Trends and Factors affecting Electricity Prices: Transition from 2023 to 2024

Introduction

Electricity is essential for our modern society and is engine for any economy. Access to affordable and clean energy for all is one of the UN's Sustainable Development Goals (SDGs). However, electricity is getting more expensive and even unaffordable. 2023 has seen this scenario in both rich, developed countries in Europe and poor, developing or less developed countries in Asia and Africa. Electricity prices that we see as the final customer depend on a number of ranging from wholesale or generation prices, regulatory framework, and government taxes and subsidies. However, a few global events or factors have played key roles in recent years. In my view, four key global trends or factors have affected the electricity prices in 2023:

1. Global energy crisis
2. High inflation and interest rates
3. Energy transition towards net zero and decarbonization
4. Digitalization and decentralization

There are certainly many other usual factors such as weather and market forces underlying these three and they have compounded or offset their effects. These three factors and trends are expected to continue their impacts in 2024 to varying degrees and will require and shape the responses from the governments, regulators, utilities, and customers.

1. Global Energy Crisis

The global energy crisis that started in 2021 has continued to affect many parts of the world, leading to higher costs for energy commodities, such as natural gas, coal, and oil, as well as electricity. The energy crisis was triggered by a combination of factors, such as:

• The demand recovery in 2021 from the Covid-19 pandemic, which increased the energy consumption and the electricity demand in many countries and regions.
• The supply constraints due to the Russian invasion of Ukraine in February 2022, which disrupted the natural gas supply to Europe and LNG supply to Asia, as well as the geopolitical tensions in the Middle East, which affected the oil production and export in the region.
• The weather disruptions, such as the cold snaps, heat waves, droughts, and storms, which affected the energy production and consumption, as well as the electricity generation and transmission, in many areas.
• The policy uncertainty, such as the lack of coordination and cooperation among countries and regions, as well as the inconsistency and unpredictability of the energy and climate policies and regulations, which created confusion and volatility in the energy and electricity markets.

The energy crisis has exposed the vulnerabilities and interdependencies of the electricity system in different areas or regions, such as:

• Supply shortages, leading to blackouts, or load shedding.
• Demand spikes, leading to price surges, congestion, or instability.
• Grid congestion, leading to bottlenecks, losses, or curtailments.
• Price volatility, leading to uncertainty, risk, or arbitrage.

This crisis has also prompted policy responses and market reforms in many regions, such as emergency measures (strategic reserves, price caps or floors), capacity mechanisms (capacity markets, capacity auctions), carbon pricing, demand response programs, and time-of-use (TOU) and peak demand pricing.

The energy crisis has also highlighted the need for more investment and innovation in the electricity sector, especially in renewable energy, energy efficiency, energy storage, and grid modernization.

The energy crisis has increased the wholesale electricity prices in many regions, as the cost of producing electricity from fossil fuels has soared. For example, the average wholesale electricity price in the European Union was 23.64€ per kWh in 2022, more than four times higher than in 2020. The crisis has increased the retail electricity prices for many customers, especially those who are exposed to the wholesale electricity price or those who have contracts with energy retailers that are linked to the commodity prices. For example, the average retail electricity price for residential customers in the United States was 13.72￠ per kWh in 2022, 9.4% higher than in 2020. The crisis has also increased the price differences among different regions and markets, depending on the availability and diversity of energy sources, the level of interconnection and integration, and the degree of regulation and competition.

2. High Inflation and Interest Rates

High economic growth coupled with the above energy crisis and related high consumer demands have increased inflation around the world to record levels, not seen in last three decades in many countries, during 2022-2023. This has affected the electricity sector (and other sectors) like a double edged sword:

• High inflation means higher prices of machinery, plant, raw materials, construction, labour, fuels, and transportation, translating into high costs of construction, development and operation of power projects and power companies.
• High inflation forced the central banks to increase policy or benchmark interest rates to high levels by unprecedent pace in 2023, increasing the borrowing costs of financing power projects, as well as the debt servicing and the credit risk of power companies.

These skyrocketing inflation and interest rates have:

• increased fixed and variable cost of power generation in regulated and unregulated markets, as well as distributed and behind-the-meter (BTM) energy resources.
• hence led to higher wholesale and retail electricity prices for electricity providers and customers.

