Businesses are acutely aware that energy costs have been going up. Those that are paying attention to their utility bills will realize natural gas has more than doubled in the past year compared to recent averages. Even the most diligent consumer might not realize that higher natural gas costs also have a role in driving up power bills.
Here’s how it works. Electricity markets are designed to bring additional power generation onto the grid as demand for power climbs. The last generator that is accepted to run, sets the price for all other generators. Natural gas generators are frequently the last ones to be accepted, allowing them to set the market price for electricity.
Natural gas generators see their costs increase as the input fuel cost increases. Therefore, whenever natural gas generators, with their increased costs, come online to meet demand, they push up the price of electricity for all generators.
The example illustrates how marginal pricing works. Natural gas is the last generator to be accepted to run in hour 4. Note how a cost increase from 4¢ to 9¢ sets the market price for all generators at 9¢.
Ontario’s Independent Electricity System Operator (IESO) data suggests that natural gas generators are the last to be brought in for 64% of all hours. Yet, natural gas generators provide just 9% of Ontario’s overall electricity supply. In the American PJM region, natural gas generators set the marginal price for 70% of all hours while providing only 40% of the net generation.
There’s more evidence that natural gas costs impact electricity markets. Figure 1 shows the correlation.
When monthly average AECO prices declined between January 2014 and May 2016, monthly HOEP followed suit. When AECO prices were stable or moving sideways between May 2016 and December 2019, monthly HOEP similarly moved sideways. And as AECO prices started to increase from the summer of 2020, HOEP started increasing too.
In recent years, Ontario has added more natural gas generators to supply its power. This move has only strengthened the link between natural gas and electricity prices.
Figure-2 shows a strong correlation in the 24-hour moving average between changes in natural gas-fired generation and HOEP. The exception to this correlation is in April 2022. Rising gas prices had a greater impact on HOEP than the decline in natural gas generation.
This relationship holds true in other markets too. In the PJM, for example, gas prices have driven nearly 70% of the variance in daily power prices over the past two years while providing 40% of total generation.
Impact of Global Adjustment
For Ontario consumers, an increase in the HOEP is only one part of the story. Any discussion around net electricity costs must consider the global adjustment (GA) rate. Global adjustment tracks the difference between the hourly market rate and the contracted generation rate for the province’s nuclear, hydroelectric, and renewable generators.
Figure-4 shows that as HOEP rises, the GA rate declines. If generators recover more of their contracted rate through market revenues, the amount they recover through the global adjustment mechanism is reduced.
Ontario customers with high global adjustment exposure, can experience limited, even reduced, net power costs as market prices increase. Conversely, consumers with low global adjustment exposure may dramatically see their net electricity costs increase.
Businesses need to understand what drives the different components on their electricity bill. For Ontario consumers, costs are typically itemized as “supply”; “global adjustment”; and “delivery/distribution”. In other markets, costs may be allocated into “supply” and “delivery”; or “supply”, “delivery” and “capacity”. In all cases, “supply” charges present the impact of market prices on the bill.
Understanding power prices is the first step in controlling power prices. Businesses who want to control energy costs in their operations often retain a trusted advisor. Industry experts can provide guidance, assurance, and support for those wanting to understand and successfully navigate volatile energy markets.