The business of electricity

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The electricity business is comprised of several kinds of businesses.

Electricity generators are investors, project developers and operators of capital intensive long-lived assets. These folks build large facilities that capture wind, water or sun, or burn fuel to generate electrons they produce. These companies tend to operate under long term power purchase agreements or procurement contracts, or are regulated. Much of the cost of generation is fixed: the property, plant and equipment. Contract or regulatory payment terms are established in advance, and remain relatively fixed, providing the long term certainty that allows these projects to be financed.

The operating costs, on the other hand, can by highly variable based on the cost of fuel, and for some generators, the costs to start up and shut down.

In Ontario and similarly structured markets in Canada, the United States and elsewhere, the cost of generation to customers is based on two things: (1) the overall cost of having the generation capacity in place, and (2) the actual cost to operate that capacity to produce electrical energy in real time.

The power market works because generators offer their capacity for dispatch to the market at a certain hourly price (based on covering marginal fuel costs), the market operator figures out how much capacity is needed to meet demand, and the price is set based on taking up the generator offers from least cost to highest until demand is met.

The market effectively sets the price each hour based on the marginal cost in that hour, so the price always should be sufficient to cover the costs of the marginal generator needed to produce in that hour.

Transmission and distribution utilities also have long-lived assets, but they’re literally all over the map. They have an obligation to serve in their franchise area and they connect to every customer. These companies are all subject to public utility regulation based on their cost of service or subject to performance-based incentives set by the regulator. The “rate” you pay for the electricity transmission and distribution services you receive is set by a regulatory board or public utility commission, and is set out in a formal tariff.

The fixed overhead, general and administrative, costs are covered by a monthly fixed charge.

The capital and operating costs are covered by a capacity charge set according to what your peak demand is at the same time that a peak is occurring on the distribution system. This is your monthly peak charge, and is expressed by $/kW-month.

Other operating costs are covered by a variable charge based on the total amount of energy you use in a month. This is a volume-based charge, and is expressed by $/kWh.

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