Pricing 101 - Part 2

July 2, 2024

Pricing 101 - Part 2

In part 2 of this series, we will dive deeper into pricing for residential customers, examining the different factors that go into the creation of tariffs for customers and the challenges that retailers face to create and maintain competitive residential pricebooks.
July 2, 2024

Pricing 101 - Part 2

July 2, 2024

Welcome to the second part of our Pricing 101 series. If you’ve not yet read part 1, you can find it here:

Pricing 101 - Part 1

Part 3

Part 4

This series sets out to explain the creation of an energy price and how an energy retailer calculates this. Part 1 explored the structure of deregulated energy markets and the changes we are seeing now in supply and demand. We then broke down why this structure causes challenges for pricing teams. In parts 2 and 3, we will dive deeper into pricing for residential and for commercial & industrial (C&I) customers, reflecting on how the different market segments produce different issues for pricing. Part 2 focuses on residential customers with Part 3 dedicated to C&I.

As we go into more detail on energy pricing, more specific differences between states and countries will come to the fore; this blog isn’t intended to cover every single variation that could be listed on a customer’s bill and some things we discuss will be US specific. 

Energy Pricing for Residential Consumers

Every individual needs to purchase energy for use in their homes both running lights and appliances through electricity and powering central heating or cooking appliances with gas. 

Components of Residential Energy Bills:

  • Energy consumption
  • Metering costs and administration
  • Transmission and distribution costs
  • Taxes and fees
  • Riders (US) 

The biggest part of an energy bill is based on the volume of energy consumed, measured in kilowatt hours (kWh). This is measured using an energy meter. In the past, utilities relied on physically reading the meters, either by the customer or by their staff, to provide fully accurate readings. This meant that meters would only be read infrequently, and consumption was based on estimates and revised later. Increasingly, utilities are supplying customers with smart meters, which provide live data to utilities to allow precise measurement of consumption. Some residential customers can also pay “demand charges” though these are much more common for C&I customers and will be explained below.

The costs of providing and maintaining meters are covered by monthly fees. This charge can also cover the cost of obtaining meter readings, though the installation of a smart meter allows this to be automated. Depending on the retailer, costs of operations can also be recovered through these charges.

The infrastructure of energy delivery also needs to be paid for. As we discussed in Part 1, vertical utilities were split into separate generators, transmission operators, and distribution companies. Providing funds for the latter two is done by placing extra fees on customer bills (to be specific, retailers are charged and are expected to then recover costs by billing customers). How customers are billed for this varies by region. In Texas, this will be a TDU (Transmission and distribution utility) charge. In the UK, these costs are covered by a mix of flat and variable charges.

The final part of a bill comes from the government. The US doesn’t have any federal taxation on energy, but states and localities may apply sales tax and municipal fees. Regulatory charges can be used for specific goals, such as funding for renewable energy generation or the installation of smart meters.

Riders are temporary modifications from the utility to the rate structure paid by a customer that are applied for specific purposes (and normally named as such). For example, a rider may be charged for renewable energy funding. Outside of the US, similar items may be applied to customer bills but they are not called riders”

When energy retailers quote residential customers, they rely on a set of predefined prices that can be looked up in a price book or price catalog. Thus, quoting an individual customer is not a complex task, but the process of generating the price book as accurately as possible with the optimal pricing outcomes for both the retailer and end customer, is a complicated, often iterative and almost always very data intensive process.

Rate Structures

The amount charged per kWh depends on the rate structure that a customer signs up for. There are potentially hundreds of different tariffs that a retailer could offer, but we can group the tariffs into a few common categories:

  • Fixed rates
  • Time of use
  • Tiered pricing
  • Green tariffs
  • Variable rates

Fixed-rate tariffs offer stability by maintaining the same price per unit of energy throughout the contract period, typically one to three years. This can be advantageous for budgeting, but consumers might miss out on savings if market prices fall.

Time-of-use tariffs charge different rates based on the time of day energy is used. Typically, there are peak and off-peak rates, with higher charges during times of high demand and lower rates during periods of low demand. This type can be beneficial for households that can shift their energy usage to off-peak times - many retailers are now offering ToU tariffs that are designed for remote work or EV charging.

Tiered rates are tariffs which vary based on the amount of electricity used by a customer. Using more or less electricity within a given period will change the unit price. How retailers set each tier will differ depending on location - for example, California offers a straightforward linear price increase with usage, whereas Texan retailers have more freedom to set tiers. UK retailers do not offer this type of tariff.

