This Is How Electricity Rates Are Actually Set

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1:20Hello and welcome to another episode of the All Thoughts Podcast. I'm Traci Alloway. And I'm Joe Isenthal. Joe, I have big news for you. Go on. I'm an electricity generator now. Oh, yeah. Tell me what's up with that. This is big news. In my personal life, I am finally the proud owner of a pretty big solar panel that is feeding into the grid in Connecticut. How's that going so far? Like, are you, has it, do you have lower electricity bills? I got one electricity bill so far, and it was about$20 for a few weeks, which is amazing. However, I have also experienced my own intermittent energy problems because we are recording today on December 5th.

1:59And in case you don't know, it's been snowing up in New England and the solar panels are covered with about eight inches of snow. So they're not producing any electricity. All the electricity is out. We have a power generator. So that's kicked on. But I'm now learning one of the downsides of renewable energy. No, it's like perfect. But this is the end of the conversation right here. It's cheap, but it's intermittent. It's cheap and intermittent. Yeah, that's basically it. But, you know, it got me thinking. I'm not in Connecticut at the moment. We are both in Washington, D.C. for a big energy conference.

2:30And because I am now an electricity generator of sorts and I feed into the grid that is owned by a giant utility, we have never actually interviewed someone from a utility. That's right. I don't think we have. I don't think we have either. And I have to say, and now this is starting to make sense to me, that like how utilities work, how pricing in particular works for electricity is this incredible black hole in my knowledge. Because this has come up, but, you know, we're not called customers. We're called rate payers. That's right. And I know that in many markets, there's this negotiation where there's some utility commission or something like that.

3:11And the utilities have to figure out, OK, we spent this much and can we raise our prices this much, et cetera. And then, you know, I know there is in some places sort of live auction markets and how the weather changes, the price changes. But I really find this incredibly hard to wrap my head around, I guess, basically the question of why you pay what for electricity. Yeah. So two things here. Number one, it seems incredibly. complex because of all the factors that you just laid out, including the patchwork of different regulations for different states and the limits there. And also, well, the political tensions as well.

3:46That's one thing we can maybe talk about. But the other thing is, it feels like the whole system is becoming more and more complex because you have more renewable energy coming on. A lot of that renewable energy, you know, you get credits for feeding that into the grid, which means special people like me are no longer actually paying that much for electricity, but we're still drawing on the resources of the utilities. And I guess there's really two things, because there's this rise of sort of distributed energy, rooftop solar and things like that, new forms of energy production. And then something that comes up a lot, the resumption of load growth for the first time in decades.

4:19That's right. And so you have the renewables, you have load growth, you have this impulse from the public and the corporate sector to reduce emissions overall, net zero. there's always net zero press releases going out over the years. And so how this all comes together, wildly complex. And usually when people are explaining it to me, I have to pause them every five seconds. Like, wait, what is that term? What's the capacity market? Again, all these things. So it's nice of you to warn our listeners in advance that they're going to have to pause this episode quite a bit. No, hopefully we'll be able to explain everything because we do, in fact, have the perfect guest.

4:51We're going to be speaking with Lon Huber. He is the senior Vice President of Pricing and Customer Solutions at Duke Energy. So Lon, thank you so much for coming on the show. You bet. Great to be here. Is it terrible for companies like Duke when their customers get solar panels? Is it bad? I keep hearing about the utility death spiral. It all comes down to pricing and the rate structure. So it's not an easy answer. If you have the right rate structures, it can actually be a beneficial thing. But a lot of times that isn't the case. And so in your Connecticut example, you're basically getting your fully bundled rate as a credit.

5:26But that fully bundled rate, although it's in kilowatt hours, it's actually made up of a lot of KW and fixed infrastructure costs. So that pole outside your house, that's wrapped into an energy charge, even though, as we all know, if your energy use drops, that pole doesn't get cut in half. You can't just pull out that pole, hand it to your neighbor. That's fixed infrastructure. And that's 70 % of the grid. Why don't we zoom out really big? What is the business model of Duke Energy? Ah, all right. This is good. So we have a franchise that enables us to furnish low-cost, reliable electrons as a precondition to economic vitality for our community.

6:07So we have essentially a set jurisdiction where nobody else can come in for certain services. And so we have our customers. This is a geographical jurisdiction. The graphical jurisdiction, right? And we're supplying the wires and in some cases, the power generation to that territory. And again, there's obligations and exchanges there. So we're under democratic control of those prices, of the return on equity for investors in this long-term infrastructure, right? So there's balances here. So you have this market discipline entity that still has accountability to local communities, to policymakers, and has a way to spread infrastructure costs in a structure that can make long-term intergenerational sense for communities.

