Why do we pay for electricity? What the energy price rise reveals about the market

A recent Credit Suisse report suggested that the Inflation Reduction Act in the U.S. would have far-reaching effects on the renewable energy sector, which could see electricity prices drop below one cent per kilowatt-hour (kWh) as early as 2025, as opposed to an average of somewhere around $0.15 per kWh now.

If this were to come true, it could effectively mean that power would be so cheap that we wouldn't need meters to monitor who has used how much and could perhaps move to a system of flat monthly payments. While this might sound like a Utopian dream to many, to know if this will ever turn into reality, we need to first understand why we pay for power in the first place.

Why do we pay for electricity?

Electricity bills do not really need an introduction. We receive them every month and pay them off diligently without much thought. In simple terms, your bill is the amount of electricity you have consumed in a given month multiplied by what it has cost the utility company to produce it, plus a little (or a lot of) profit.

The cost of producing electricity varies depending on the fuel used. Depending on where you live, coal or natural gas might be the cheapest way to do so, or, if available, nuclear power or renewables may be the cheapest in terms of price per unit.

However, utility companies also build infrastructures such as high-tension wires and substations that are required to bring the power generated at a power plant to your home or office. At times, components of this distribution network may break down or need replacement as they approach their end of life. These costs, as well as overheads such as payroll and office costs, also need to be paid for and are recovered from customers under the heads of transmission and distribution charges. These are smaller fixed charges that you see in your bill every month or are included in your unit pricing.

Why have energy prices risen so sharply?

In recent months most of us have felt the pinch of the sharp rise in power bills. This has been attributed to the ongoing conflict in Ukraine, which has shot up prices of fuel, such as natural gas as well as coal, as compared to last year.

Utility companies use a combination of power sources to supply energy, generally starting with the cheapest method and then adding the next expensive method to the mix when the demand for power increases. Since prices of fuels have generally risen across the board, even when utility companies use the cheapest energy source, charges for consumption still tend to increase over time.

The exception to this would be renewable sources of energy, where the energy is often generated locally and tends to be available at a lower cost; and an event like war does not affect the supply. Of course, renewable energy still needs the infrastructure to generate, store, and deliver this power, which comes at a cost. Currently, the costs for renewables are increasing, although not by nearly as much as those for fossil fuels, making renewables currently much cheaper than fossil fuels to produce.

As countries and companies turn further towards renewable sources of energy in their bid to reduce their carbon emissions, the costs of harnessing these energy sources are expected to come down further. Where the market forces may take a while to kick in, government subsidies will do the job.

How can Inflation Reduction Act help?

The Credit Suisse report states that the IRA will have profound effects on industries in the coming decade and beyond. Most media reports have pegged the U.S. government spending on fighting climate change at $374 billion. This number has come from the U.S. Congress Budget Office's estimation of how the tax credits in the IRA will be used.

However, Credit Suisse points out that the US government spending on the IRA might actually double, to over $800 billion, because the IRA has not written any budget or limits on government spending, and the tax credits remain uncapped. This effectively means that companies and businesses that can use these tax credits will continue to use them without any upper limit. This, in turn, will push more private investments into the clean energy sector, which will bloom in the years to come.

Large investments and opportunities would mean that the U.S. could soon be a market leader in energy generation, and that includes hydrogen fuel, carbon capture, and storage systems, the report stated. Before the decade ends, US-generated wind and solar energy could be the cheapest in the world, produced at prices of less than $5 per megawatt hour, effectively too cheap to meter.

Can my power bill ever be zero?

The state of California has been leading the way in renewables in the U.S., and was even powered by 100 percent renewable energy on a few occasions this year. A rise in renewable energy generation capacity in the coming years will increase the frequency of occurrence of such events up to the point when the state is almost entirely run by renewables.

In the future, the energy potential from solar, wind, and other renewables will be sufficient to meet our energy requirements and eliminate our dependence on fossil fuels. Since utility companies will no longer pay for the fuel supply itself (although, of course, they will still have costs associated with generation, storage, and delivery), your power bill could reduce significantly, something that some users of renewable energy have already seen.

Currently, some utility companies pay users who generate energy using their own solar array and supply the excess to the grid. So if your power consumption is lower than your generation capacity, you can have a negative bill even today, where the utility company pays you every month. This is after they have recovered the fixed costs associated with keeping your home on the grid.

However, as utility companies build their own infrastructure to tap into renewables and increase their power generation capacity, they could stop purchasing power from the small, individual owners. If you remain connected to the grid, your power bill will also reflect the expenditure the companies have made on real estate for their set up, which includes offshore land leases that are currently at an all-time time high.

According to the U.S. Energy Information Administration (EIA) the price of electricity to residential customers has increased by around 15 percent over the last 10 years. This increased dramatically when the conflict in Ukraine began but could be poised for a downward spiral once renewable energy capacities go big. This will likely spur utility companies to invest in renewable energy technologies that are even more efficient.

The power bills of the future will likely be much cheaper, reflecting the cheaper costs of production and generation using renewables.