Green tariffs are still relatively rare, but where offered they enable consumers to receive a certain percentage of electricity directly from renewable sources, up to 100% in some cases. 

Variable-rate tariffs or “Dynamic tariffs” fluctuate with the market price of energy. When market prices drop, consumers can benefit from lower rates but they may face higher bills if prices rise. These tariffs offer flexibility but come with unpredictability in energy costs. Currently, tariffs like this are largely found outside of the US due to regulation that prevents retailers from offering them. Texas was the one exception, but this was stopped after Storm Uri in 2021.

How retailers have sought to lower bills

Aside from their own attempts to reduce costs, retailers and governments have encouraged consumers to manage demand and invest in efficiency measures to help manage residential bills.

Many countries have invested in the rollout of smart meters not only to improve the measurement of energy consumption for utilities but also to enable customers to more accurately track their daily usage and make changes in response. There is also hope that internet of things will deliver more demand management levers for utilities to use, with customers having the option to agree to demand management systems in exchange for better deals. In return, utility companies can switch off certain devices.

On-site solar and energy storage offer a more active way for customers to lower bills. Investing in their own generation can cut out paying retail prices at times, while storage lets customers purchase energy during lower cost periods for use later when prices are high. If there is excess capacity, customers can sell energy back to the grid if the capability exists.

One radical difference that Texas has pursued is the lack of a forward capacity market for energy. In other US markets - as well as many other nations with free markets - a capacity market is used to maintain a surplus above predicted peak demand, often years in advance. This provides some more certainty to generators, but it comes at a high cost. Texas has consistently managed to offer much lower electricity bills by removing the capacity market. The state has used other mechanisms to maintain supply at peak times, with the most recent proposal being the Performance Credit Mechanism (PCM), but there is still a lot of debate on how ERCOT should best manage periods of peak demand.

Difficulties in pricing for residential 

A residential customer visiting a retailer’s website in most countries would not have a huge amount of choice. There will be the standard tariffs listed above, perhaps some variations by location, and potentially green tariffs and some specialized EV tariffs. This might sound simple, but the volatility of the energy market places constant pressure to keep price books up to date and competitive. To add to this, the growing availability of customer data means that specialization in products will be a major competitive advantage going forward. 

Creating a price should be the simplest aspect of a pricing team’s job, but plenty of barriers exist. Retailers will have a set of formulas, in spreadsheets or other software, that combine relevant data to output prices. This was fine 20 years ago when the market was simpler and the amount of industry data was low, but modern pricing teams are struggling to move quickly on outdated technology. The pricing process tends to be manually updated and executed with limited automation. Instead of updating prices to respond to market conditions, teams are stuck on yearly repricing due to the effort involved in updating prices. On top of that, systems simply can’t make use of all the available data, making it hard to have complete insight in portfolio profitability. This makes energy retailers slow in reacting to market changes and results in big risk-taking with uncertain margins & profitability.

Looking forward, the expectations of residential customers will be for more tailored prices that can match precise circumstances, instead of the same off-the-shelf tariffs as everyone else. Incorporating options for a percentage of renewable energy, for more accurate ToU pricing, or even for dynamic tariffs that expose customers to wholesale prices, will not be possible on existing technologies.

How Gorilla solves problems in residential pricing

The Gorilla platform was built to solve pricing problems through unparalleled data processing power. Gorilla’s advantage is not complicated: it’s faster, more accurate, and able to scale to any size. Prices can become outdated very quickly in the modern world, but keeping these up to date is not easy when pricing processes take days or weeks. That changes when you can reprice super quickly and do it as often as you like, which is what Gorilla provides. Re-costing is a similarly quick process, eliminating the yearly re-price. 

Developing new, more tailored tariffs is far easier thanks to the intuitive interface and ease of use of Gorilla. Users can easily copy a costing structure but apply different price outputs to rapidly generate new prices. The flexibility to price top-down or bottom-up, adding in new generation assets, lets teams rapidly price up new products and stay ahead of the competition. The arrival of smart meters and subsequent rise in the amount of data available will open up a lot of new opportunities, if retailers have the tools they need. Check out Residential Pricing today to see the difference it could make.

That concludes part 2 of the series. We’ve looked at the makeup of energy bills for  residential customers and discussed attempts to keep bills lower . We’ve also examined the specific difficulties that retailers face to produce tariffs that can maintain margin and remain competitive. Part 3 will examine the same topics for C&I customers

Pricing 101 - Part 3

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