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Electricity prices: Why the price of electricity fluctuates

The price of electricity hits the headlines whenever it goes up. It always seems as though everything is in the hands of fate, but in reality these changes are not arbitrary. They occur due to specific circumstances and do not affect everyone equally.

Regulated or deregulated electricity

From time to time, increases in the price of electricity are very much in the news. This is only logical, since we all need electricity to exist. But what is behind these price fluctuations? How much does electricity really cost?

To begin with, it is very important to understand one thing that sounds complicated but is actually quite simple. In Spain, there are two different markets for electricity: free' or deregulated market and a regulated market.

  • Free market: electricity costs what it says in the contract you sign. There are many different rates and many companies that offer them. In the short term, this market is not affected by the fluctuations that make the news.
  • Regulated Market: the price of electricity depends on supply and demand, being updated every hour of every day and undergoing the fluctuations that end up being broadcast by TV news programmes. There is only one rate (the regulated rate or 'PVPC' in the Spanish abbreviation in its various modes) and only specific electricity companies (the so-called reference marketers) are allowed to offer it.

Approximately half the Spanish population is in the free market and the other half in the regulated market.

During 2018, the regulated price of electricity underwent the following fluctuations:

How the regulated price is calculated: demand

Since April 2014, consumers with a contracted power of less than 10 kW have paid for each kWh of electricity consumption according to a system that takes into account supply and demand.

From the point of view of demand, the more electricity is needed, the more expensive it is. The less electricity wanted, the cheaper it is.

Digital meters record the consumption and the reference marketers invoice each hour of consumption at the price that is applied to each kWh at the time of consumption. It is usually cheaper to consume electricity in the early hours and more expensive when everyone else is doing so (for example at dinner time). This is the importance of demand.

How the regulated price is calculated: supply

But not everything is determined by demand. The supply of energy is also very important.

As stated, price variations in the regulated market are produced by differences between supply and demand.

With supply, account must be taken of all the different ways of generating electricity They do not all cost the same:

  • The cheapest energy is that generated from renewable sources such as solar, wind and hydro. The price of nuclear energy is low too, but in Spain, unlike other European countries such as France, it fails to cover all energy needs.   
  • Thermal (coal) energy and co generation or combined cycle power, in which the main fuel is gas, tend to be more expensive.

The main renewable sources in Spain (water and wind) depend on uncontrollable external factors. Sufficient rainfall is a prerequisite for producing hydroelectric power. And sufficient wind is necessary for wind turbines to generate power.

On this basis, the price is determined as a mixture (the so-called "energy mix") of the various energy sources, from the cheapest to the most expensive. First are the cheapest energy sources (renewables and nuclear) and then the more expensive ones (thermal and combined cycle). And so on until demand for energy is fully met.

“The variable prices of the regulated electricity market depend on the interaction between supply and demand. ”

Why electricity prices increase

The price of electricity goes up when any of these three things happens:

A) There is less supply of cheap energy.

B) There is a greater demand because people are consuming more.

C) A + B

The result is that there are hours of the day when energy is more expensive and also times of the year when the clearest trend is upwards.

On the demand side, over the course of the day there are two periods of heavy electricity consumption. In winter, the first peak period usually occurs between 11 a.m. and 1 p.m. when there is a high level of activity in companies, shops and homes (daily tasks, food preparation, etc.). The second, with prices generally higher in winter, occurs between 7 p.m. and 9 p.m. In this case shopping activity combines with people returning home, leading to increased electricity consumption due to routine tasks or leisure activities. The big difference is that in summer the increased energy consumption due to air conditioning and the different working day adopted by many businesses (summer schedule, early start and finish, no lunch break) means that the main peak period is concentrated around noon.

This daily pattern can be increased by certain circumstances. The main one is the weather. Extreme cold or heat, which boosts the use of heating or air conditioning, increases electricity consumption. There are also days of increased consumption due to more activity, as happens at Christmas due to shopping.

But supply is also involved. If less cheap electricity from renewable sources is produced and electricity from thermal or combined cycle sources has to be used, the price of energy goes up. As it does if there is an increase in the price of fuels such as coal (thermal energy) or gas (combined cycle plants).

All this means that at times of greatest demand for energy (cold spells in winter and to a lesser extent, heat waves in summer) and lower production of renewable energy due to lack of wind, the highest energy prices are usually reached.

“Increases in the price of electricity in the regulated market are related to lower production of renewable energy (due to deficient wind or rainfall), and an increase in consumption (due to cold spells or heat waves).”

What electricity prices decrease

Electricity prices do not always increase. There are many positive circumstances that can lead to the price of energy falling. In addition to the existence of off-peak times, there are circumstances that push down prices.

Once again, the weather is the main cause. Bad weather with strong winds can lead to energy demand being met from lower-priced wind sources. On the supply side, a fall in fuel prices also has a positive impact by reducing the price of higher-priced energy sources (thermal and combined cycle).

On the demand side, a more moderate temperature means that energy consumption for climate control decreases (both for heating and air conditioning). Also at weekends, with less business activity, energy demand is lower than on weekdays.

For all these reasons, at certain times of autumn and spring, (when temperatures are neither very low nor very high) and there tends to be more wind and rain, the price of electricity is usually at its lowest for the year.

In short, the price of electricity does not rise or fall arbitrarily. The time of day, the time of year, fuel prices and the weather are the variables by which the price of electricity may rise or fall.

“Decreases in the price of electricity in the regulated market are related to periods of strong winds, heavy rain and moderate temperatures, meaning that not much energy is consumed.”
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