While there are clear signs of lower inflation towards the end of 2023 and the central banks are expected to start cutting interest rate in 2024, electricity prices will remain high in the new year but may increase at lower rates than before. This is because the electricity sector is subject to long-term contracts, regulatory frameworks, and market structures, which may not adjust quickly to the changing economic conditions.

3. Net Zero Transition

The net zero transition is the global effort to achieve net zero greenhouse gas (GHG) emissions by 2050 or sooner, to limit global warming to 1.5°C above pre-industrial levels, as agreed in the 2015 Paris Agreement. The transition requires:

• rapid ramping up of renewable energy, such as solar and wind.
• massive electrification of other sectors, such as transport and heating, through technologies such as electric vehicles and heat pumps.
• international cooperation and coordination, as well as ambitious and credible policies and actions, to ensure a fair and just transition for all.

The transition has mixed effects on wholesale and retail electricity prices for different customers and regions, depending on their policies and measures. On one hand, it can lower electricity prices for some customers and regions, by:

• Increasing the supply and reducing the cost of renewable energy, as well as reduce the dependence and vulnerability of electricity system and market to fossil fuel prices and supply disruptions.
• Improving the energy efficiency and reducing the energy demand, and hence reducing the electricity bills for customers, the peak demand and the capacity requirements for the electricity system.
• Creating new opportunities and benefits - such as net metering, feed-in tariffs, or demand response programs - for customers who produce electricity from renewable sources or reduce their electricity consumption.

On the other hand, the net zero transition can increase the electricity prices for some customers and regions, by:

• Imposing carbon pricing or other environmental charges to increase the cost of producing and consuming electricity from fossil fuels (coal, gas, or oil) and provide an incentive for the electricity providers and customers to switch to low-carbon alternatives.
• Requiring additional investments and upgrades in the electricity infrastructure and services (such as transmission and distribution networks, interconnections, storage, and flexibility solutions), which can increase the fixed and variable costs of the electricity system and market, and hence the charges and fees for the electricity customers.

4. Digitalization and Decentralization

Digitalization and decentralization are the trends that are reshaping the electricity sector, by enabling more data, connectivity, intelligence, and participation in the electricity system:

• Digitalization refers to the use of digital technologies, such as smart meters, sensors, artificial intelligence (AI), and blockchain, to collect, analyze, and optimize the data and information in the electricity system, enhancing its efficiency, reliability, and flexibility.
• Decentralization refers to the shift from centralized to distributed electricity generation, consumption, and management, enabled by distributed energy resources (DERs), such as solar panels, wind turbines, batteries, and microgrids, empowering customers and communities to produce and consume their own electricity, as well as to participate in the electricity market.

Digitalization and decentralization can have different impacts on the electricity prices for different customers and regions, such as:

• Creating new business models, services, and platforms for electricity providers and customers, such as peer-to-peer (P2P) trading, virtual power plants (VPPs), demand response aggregators (DRAs), and energy communities, which can offer more choices and value for customers but can also require more complex and dynamic pricing and tariff structures, as well as new regulatory and policy frameworks, standards, and protocols.
• Improving and optimizing the electricity system operation and performance, enabling more visibility, flexibility, and resilience of the electricity supply and demand, as well as more quality, security, and reliability of the electricity service, which can lower the cost and increase the value of electricity for customers and providers.
• Creating new issues and trade-offs for the electricity system planning and regulation, requiring more coordination among different stakeholders and more innovation and adaptation of the electricity market design and protocols, which can affect the cost allocation, cross-subsidization, price signals and behavioral responses.
• Facilitating the energy transition and decarbonization, by increasing the share and reducing the cost of renewable energy, by improving the energy efficiency and reducing the energy demand, and by creating new opportunities and benefits for customers who produce or reduce electricity.

Conclusion

Electricity prices and their structures have changed significantly in 2023 and will / may change further in 2024, due to the global energy crisis, high inflation and financing costs, and the net zero transition.

These changes have different impacts on different customers and regions, depending on their exposure, choice, and preference. These changes also create new opportunities and benefits for the electricity sector and society, such as:

• improving the efficiency, reliability, and sustainability of the electricity system,
• fostering the competition and innovation in the electricity market, and
• facilitating the transition to a low-carbon economy.

Electricity prices and their structures are therefore dynamic and evolving, requiring constant monitoring, evaluation, and adaptation.