How do we pay for electricity?
Last updated 3/17/2020
One of the most important things to understand about electricity is how we pay for the ongoing operation of the grid. It costs money both to produce electricity and to transmit it to end users. The amount you pay on your electricity bill every month is a combination of these charges.
How does electricity pricing work?
For most homeowners, electricity is priced on a per kilowatt-hour (kWh) basis. This means that your monthly electricity bill is calculated by multiplying the amount of electricity you used in a month by your electricity rate.
The electricity rate you are on differs by the region you live in, as well as the utility you purchase power from. Utilities establish the price of electricity to recover all of their costs, and often are required by law to revise their rates slightly every six months to a year. The price of electricity can change due to variations from the forecasted demand for electricity, changes in fuel prices, or to account for new investments by your utility in the transmission and distribution system or new sources of power generation.
What are you paying for on your electric bill?
Over time, the cost of electricity has increased steadily, as utilities built more and more power plants and a wider interconnected web of transmission lines to meet the increasing needs of a growing economy and population. In fact, according to the US Energy Information Administration (EIA), the price of electricity has increased steadily by about 1.3% per year over the previous 10 years. If these trends continue, that means that if you currently pay $100 per month for electricity, 25 years from now you’ll pay $136 every month for electricity.
When you pay your electricity bill, the money you spend goes towards two primary things: first, paying for generating the actual electricity that you used (i.e., burning coal at a power plant to produce power) and, second, maintaining the grid (i.e., fixing or replacing any aging transmission infrastructure).
In other words, your monthly electricity bill is paying directly for purchasing any fuel that your utility burns, for the annualized cost of building the power plant, and maintaining the network of poles and wires that move electricity from region to region as well as within your own neighborhood.
What are the components of your electricity bill?
In many parts of the country, the electricity rate on your bill is split into two components: a supply charge, and a transmission and distribution charge. At a high level, the supply charge covers the cost of producing electricity while the transmission and distribution charge covers for the cost of getting that electricity to you via the grid.
The supply charge is directly a result of what power plants are used to produce electricity in your region. In most parts of the country, utilities use the least expensive power plant first and gradually turn on more and more expensive power plants as the need emerges. This method of calling on power generators is called the supply stack: when there’s lower demand on the system, the price of electricity is lower, while when demand for electricity increases, so does the price we pay for it.
The price at which each power plant runs is determined by its fuel cost: i.e., how much does it cost to purchase the fuel it uses to produce electricity (such as coal or oil). For the most part, nuclear power plants have the lowest fuel costs, while the cost of producing electricity with coal and natural gas is higher, with natural gas somewhat less expensive than coal these days.
Notably, renewable energy resources such as solar and wind have no fuel costs and produce energy for little to no ongoing cost, making these resources consistently the cheapest available and helping to decrease the cost of electricity for the grid as a whole.
The supply charge you pay closely correlates to the primary type of electricity produced in your region. If you live in a natural gas heavy region, the price you pay for electricity is tied to natural gas prices, while if you live in an area where power primarily comes from coal facilities, then your supply charge is tied to the cost of coal. Likewise, living in a region with a high volume of renewable energy resources can decrease your supply charge.
Transmission and distribution charge
The transmission and distribution charge, alternatively referred to as the delivery charge or the poles and wires charge, covers exactly that: it pays for building and maintaining the telephone poles and electrical wires that move electricity from power plants to your property. You can think of the delivery charge as effectively the same as paying for shipping and handling on any product you buy online.
The transmission system is a series of high-voltage power lines that carry electricity across long distances from large, central power plants to population centers. The distribution system is the network of smaller, more local, lower voltage power lines that carry the electricity to individual homes and businesses.
Transmission and distribution lines are similar to water or gas pipelines: they have a capacity limit for how much electricity they can carry at once, determined by the voltage of the individual lines. Similar to how more water and gas pipelines have been built over time to accommodate the greater need for natural gas or water in budding population centers, so too have additional transmission and distribution lines been built over time to accommodate an increasing need for electricity.
Your transmission and distribution charge helps pay for both the build out of the transmission and distribution system as well as any ongoing maintenance required to keep electricity flowing through the wires. This ongoing maintenance includes preventative tree trimming, replacement of telephone poles, rebuilding and upgrading of substations, and ensuring that the transmission and distribution system remains robust and resilient in the event of a major storm event.
There are additional charges that may be present on your electricity bills. For instance, if you live in a state with energy efficiency and renewable energy targets and programs, a very small percentage of your electricity bill may go towards a renewable energy charge, distributed solar charge or energy efficiency charge. Collectively, these are often referred to as system benefits charges. To give a sense of the size of these charges, in Massachusetts, the energy efficiency charge is around 5% of your bill, while the renewable energy and distributed solar charges are both below 0.3% of your monthly bill.
Additionally, many utilities are now implementing additional, fixed monthly fees, such as a customer charge, which is a monthly payment for using the utility’s hardware–your electricity meter–to connect to the utility’s network, the same way a cable or internet company might charge you monthly for a cable box or modem that they provide you. Alternatively, your utility may now include a demand charge, which is a charge associated with the maximum amount of electricity you use in a given month.
How to read your electricity bill
Reading–and understanding–your electricity bill can be difficult. In fact, half of Americans don’t know what electricity rate they’re on. But with a few simple tricks for reading your electricity bill, it’s easy to determine what rate you’re on, what’s included in your monthly electric bill, and how to calculate what your bill is each month.
- First, determine what kind of electricity rate you’re on. Are you on a flat rate or a time-of-use (TOU) rate?
- Next, look for the two primary charges on your bill–the supply charge and transmission and distribution charge. Make sure you can separate them from any other miscellaneous charges.
- Finally, determine your monthly electricity usage and calculate your total bill.
It may seem intimidating at first, but knowing how to read your electricity bill can have major benefits, as knowing what you spend your money gives you the knowledge to figure out how to cut your monthly bills.