may be to allow the
utilities the flexibility to diversify their electricity supply and reduce the
price of electricity below that of the short-term forward markets and to share
significantly in any resultant savings.
While researching this post, it struck me that there is considerable
variety in the types of electrical utility and a great deal of experimentation
occurring in NH. NH arrived early to the deregulation ball and then pulled back
when things went awry in California (see Should
l I Stay or Should I Go?). As a result we have an integrated utility, PSNH,
still in the generation, transmission, and distribution business; we have two
deregulated utilities, Unitil and Liberty, that are out of the generation
business and who buy all their electricity on the wholesale markets; we have a
cooperative in NHEC which is not regulated by the NH PUC; and we have a few
municipal electric companies. With all of these options in NH, we have a unique
opportunity to figure out which model is the best, and which consistently and
reliably delivers low cost electricity to NH ratepayers.
The past two winters have seen a refrain of “Gonna Take You
Higher”* and I anticipate that the NH annual average electricity price will
rise again this year. When deregulation was introduced, we expected the markets
to automatically deliver lower electricity costs. This has not always happened.
Sure, we have run into cold winters, natural gas pipeline capacity issues, and
the shutdown of nuclear and coal plants, but deregulation appears to have
fallen short on some of its promises. This requires some reflection and is
certainly worthy of a future blog post.
Electricity markets are different from other energy markets,
many of which have an inventory buffers in the form of storage or stockpiles to
overcome temporary interruptions and market dislocations. Electricity, on the
other hand, needs to be simultaneously generated and consumed: it cannot be
stored, and the underlying market components and structures are hellishly
complicated. There are a limited number of market players, liquidity can be problematic
at times, and − regardless of the cost − it needs to be “on” all of time.
Moreover, in NE, the market for electricity now rests on top of the local
market for natural gas – another commodity for which local storage is very
limited and where delivery constraints come into play. With so much of our
electricity dependent on natural gas, we could even reach situations where
there is insufficient natural gas to generate the electricity we need. From
this viewpoint, it appears that heavy dependence on natural gas has compromised
the reliability of our electricity supply. This is all frightfully messy.
I am a proponent of the letting the invisible hand of the
market do its work, but it does need to do so under the very visible and
intelligent hand of regulation. My 1/8 of a KWh worth is that progress has been
made but there is still work to do to get things right for NH electricity rate
payers.
Until next time, remember to turn off the lights when you leave the room.
Mike
Mooiman
Franklin
Pierce University
mooimanm@franklinpierce.edu
(*Gonna Take You Higher – A line from the chorus of Sly and
the Family Stone’s tune, Want to Take You Higher, and a great
example of the funky soul music from the 1960s. This was one of the tunes in
the Family Stone’s set at Woodstock when they played it at 3 am and had the crowd chanting “Higher”. Here is a video of a
1969 show that gives you a sense of the power and drive of Sly and the Family
Stone. Enjoy I Want to
Take You Higher.)