6:59So you mentioned economic vitality just then. And one of the things I often hear when I occasionally read books about electricity or the grid is this idea that electricity cost is still heavily subsidized in many ways because we still view it as a sort of social good that enables us to do things like manufacture stuff and power our homes. And I guess my question is, like, to what extent do you think that's true? Well, it is certainly true that it is an inelastic necessity to modern civilization, right? I agree. But for the most part, there isn't necessarily, I would say, a large amount of subsidies, at least on the state level.

7:40There's some federal tax credits. But again, a lot of those apply more broadly to the sector. But what you could hear is, well, certain types of customers might be subsidizing other types of customers. And so that can pop up where you have these certain classes, whether it's maybe the industrial class could be subsidized by the residential class or vice versa. And that is inherent in a fixed network system. Or the non-net metered customers paying the net metered customers, i.e. me. That's right. You explain what Duke is. What is your title is Senior VP of Pricing and Customer Solutions. So what is that role?

8:18Yeah. So this is all about helping our customers out, not ratepayers, our customers. Our customers. Right. So these are a large account. Did you actually use the word customers? Yes. The industry has changed a lot. Just, I mean, when I first got in the industry, it was ratepayer all the time. If I'm operating on dated information, then I'm happy to be correct. No, but why was that the common term? I mean, partly there was just not the technology or visibility into customers. There was a mentality there to a culture built up. But for the most part, it's like if you don't have any of the analytics, if you don't have the meters, if you don't have the communication back and forth, you're sort of at a distance.

9:00And all that has changed dramatically in every category. I'm updating my I'm updating my mental framework of how you see how you see it. OK, so you go on with the pricing. Right. Right. And so I've got economic development as well. And so that's new businesses coming in. the existing businesses that are there that also want to grow, the pricing and rate structures all around that. And again, this is for all of the Duke states and customer load analytics, things of that nature to sort of make it all work and do an A to Z to solve customer problems or goals. So if a customer is like, hey, I want to bring a new manufacturing to the state, my team will work in conjunction with the government and we'll say, okay, well, here's a great site or here's a great community that would really fit the workforce you're looking for, the size of business you're bringing, that type of thing.

9:49So when it comes to actually setting those types of rates, can you talk to us about, I guess, the building blocks that would go into that? Like, what are you putting presumably into a giant Excel spreadsheet and then spitting out as the final number? Yeah, well, it all comes down to something called the revenue requirement. Okay. And the revenue requirement basically says, how much money do you need to collect from your customers to cover your investments, to cover operations, and then taxes returned to investors. So that is the big number. Then from there, you slice and dice that based on how the different classes are using energy, right, the makeup, the load profiles, and so forth.

10:31And you create pricing around that to collect that revenue requirement. But it gets really complicated because the easiest way to collect that revenue requirement is by just having everybody pay a big fixed charge, right? That would be the easiest thing. If I, you know, I need to collect 100 from you, give me 100 each month, right? But that doesn't send the best price signals, does it, right, for you to conserve? Because you would just be using a huge amount of energy because it'd be$100 every month, no matter what you use, for the most part, right? And there'd be a little bit of fuel there. And so that wasn't palatable, that type of pricing to collect that type of revenue requirement.

11:07And so then it was, Well, what's the next easiest thing to do, given the state of technology that we have? And that's where you see a lot of the legacy pricing, where it's mostly just usage KWH-based. All right, let's talk about the different types of markets then. So there are markets where there's some commission, right, that determines a legitimate price. Yeah, every state has a public utilities commission, or however they might label it. And so you talk to us about how you interface with the commission. What are the conversations like? How often are they? And what are you actually talking about with them?

11:39Yeah, regulators are key to making this all work. And they have staffs that work and they scrutinize all of our filings. And so we're in there and there's just basic sort of automatic, oh, that's true ups because fuel went up and, you know, whatever else outside of the control. or we've got these programs that we're updating to more intensive processes like rate cases, where you go in and you say, okay, well, we have made these investments. We're about to make these investments. And here's what we think is prudent. And here's where we think the capital markets are in terms of return and debt markets and so forth.

12:14And so there's a lot of scrutiny there. There's formal data requests. We get thousands upon thousands of data requests, formal that come in and then they're on the record. Some of them are confidential and then only with parties that that sign certain agreements, but everything is just very well scrutinized in these settings. Some of these proceedings are very contentious and you're under oath. Others, you know, most parties agree and they're like, hey, yeah, this is a good idea. Yeah, go forth. Or it's so routine that it doesn't have a big impact. Remind us how many states you're operating in?

