Why low oil prices mean higher electricity prices

Oil is crashing. Gas is down. But your electric bill doesn't really care.

Every trip to the gas station is a reminder of just how dramatically oil markets have changed in the last 12 months. As of today, crude is trading at $46, a whopping 60% lower than just one year ago. How will this affect your electricity bills? Shouldn’t they get cheaper as oil crashes?

The short answer is no. Pull a chair for a little energy wonkery to learn why.

First, except for very few remote locations, oil is no longer used for power generation – coal and natural gas shoulder most of the generation load, with gas being the preferred marginal resource. And because electricity prices are determined by auctions, the marginal fuel dictates the price. In most markets that means that wholesale electricity prices closely follow natural gas prices. Gridium studies put the correlation at 98% at most nodes in the California market. When you buy electricity in most markets, you’re buying natural gas.

So if electricity is governed by natural gas, how does the change in oil price govern natural gas? You might be surprised to know that as oil has plummeted natural gas has held fairly steady. In the chart below we show two commodity prices indexed over the last 12 months. You can see the massive price spikes triggered by polar vortexes in the winter, followed by a slide in the fall — roughly half of oil’s drop in the same time period. Prices may be down, but volatility is up, so don’t expect much relief on wholesale prices due to natural gas.

Graph of oil and natural gas prices.

Ultimately these prices are a question of complex webs of energy supply and demand. On the supply side, the fracking industry’s ability to weather the price storm is what the industry is watching for price signals. It is widely viewed that most fracking is unprofitable under $70 a barrel – so it’s only a matter of time before rig counts start dropping and the ample supply of domestic oil and gas shrinks. Put more succinctly, don’t bet on cheap domestic natural gas for long.

Secondly, you’d be shocked how little of your electricity bill pays for fuel. For most Gridium customers, less than half the electric bill is actually due to generation charges. Even if gas falls far enough and long enough to impact power contracts with utilities, only half the savings would be passed on. The reality is that most of the electricity bill is for infrastructure related expenses, which only seem to increase in price across the world.

Thirdly, a crash in oil prices hurts the one booming industry that might actually lower your bill. Think its solar? No, solar is doing just fine. It’s electric cars. Tesla is down 1/3 in the last three months and analysts are forecasting a one third drop in the number of vehicles sold in a low oil price world. As we have said before, rates are calculated, and for lower rates, we need more users of the electricity system. A big influx of electric vehicles will lower rates for everyone, but if oil stays low, we’ll see fewer electric cars.

So for now, smile a little when you fill up at the pump. Just don’t expect the oil market to result in electric bill savings any time soon.

About Tom Arnold

Tom Arnold is co-founder and CEO of Gridium. Prior to Gridium, Tom Arnold was the Vice President of Energy Efficiency at EnerNOC, and cofounder at TerraPass. Tom has an MBA from the Wharton School of Business at the University of Pennsylvania and a BA in Economics from Dartmouth College. When he isn't thinking about the future of buildings, he enjoys riding his bike and chasing after his two daughters.

0 replies on “Why low oil prices mean higher electricity prices”

You may also be interested in...

4 Steps to a Better Utility Rate

Need a quick way to lower energy costs? Lean on Gridium to run the analysis and figure out the best utility rate for your unique operation, so you don’t have to.