Rocketing energy prices have been dominating the news, both in the UK and globally. The price of gas has jumped to an all-time high, taking electricity prices with it, and causing the UK Government to step in to support people and businesses.
The UK Energy Prices Bill, introduced on the 12 October to “make provision for controlling energy prices”, is an “unprecedented intervention”. It’s being progressed as emergency legislation, and is expected to become an Act before the end of October. This means that the Senedd won’t have time to fully consider consent for the Bill in the usual way. Instead, Plenary will debate a last-minute legislative consent memorandum (LCM) this afternoon.
This article will look at how energy is priced, the link between gas prices and electricity generation, recent trends in energy prices, and causes and responses, including the Energy Prices Bill.
The price of energy
There are three key elements which intersect to give us energy at our fingertips:
- Generation - historically, electricity has been generated through burning fossil fuels, but increasingly renewable energy is used, as well as nuclear power and imports from other countries;
- Transportation - energy is transported through a grid which manages supply and demand; and
- Markets - as consumers we get our gas and electricity from suppliers who buy energy in the wholesale market and sell it on to us.
The energy market is just like any other market, it’s driven by balancing supply and demand. There are, of course, a number of factors at play which influence the wholesale price, which is one of the largest components of customers overall energy cost.
There is one wholesale price for electricity across the UK, which isn’t regulated i.e. it’s open and competitive. Electricity generators bid to contribute to the power grid. These bids are accepted until demand is met in what is known as the ‘merit order’. Simply put, it’s a ranking in order of preference, so sources with the lowest cost, typically renewables, are accepted first, and sources such as gas- and coal-fired power stations are the last.
Figure 1: illustration showing the ‘merit order’; less expensive sources are chosen first, however the power, from whatever source, that meets the peak demand, sets the overall wholesale price. The proportions of each energy source are approximate and for indication only.
The cost of the last source used to meet demand, typically gas, sets the wholesale price of electricity. The Institute for Government explains:
…although generation methods that have low marginal cost (including renewables and nuclear) produce the majority of UK electricity, the price that is paid for it in both wholesale and retail markets is set much higher, at the marginal cost of generating electricity with gas.
Outside of the wholesale cost, the remainder of the price we pay for energy is a combination of other operational costs, including:
- Network costs – the cost of using the grid;
- Environmental and social obligation costs – a contribution towards government energy policies, such as energy efficiency improvements in homes and businesses, help for vulnerable people and encouraging take-up of renewable technology; and
- Operating costs - things like customer service and billing, as well as company profit.
Energy trends
The wholesale price of energy is increasing, with the main driver being the increasing cost of gas. This is due to a combination of events, resulting in a reduced supply coupled with an increasing demand.
The Russian invasion of Ukraine has led to countries reducing their reliance on Russian gas. Whilst there are no gas pipelines directly linking the UK with Russia, and imports from Russia made up less than 4% of the total UK gas supply in 2021, avoiding Russian gas reduces supply levels globally, while the demand stays the same. This pushes the price up.
2021 was a difficult year for some of the UK’s sources of power, including unplanned outages at nuclear reactors, and a fire in Kent impacting energy coming into the UK from France. The winter of 2020/21 was particularly cold and long, which meant we used more gas than usual to warm our homes and businesses. This has led to UK gas storage, already limited, being at historically low levels.
European suppliers have problems of their own. When you can’t get the power you need from one place, you’d usually go to another. But all of the places the UK usually gets its power are struggling to meet demand. Asian and South American countries are also buying more gas, increasing demand even further.
Price Cap
UK legislation introduced in 2018 required Ofgem, the energy regulator, to limit the rates a supplier can charge to domestic customers. It put a ‘price cap’ on the cost per unit of electricity and gas, as well as limits on the standing charge for each, and re-evaluate every six months.
The Default Tariff Price Cap was introduced in 2019. As wholesale prices increased, Ofgem increased the level of the price cap. In February Ofgem announced, the price cap would increase by a further 54%, which it described as “extremely worrying”.
In August, Ofgem confirmed the price cap will be updated quarterly, rather than every six months, and laid out the price cap levels for the 9th period; 1 October 2022 – 31 December 2022. This raised the price cap once more, with an average cost of energy between £3,549 and £3,764.
Government measures
In response to the rising cap, the UK Government announced that average bills will be held at £2,500, under the Energy Price Guarantee. This means that the October price cap will no longer be implemented in full for customers.
Whilst the price cap was calculated using a methodology based on market prices and regularly revised, the Energy Price Guarantee sets a maximum unit price (below the level the price cap was set to rise to). It was originally fixed for two years from October 2022. However this has recently been reduced to six months. It's reported that average energy bills could exceed £4000 after April 2023.
Amongst other measures, the Energy Price Guarantee includes a temporary suspension of social and environmental obligations costs (known as green levies) for customers, transferring the costs to the UK Government.
The UK Energy Prices Bill
The UK Energy Prices Bill aims to give a legislative framework to measures aiming to control the price of energy. This includes the Energy Price Guarantee, alongside other recently announced government measures; the ‘energy bills support scheme’, and the ‘energy bill relief scheme’, discussed in a recent Senedd Research article.
The Bill contains measures to set a temporary fixed price, or a 'Cost-Plus Revenue Limit', for low-carbon generators. This is designed to break the link between high gas prices, and the price of electricity from low-carbon generators.
To put it simply, if the wholesale price of electricity is being set by the price of gas, those generators that don’t use gas don’t have increasing costs yet are benefiting from soaring wholesale prices. The measures in the Bill essentially limit the profits low-carbon generators are able to make.
This has been described as a ‘windfall tax’ on clean energy generators, with fears it could impact investment in renewable energy development, and in turn targets to reduce emissions to net-zero.
Concerns have also been raised by energy developers, over powers in the Bill to allow the Secretary of State to modify energy licences and ‘give direction’. These powers have been described as a ‘power-grab’, that allows the Secretary of State to effectively overrule Ofgem.
More details on the provisions in the Bill, and its passage through Parliament can be found in this House of Lords Library briefing.
Article by Lorna Scurlock, Senedd Research, Welsh Parliament