12:46Six and seven, if you include in only gas supply state. So one question I wanted to ask, and, you know, hopefully in a slightly diplomatic way. But what are the what are the big frictions with regulators? Like, is it mostly over cost and pricing structure or does it go to environmental? Like, what is it that you you fight about when you're speaking to regulators? There's another key party involved in all this, and that's the consumer advocate. Most states have it. I used to be working in a consumer advocate office, actually, in the beginning part of my career. And they are meant to really, you know, scrutinize things from more of a using and consuming public lens.

13:25So they'll be representing the criticisms about pricing and things like that. So they're representing a constituency there. And the Public Utility Commission is usually the entity in charge of balancing all the different parties and taking in this information. It's quasi-judicial. And so you have some judges. They're the ones that everyone gets mad at, presumably. They're the public face of sometimes a lot of it. And it really just depends on the state and what's going on. You know, you typically always push back on rate of return, for instance, what you're paying for equity and investors. And that's sort of steady state.

14:04And then things get controversial if something goes wrong on a power plant or, you know, something of that nature. But there's sort of that consistent rate case mode that provides some friction there for sure.

14:32Your best bottling plant employs 3 ,300 people. How do you get 3 ,300 people working at peak efficiency? Your best store has reduced waste, water, and energy usage. How do you make every store like your best store? Your best property has every guest raving. How do you make every property like your best property? The answer is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. How many vendors does it take to meet all your organization's food needs? Just one, EasyCater, the workplace food platform that lets teams order from a huge variety of restaurants, over 100 ,000 nationwide, all through a single vendor.

15:17In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. Let's get into the economics of different types of energy production and consumption and so forth. We've added tons of renewables to the grid over the years, pretty much across the country. Some have gone really fast, like Texas and California. Others not as fast for obvious reasons.

15:54Why does that not cause the price of electricity to collapse? Great question. and it gets to all the different aspects of what makes up that electricity bill. And so when I mentioned before that a lot of the costs are fixed infrastructure costs, right? This is a huge grid. It spans thousands upon thousands of miles, right? Our grid can wrap around the world like, you know, six times. That's a cool stat. That's how, like just the mammoth, that's just our distribution system. So that's how big that we're talking about. And so you have that fixed infrastructure, which includes power plants, the power lines, everything of that nature.

16:34You have the fuel and all the different fuel supply and administration and just everything from like tree trimming. If you have that many miles, you have to think about the trees. And then what if a drunk driver hits one of the poles and a squirrel starts gnawing on things, right? There's a lot in that price of an electric bill. So if you have an intermittent renewable resource, well, what is that good at offsetting? Well, it's good at offsetting fuel expense. If it aligns with the peak of the utility system, it can also avoid future power plants or purchases on the market for capacity. But it all depends on the individual resource and the location to see if it can bring that capacity value.

17:16But at least it can provide a fuel savings. And so that's a smaller part of the bill. Yeah. Right. And so if you're only offsetting a smaller part of the bill, that's why you don't see that downward pressure. And another thing is a lot of different types of renewables are heavy upfront capital expenses. Right. And so that initial investment puts upward pressure on rates, even though it gives a nice long term hedge or discount on fuel. So you mentioned long term just then. And one of the things that I do not envy utility providers in having to do is to try to sort out immediate energy needs, you know, for the state of our economy and our society right now, but also try to make those giant capital investments for like decades out into the future.

18:00How do you guys think about that? That seems tough. it's a lot of responsibility. And it's a collective decision, right? When I mentioned regulators, consumer advocates, other stakeholders, policymakers in the state. And if you look at utilities in the past, they have completely shaped the landscape of states. And so Duke Energy, for instance, I mean, we were like, hey, hydro. And we built a huge amount of lakes all around the Carolinas to get that power. Then we... There are a lot of lakes in the Carolinas, right? Yeah. And some of them are artificial from, you know, and that brings recreation.

18:36It brings so many different other things to the state. It changes the landscape. You know, then you get into nuclear, right? These are like 80-year assets. And back then you needed to have, and even still today, pumped hydro to store some of that nuclear during the down times of the day. And so now you're creating different lakes at elevations to move water up and down as long duration storage. So these are like big landscape changing investments. Just like the original battery, right? So you have excess electricity at some point, maybe during the night with nuclear or during the day with solar, and use that electricity to lift water to a high elevation.

19:14And then at night it rolls downhill and then spins a wheel or something like that. That's exactly right. I've always thought that was just such a fascinating concept. But on batteries, so you mentioned that one of the issues with, say, solar or what we think of as renewables is that they're intermittent and so forth. battery technology is getting a lot better. And I keep seeing stats about how, again, in some markets like Texas and California, especially during high stress periods, you increasingly see grid level batteries playing an important part of the mix and supplying energy. In the last few years, how much have you seen batteries and the improvement in battery technology sort of change the economics of renewables?

