Electric Industry 101, Your 5-minute Guide to the Electric Business
What is the electric industry and how does electricity get to my house?
If you are new to the electric industry, you’ll soon see that it is like any other manufacturing business, except that the manufactured product is invisible. You can see electricity when you use it, and you can feel it if you touch it (don’t do that).
The process of manufacturing and delivering electricity is fairly complex, but it is well-organized, and the way it is done today has remained essentially the same for over 100 years.
This article is designed to give you high-level information on how the business works, from power production to delivery to end-users.
Key points of the electric industry
1. The electric business is vital to a thriving society.
2. Power delivery to your home or business is a complex undertaking, but the process has remained unchanged for over 100 years.
3. Industry practices such as those for designing electric rates have deep roots in traditional approaches. The cornerstone of electric rates is that they should be fair and equitable.
4. The electric industry is undergoing a period of significant change, which will continue in the future.
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The electric business is vital to a successful society
Think of society without electricity. Machines for manufacturing, air conditioning, electric heat, computers, internet, cell phones, refrigerators, lights, etc., would not be possible. The obvious question, we all know of the necessity of electricity in society and the importance of electricity in our lives and economic development.
It’s funny, but here is a product that everyone needs on-demand, and our customers always tell utilities that it costs too much, and they also want to tell utilities how to produce it. Interesting.
But the, electric industry is necessary for growing and maintaining the world’s economy. The industry is at a crossroads. There is immense changes in progress on power supply resources and competition from customers through their distributed generation. Challenges also abound in implementing technology, the storage of energy through batteries, the need to upgrade infrastructure, build out a system for charging electric vehicles and maintain the integrity of the grid.
The trend of the industry is solid. There is a move towards using more electricity; this is called electrification.
How does electricity get to my house?
Delivering electricity to your house or business is a complicated process. Fuel is used to generate electricity in a generating plant. Fuel sources include coal, natural gas, diesel fuel, nuclear fuel, and renewable energy (wind, solar, biomass). The generated electricity is sent to high-voltage transmission lines, where it is delivered to a municipality or group of customers, and the voltage is reduced further. The electricity is then “stepped down” to 120v by a transformer and is delivered to homes and businesses through distribution infrastructure (overhead or underground lines).
This illustration shows the progression from generation to delivery:
Electric System
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Building infrastructure is a capital-intensive process, and utilities and cooperatives use a combination of debt and rates to build and maintain the electric system.
Revenue bonds (loans from Rural Utilities Service for co-ops)
Customer rates
Infrastructure charges
Short-term loans
Public-private partnerships
Grants
Types of electricity providers and rate regulations
There are several types of electricity providers. Each type does the same thing, but the governance structure and oversight of each differs:
The types include:
Transmission providers - regulated at the federal level
Electric cooperatives - owned by their customers
Investor-owned utilities (IOUs) - owned by stockholders
Public Power utilities - a government-created utility
Most public power utilities and cooperatives are regulated at the local level for rates by utility boards or city councils (a few states regulate the rates of municipal utilities). Investor-owned utilities are regulated at the state level by utility commissions.
Power markets
North America is made up of eight “power markets.” Each power market controls transmission grid within its borders. The role of power markets is to control and facilitate the movement of electricity within their service territory. The power markets schedule power needs for periods, as the next hour and next day to balance the supply of power with the use of power by end-users.
An “unbalanced” grid results in operational issues or, in a worst case scenario, brownouts and blackouts. In the winter of 2020, an ice storm in the Texas power market - ERCOT - brought the Texas grid to a “black start” situation, meaning the power grid imbalance caused a number of power plants to go offline. This is rare but shows the importance of an overall grid power management system.
This illustration shows the organization of power markets in North America. Power can move across and between markets, but it acts almost like an air-traffic control system, with each power market responsible for the movement of energy within its grid.
North American Power Markets
A regulator of the electric grid's reliability is the North American Electric Reliability Corporation (NERC). NERC makes rules Building infrastructure is a capital-intensive process, and utilities and cooperatives use a combination of debt and rates to build and maintain the electric system.
The debt used includes:
Revenue bonds (loans from Rural Utilities Service for co-ops)
Customer rates
Infrastructure charges
Short-term loans
Public-private partnerships
Grants
Types of electricity providers and rate regulations
There are several types of electricity providers. Each type does the same thing, but the governance structure and oversight of each differs:
The types include:
Transmission providers - regulated at the federal level
Electric cooperatives - owned by their customers
Investor-owned utilities (IOUs) - owned by stockholders
Public Power utilities - a government-created utility
Most public power utilities and cooperatives are regulated at the local level for rates by utility boards or city councils (a few states regulate the rates of municipal utilities). Investor-owned utilities are regulated at the state level by utility commissions.
