How Do Energy Companies Calculate Their Rates? | Power Wizard Blog

How Do Energy Companies Calculate Their Rates?

May 7, 2019 Published by Categorized in: , Tags: , ,

Learn how Texas Retail Electricity Providers Determine the Price of Their Plans

Everyone who’s ever purchased a Texas electricity plan for their home has asked two specific questions during the search process:

 

  1. Which of these plans is right for me?
  2. How do these energy companies calculate these rates?

 

The first question is exactly why Power Wizard exists. As in, the answer depends completely upon you, which is why we compare thousands of plans with your energy usage habits to find the one that’s right for you.

 

Answering the second question requires a bit more nuanced understanding how the energy industry works, but the price of electricity plans can be broken down into four key elements:

 

  • Supply and Demand
  • Seasonality
  • Transmission and Distribution
  • Purchasing Processes

 

Let’s dig in a bit deeper into those crucial factors.

 

1) Supply and Demand

 

Unlike other goods, electricity can’t be stored in any capacity, so it’s created exactly when it’s needed. This literally means that, as more people start turning on devices that use electricity – heaters, air conditioners, televisions, kitchen appliances, and more – the price for electricity goes up. That’s literally demand in action.

 

On the other side of the equation, supply presents a different challenge because meeting the demand for that electricity requires coordinating efforts between generators that don’t always work together very well. Each generation company can charge a different price to start operations. This means both the utility companies and Retail Electricity Providers (REPs) have to negotiate a different rate for each generation company.

 

It’s all in the name of providing enough supply to meet demand. If demand is low, you don’t need lots of supply, which means those generators will charge a low price to operate because they need the business. If demand is high, the generators can charge higher prices because the energy companies really need to ramp up supply very quickly.

 

2) Seasonality

 

When and how people use energy in relation to the seasons directly impacts supply and demand. Sure, that seems quite obvious – people living in Houston, TX will use demand much more electricity in July than they will in January – but energy traders must account for those more dramatic peaks and valleys in usage when making purchases for long-term fixed-rate plans. Calculating for and anticipating seasonal demand for electricity means that energy companies engage in higher-end economic modeling in order to ensure their prices are appealing to customers while also hedging against big seasonal spikes in usage.

 

3) Transmission and Distribution

 

REPs aren’t responsible for transmitting electricity across power lines and distributing it to homes and businesses. That’s the responsibility of the utility company. As you might imagine, the utility company doesn’t do that work for free, so the electricity companies have to pay the utility companies to get electricity to their customers.

 

Admittedly, those transmission and distribution charges don’t change that often, but since they are passed onto customers, they must be factored into the electricity prices customers are shown. In fact, many electricity companies break out these charges on their bills to show customers which charges go to them and which ones go to the utility company.

 

4) Purchasing Processes

 

Eventually, everything trickles down to how energy is actually purchased. Since supply and demand fluctuate on a regular basis even on the mildest spring days, energy companies monitor those prices on 15-minute increments as measured cents per kilowatt-hour (kWh). They use this information to determine the best times and prices at which to buy that energy.

 

But real people don’t think about energy like that, and they certainly don’t buy it like this. Hence, the price you see from REPs for their plans is a projection of the average price they’ll pay for that plan in those 15-minute increments for the life of the contract term. Or put another way:

 

  • You see an electricity plan with a rate of 10 cents per kWh for a fixed 12-month contract term.
  • That’s the rate you will pay for each kWh of electricity you use for 12 months.
  • The REP bought energy in bulk at that price because projections say the average price will be around 10 cents per kWh for that contract term, even with seasonality involved.
  • The REP hopes that average price stays just under 10 cents per kWh so they meet their margins and make some profit.
  • The REP hopes the average price doesn’t go above that rate because that means they’re losing money on everyone who bought energy at that price.

 

In short, the energy companies purchase electricity based upon how much they think people will use in the future, how weather could impact that usage, and the cost of transporting it on power lines. Their ultimate goal: Calculate a low-enough rate that attracts enough customers while still being high enough to turn a profit.

 

Try Power Wizard today. Our advanced technology cuts out the industry noise and finds you the plan that gives you the best chance to save!

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