19:52Yeah, again, and this gets to the beginning of why this area is so complex, because not only do you have the patchwork of regulation and utilities, but each geographic region, when you have weather dependent generation, it brings something unique. And so a solar plus storage facility in Arizona is going to have a lot of different economics than say a North Carolina. And so you've got more sun, maybe cheaper, flatter land, and you have a summer peak that you really worry about in an Arizona. And so a four-hour mixed with tracking solar can provide a decent amount of capacity value in Arizona. Switch to, say, Midwest.

20:37Well, where can be the peak? The peak could be winter. Well, what does the winter peak look like? Well, it could be a week of cloudy weather where you see no sun. And these very cold extreme weather events could last for many days. So that's a very different set of economics and outcomes. And so it really depends on where you are. In general, batteries in around the four-hour duration have really come a long way paired with renewables, especially in those markets where you have that summer peak. But we're still trying to crack the longer-term extreme weather event type of peaks. So it is kind of true that at the moment we sort of perversely solve the problem of intermittent energy and the fact that, you know, solar and wind tends to come on and off with more generation, right?

21:26So we don't store the extra energy. We just try to make up for it with generation from other sources when that goes offline, when the solar and wind goes offline. How far are we from solving that storage problem? Just to press on Joe's point. Well, that is the big question. Is there a startup out there that has the solution that'll be ready in five years and can scale with some type of new long duration storage technology, right? There's Form Energy. There's others that are out there that could be very promising. So time will tell when those breakthroughs will happen on the storage side. But to your point, right now it takes a great diversity of resources to make this all work and all the above.

22:08And that's why there's concern of when certain states or advocates say, well, we don't like that particular resource or, you know, we want you to do more of that. There has to be a balance there because they all sort of work in synergy. And there's really complex modeling that sort of shows how this all works to keep that reliability during those extreme events. But what you don't want to do is have to build two systems, a renewable system that is there when the weather is great and then an entire backup fossil system. Well, so the third thing that we haven't started talking about yet when you talk about like these different conceptual systems, the fossil fuel system, the renewables and battery system, and that's nuclear.

22:45And one thing that's come up on the show in the past is that some of the advocates of much more aggressive nuclear build out don't like the current market structure model because they say, look, we have these huge, gigantic upfront costs and we need some price certainty. And if we're going to have a electricity market in which we're not getting any revenue during the really sunny days because Tracy doesn't need to pay anything into the grid at all. It's all my fault. It's really hard to justify the planning and the upfront cost and the years of construction and work for everything that we know that's difficult about nuclear.

23:27Do they have a point that when we're thinking about market structure for electricity, that it's hard to optimize for a world that has a lot of nuclear, but also has a lot of room for the traces or the solar farms of the world? Yeah. So this gets back to the larger market structures out there. And so some markets are considered restructured, meaning they have opened competition on the generation side of the business, right? The wires is a natural monopoly. You don't want a thousands exacting wires across the street, right? But generation was thought, well, there could be some competition there.

24:02And so some markets reformed, others stayed vertically integrated. And like I mentioned, we're in both so we can see both and what works and what doesn't and where you can get some advantages and where there's some issues. And again, as we talked about, there is a trend of a lot higher load growth. And these markets came about during a time where it was relatively calm and flat to maybe a modest load growth. And they set up their markets where, again, you have energy and capacity and they have energy markets, which are a lot deeper. But capacity markets in the end of the day are fixed infrastructure, big, lumpy investments.

24:38How do you encourage fixed infrastructure out there? What price signals do you send? Because you're either sending too much dollars or too little dollars. It's very hard to get right on the infrastructure side. Some markets just said, like ERCOT, we're not going to have something specific for capacity at all. Others have capacity price signals. And so that's the inherent tension of where do you get that revenue to recover those big investments? Sorry, just on this point, you mentioned ERCOT. So that's Texas, right? So in Texas, basically, it's anyone can plug into the grid and sell, but there's no excess capacity.

25:13What is a capacity market specifically? A capacity market is all about providing the payments needed to encourage big new infrastructure investments with generators. Right. So in this example. So it's money to a producer of energy that is like you're going to pay them to exist, basically, regardless of what that day's market conditions are like for electricity. And so if you have some, if the energy prices are very low because everybody has zero marginal cost renewables that day because it's sunny, they're still getting capacity payments, right? As long as they show up. And there's big penalties if they don't.