Why Do Electric Rates Vary So Much Across the U.S.?
by Bob Shively, Enerdynamics President and Lead Facilitator
Electric rates vary significantly across the U.S. Here are average rates for the year 2020:
Source: U.S. Energy Information Administration
While not shown on this graph, rates can also vary within a state depending on what utility provides a customer’s service. Within a utility, rates also vary significantly by customer type:
Source: U.S. Energy Information Administration
To understand how rates can vary so significantly, we first need to consider the components that go into electric rates. A recent study of California rates by Lawrence Berkeley Labs broke rate down into five components:
- Generation
- Transmission
- Distribution
- Greenhouse gas pollution costs (this is only applicable in states that have applied a price to greenhouse gas emissions)
- Public purpose programs and other costs
Differences among customer classes
It is fairly easy to understand why prices vary by customer type. Larger customers such as industrial consumers have high load factors meaning they require less unused capacity for the bulk of their operating hours and they achieve efficiency of scale for distribution facilities. For instance, a large commercial customer might require one or two meters for a facility that uses the same amount of energy as 1,000 homes. And the facility receives one bill and can be serviced through one dedicated account representative, while the equivalent number of homes requires 1,000 bills to be processed and a call-in center ready to answer the phone when the residential customer has a need.
Differences among utilities within the same state
I live in a small community just outside Fort Collins, Colo. Within a few miles of my house there are three different utilities that might be your electric provider depending on where you live. These include the City of Fort Collins Utilities, the Poudre Valley Rural Electric Co-op, and Xcel Energy. Average residential rates vary from about 10.5 cents/kWh to 12 cents/kWh. Why such a difference within just a few miles? Each utility has its own characteristics that impact its generation mix, its required transmission and distribution facilities, and its cost of financing capital investments. The City of Fort Collins Utilities is a municipal utility, so it has lower financing costs but years ago made the decision to underground all of its distribution lines. So, the distribution component is higher than for the other utilities that provide overhead services in most areas. The Poudre Valley co-op serves a mostly rural area and has transmission and distribution lines spread through the foothills and mountains. This impacts its transmission and distribution cost components. But the co-op has access to federal hydropower projects that have a low cost of generation. Meanwhile, Xcel Energy is an investor-owned utility, and its financing includes equity that currently earns a rate of return of 9.3%, which is much higher than the borrowing costs for the other utilities. But since Xcel serves most of the populated regions of Colorado, its costs are spread over more customers. This brief example shows how rates can vary so much among utilities within a small region.
Differences between states
So then, why do rates vary so much when you cross a state line? Some reasons are obvious. Hawaii and Alaska, for instance, have traditionally depended on imported oil or diesel fuel transported across long distances for much of their electric generation. But why should crossing the border from Wyoming into neighboring Colorado result in average rates jumping from 8.29 cents/kWh to 10.25 cents/kWh?
In the United States, retail rates are regulated at the state level. This means each state develops its own policy in setting rates and utility policy without federal oversight. So regulatory policies adopted at the state level have a significant impact on rates. Wyoming is less into regulating environmental impacts of generation than Colorado. Colorado is already rapidly transitioning to low-carbon generation sources, and the largest remaining coal unit used by Xcel was only recently built. Wyoming receives most of its generation from older depreciated coal generation. And the population of Colorado is significantly more urban than Wyoming. Distribution facilities tend to be more expensive in more dense urban areas. Also at play is the amount of transmission required to move power to customers. While this may be similar between Colorado and Wyoming, other states that depend on importing power from other states (for example California, states in the Northeast) will have higher transmission costs. Some states have plentiful hydro power or renewable resources, others must transport fuels long distances to operate their generation facilities. So, because each state determines its own energy policy and different states have better or worse access to supply resources, each state is somewhat of a unique situation when it comes to costs.
What does this mean for the utility industry going forward? Given the current state-based regulatory model, major differences in resource availability, and the three different types of utilities, it doesn’t appear that the rate variance will disappear anytime soon. We can expect that electric prices will continue to vary significantly across the U.S.
Get a greater understanding of the utlity business through Enerdynamics' online courses Introduction to Utilities and How Utilities Makes Money.
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