Power markets
North America is made up of eight “power markets.” Each power market controls transmission grid within its borders. The role of power markets is to control and facilitate the movement of electricity within their service territory. The power markets schedule power needs for periods, as the next hour and next day to balance the supply of power with the use of power by end-users.
An “unbalanced” grid results in operational issues or, in a worst case scenario, brownouts and blackouts. In the winter of 2020, an ice storm in the Texas power market - ERCOT - brought the Texas grid to a “black start” situation, meaning the power grid imbalance caused a number of power plants to go offline. This is rare but shows the importance of an overall grid power management system.
transmission utilities to follow to maintain grid reliability. This includes spending by the transmission owners on maintenance activities such as tree trimming rights of way and cybersecurity protection for critical infrastructure.
NERC levies fines to utilities that do not meet the compliance requirements.
Electric terms and operations
How do customers pay for service?
Electric rates are developed in a three-step process:
1. A revenue requirement is developed of how much revenue needs to be generated over a year for electric operations, capital improvements, and debt payments.
2. The cost to serve each customer class (residential, commercial, industrial) is determined in a cost of service study, which takes the revenue requirement and allocates it to each customer class based on their energy usage and demand on the electric system.
3. Electric rates are developed, based on the cost of service study, adjusted for other factors, such as historical rates, oversight board input, and equitability.
The general rate-making philosophy in developing electric rates follows these principles:
Rates should be fair and equitable
Rates should generate revenues that recover the cost of service for a defined period
Rates should reflect what caused the cost
Rates should be predictable
Cost of service and actual rates are not necessarily the same due to strategic goals and historically embedded utility trends. Politics also comes into play as Board oversight can override any of these principles.
The state of the electric industry
The electric industry was long predictable, maybe not sleepy, but the process of delivering electricity did not change and regulatory oversight was fairly consistent. Customers had slow and steady rate increases.
Then, the roaring '90's. A few hot summers exposed the weakness in the transmission grid and spurred more infrastructure construction as well as putting the brakes on customer choice. Some states passed legislation to allow customers the freedom to choose their electric provider.
As we've moved through the 2000's power supply sources are shifting from traditional fossil fuels to renewable energy. Although, as of the writing of this article, solar and wind renewable energy is not a complete solution due to the lack of sufficient battery storage for use in the nighttime hours.
What are some current industry issues, and where are we going?
Current and future electric utility issues
Current issues being faced and addressed in the industry, which also impacts the future, in no particular order include:
Change in the power supply mix
Cybersecurity
Energy storage technology and sufficiency
Grid reliability
Distributed generation issues (customer generation)
Growing energy demand
The internet of things and electricity management
Aging assets and the need for replacement
Technology investment
Today's utility relies on a mix of fossil fuels and renewable energy resources for supplying power. The amount of renewable energy was 19% in 2019 and is expected to grow to 38% in 2050. This transition will result in retiring some existing coal generating units to be replaced with solar, wind, and more natural gas generation.
Electric Industry Today
Tomorrow's utility will continue the trend of asset replacement and the other issues mentioned, but a growing force in the industry will be customer generation through the use of customer solar installations. The ever-increasing micro-grid energy source will need to be factored into the overall power supply mix of any co-op or utility.
Electric Industry of the Future
Takeaways
The electric business is dynamic, interesting, and a necessary part of a vibrant society. This article was designed for the unfamiliar to be a high-level primer of an overall look at the electric business. Links in the article will take you to more detailed articles on specific topics. Look for continued rapid change in the industry.
About Russ Hissom - Article Author
Russ Hissom, CPA is a principal of Utility Accounting & Rates Specialists a firm that provides power utilities rate, expert witness, and consulting services, and online/on-demand courses on accounting, rates, FERC/RUS construction accounting, financial analysis, and business process improvement services. Russ was a partner in a national accounting and consulting firm for 20 years. He works with electric investor-owned and public power utilities, electric cooperatives, broadband providers, and gas, water, and wastewater utilities. His goal is to share industry best practices to help your business perform effectively and efficiently and meet the challenges of the changing power and utilities industry.
Find out more about Utility Accounting & Rates Specialists here, or you can reach Russ at russ.hissom@utilityeducation.com.
The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists. You should seek formal advice on this topic from your accounting or legal advisor.