TOPIC #1
Energy Cost and Affordability: Watching Trends
As macro trends alter the energy landscape and significant investments in energy transition are contemplated, focus turns to maintaining affordability.
A Historical Trend of Good News
- Over the past decade, energy costs have generally been stable or declining, in sympathy with broader trends. From 2012 to 2021, the U.S. average cost of electricity increased by less than 1% per year, compared with the broader consumer inflation rate of just under 2% annually.
- While utilities have grown capital investment in utility infrastructure, increases in utility rates and bills have generally been modest because of several structural factors:
– Low-fuel (especially natural gas) costs for power generation
– Increased competition
– Consolidation (with scale economies)
– Lower Treasury rates (and hence lower required returns on equity)
– Generally lower commodity costs
Figure 1.1: Total Consumer Price Index vs. Electric Consumer Price Index (Monthly) (Index: Jan. 1960=100)
Source: Federal Reserve Bank of St. Louis
KEY TAKEAWAYS
A long trend of lower electricity costs, tied to low natural gas prices, has reached an inflection point. To date, low natural gas costs have tempered rate increases even as utilities have continued to invest in their systems.
Looking ahead, increasing grid investments and incremental spend to reach net-zero objectives will require significant investments, but utilities and regulators will need to balance variables of net-zero, reliability and resilience, and energy affordability.
Policymakers, regulators, and utilities may be faced with difficult trade-offs as they weigh reliability requirements, clean energy targets, and customer affordability.
The IRA could help temper rate increases and reduce energy costs for consumers adopting energy efficiency measures, but it is too early to tell how and whom it will assist.
A long trend of lower electricity costs, tied to low natural gas prices, has reached an inflection point. To date, low natural gas costs have tempered rate increases even as utilities have continued to invest in their systems.
Looking ahead, increasing grid investments and incremental spend to reach net-zero objectives will require significant investments, but utilities and regulators will need to balance variables of net-zero, reliability and resilience, and energy affordability.
Policymakers, regulators, and utilities may be faced with difficult trade-offs as they weigh reliability requirements, clean energy targets, and customer affordability.
The IRA could help temper rate increases and reduce energy costs for consumers adopting energy efficiency measures, but it is too early to tell how and whom it will assist.
Transitory Period or End of an Era?
- Beginning in mid-2020, however, natural gas and other commodity prices began trending upward, sometimes at a significant rate. Natural gas has risen from under $2/MMBtu in 2020 to nearly $10/MMBtu in 2022. This increase has come because of multiple factors, including warm weather leading to higher gas demand for power generation and lower than usual gas inventories. While too early to tell its potential effects, increased global LNG demand may also impact domestic gas prices (most certainly in New England).
- In addition, commodities necessary for batteries, most notably lithium, as well as other key electric infrastructure metals such as copper, have seen price increases due to several factors, including geopolitical events, supply chain issues, and growing demand. In fact, the price of lithium increased more than 700% from the beginning of 2021 to the summer of 2022.
- The question for regulators and utilities, as well as policymakers, is whether these cost trends are transitory (a word that has inspired much debate of late) or part of a broader, more long-lasting trend of generalized inflation.
Figure 1.2: Actual and EIA Forecasted Henry Hub Monthly Natural Gas Prices ($/MMBtu) (Jan. 2018–Dec. 2023)
Source: EIA
Downstream Impacts on Electricity Costs?
- Over the past decade, utility capex, and more recently natural gas prices, have increased at a greater pace than the Consumer Price Index and average U.S. electricity prices. And while many utilities have fuel cost hedges to limit their exposure to large price increases, as those hedges expire, utilities may be rolling over hedges at higher price levels.
- In 2020, however, at the same time natural gas prices began to spike, inflation and electricity prices started to rise. This is being reflected in growing rate increase requests.
- Even as these trends are driving electricity cost increases, electric utilities are planning—and in some cases mandated—to significantly grow investment in all elements of the electricity value chain as part of energy transition, such as:
– Distribution: Accommodating building and vehicle electrification, modernizing the grid, adding storage and other non-wires alternatives, and expanding efficiency and demand response programs
– Transmission and system operations: Expanding regional footprints, interconnecting renewables, replacing aging infrastructure, resilience investments, load growth in growing regions, electrification, and flexible resource procurement to ensure resource and energy adequacy
– Generation: Adding new resources, both dispatchable and variable and emitting and non-emitting; increasing gas interconnections; and piloting new technologies (hydrogen, advanced nuclear, carbon capture, utilization, and storage)
Figure 1.3: Change in Key Prices and Selected Utility Capital Expenditures (2012–Present) (Index: 2012=100)
Source: Federal Reserve Bank of St. Louis, Edison Electric institute
Downstream Impacts on Electricity Costs? (Cont.)
- Cost and investment estimates for net zero vary depending upon scenario and assumption and the blend of potential investments noted above. For example, Princeton’s 2020 Net Zero America report estimates that a system with aggressive end-use electrification and 100% renewables will require the following electric capital investment to meet a 2050 net-zero goal:
– Distribution: $370 billion in the 2020s and $700 billion per decade in the 2030s and 2040s
– Transmission: $2.4 trillion of high-voltage capacity through 2050
– Solar/wind: $3.2 trillion of solar and wind capacity through 2050
- Of course, not all of those costs are net-zero-related capital; significant amounts are for anticipated infrastructure spending regardless of net-zero investments. For context, net property, plant, and equipment of electric investor-owned utilities at year-end 2021 were about $1.36 trillion. Even assuming that the Net Zero America estimate is a high case, the amount of capex for the utility industry will be substantial over the next decade or more.
Figure 1.4: Monthly Historical and Short-Term Forecast Average U.S. Residential Electricity Price (¢/kWh)
Source: EIA
Figure 1.5: Past and Pending U.S. Electric Utility Rate Increases by Year (2003–2023) ($ Millions)
Source: S&P Global Market Intelligence-Regulatory Research Associates
Figure 1.6: Electricity Price Increases: Potential Short- and Long-Term Drivers
Source: ScottMadden analysis
Growing Emphasis on Affordability
- As utility costs and prices trend upward, regulators, utilities, and stakeholders are refocusing attention on affordability. That issue garnered attention during the COVID-19 pandemic when stay-at-home orders caused job dislocations and related income reductions affecting some customers’ ability to pay utility bills. Now, despite economic recovery, across-the-board consumer costs are affecting energy affordability.
- To date, aggregate energy burden—the percentage of household income spent on energy expenditures—has remained modest overall. According to the American Council for an Energy-Efficient Economy, as of 2017, U.S. households spent an average of 3.1% of income on home energy bills. Looking by groups, however, reveals significant differences by income and other categories (see Figure 1.7). Recent electricity price spikes are gaining broader attention, as a recent survey found that 20 million American homes had fallen behind on their utility bills.
- Affordability is defined differently from jurisdiction to jurisdiction and sometimes not consistently across regulatory proceedings. For instance, only relatively recently (summer 2020), California adopted metrics by which it would assess relative affordability of essential utility service across its proceedings. The California Public Utilities Commission (CPUC) has also produced an annual affordability report (beginning in 2021) in which it gauges utility bills (power, gas, water, and telecom) against three metrics (see Figure 1.8):
– Affordability ratio (for households in the 20th income percentile)
– Hours at minimum wage
– Impacts on disadvantaged communities
Because these reports are relatively new, California has limited trending information. But its latest published report notes that more than 13% of households were in areas where electric affordability ratios for the 20th percentile income were above 15%, which is an indicator of unaffordability.
- Many regulators and utilities will monitor affordability in their rate proceedings, focusing on the impact of increased spending on all customers, with a view toward geographic areas and customer segments more significantly affected by increasing bills. These findings could lead to actions on implementation and effectiveness of low-income energy efficiency, energy assistance, and alternate rate programs.
Figure 1.7: U.S. Household Percentage of Income Spent on Electricity by Income Tier (2018–20 Actual and 2021–22 Estimated)
Source: National Energy Assistance Directors Ass'n
Figure 1.8: California’s Recently Implemented Approach to Affordability Metrics
Source: CPUC
To the Rescue?—Potential Impacts of Inflation Reduction Act
- In August, Congress passed and the President signed the IRA. The legislation includes $369 billion in investments and incentives designed to significantly lower the cost to manufacture and deploy zero-carbon technologies, energy efficiency measures, and building electrification.
- The legislation contains provisions for production and investment tax credits for clean energy projects. The effect of the tax credits and government investment assistance in clean energy and related transmission and distribution infrastructure could reduce revenue requirements for utilities, which would be transmitted to customers via lower rates.
- One early analysis of the IRA assumes that non-carbon-emitting energy investment will shield electricity customers from natural gas price volatility and perhaps reduce gas prices, leading to lower bills (see Figure 1.9).
– The IRA is expected to save electricity consumers between $209 billion and $278 billion from 2023–2032, as that analysis posits that electricity prices will decline between 5.2% and 6.7%.
– Over the decade, the analysis projects annual savings of $170 to $220 on electricity bills for the average U.S. household.
- The IRA also provides incentives for energy efficiency and electrification that may offer substantial energy savings to end consumers.
- It is unclear and still early to determine whether these interactions between government incentives, utility investment requirements, and fuel (specifically natural gas) prices will work to reduce rates. Utilities and policymakers will watch this closely.
Figure 1.9: Projected Change in Average Retail Electricity Prices (2023–2032) With and Without Inflation Reduction Act of 2022
Source: Resources for the Future
Considerations for Utilities
- As utilities contend with increasing investment requirements and, for now, higher natural gas, commodity, and labor costs, they will need to consider some key questions:
– Will electrification hit a cost “wall” as investments increase substantially beyond historical replace and upgrade cycles?
– Will increasing rates and/or bills cause customers to push back on energy transition investments, questioning their cost effectiveness?
– Will the utility industry revisit its “death spiral” fears from a decade ago as higher rates incentivize distributed energy resources?
– What are the implications of cost allocation to customers for increasing spend, particularly as it affects moderate- and low-income customers?
– What are implications for rate design, as systems introduce more fixed, non-volumetric costs (grid enhancement, reliability investment) together with zero-marginal cost renewable resources and increasing levels of energy efficiency?
IMPLICATIONS
Utilities must balance affordability, reliability, and clean energy in providing electricity service to their customers. It is unclear whether the elevated inflation rate seen in electricity costs will be persistent and long-lasting.
But as energy transition costs grow, utilities and their regulators will be well served to consider ways to temper rate hikes, enhance programs that assist in ensuring energy affordability (including special rates, payment assistance, and efficiency), and tailor rate designs to higher fixed system costs.
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