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The second global energy crisis of this decade has reignited questions about Britain’s grid strategy, specifically: why does it continue to have one of the most expensive electricity markets in the world?
Despite the growing role of domestically generated renewable power, electricity wholesale prices in the UK have more than doubled since the war in Iran triggered a global squeeze on seaborne gas shipments from the Gulf.
The resulting jump in global market prices has pushed up costs across the energy system in Britain because of its reliance on gas.
The Treasury on Tuesday moved to try to reduce that dependence with measures to weaken the link between electricity generation and gas markets. Here we look at why the two are intertwined and what impact measures to break the connection could have on bills.
How reliant is the UK on gas?
Very. The UK relies on gas for about a third of the primary energy used across the economy as a whole. This includes 23m gas boilers used by households, about 85%, to heat their homes and water. Meanwhile, gas power plants generate almost 30% of the country’s electricity.
Almost 80% of the UK’s gas is sourced from North Sea pipelines; either from the UK’s declining oil and gas basin or from fields in Norwegian waters. Tankers of liquified natural gas (LNG) from countries including the US, and withdrawals from storage, make up the rest. The Gulf makes up surprisingly little of the mix, with Qatar accounting for just 1% last year.
The problem is that even though the UK has a diverse range of gas sources, wholesale prices have surged because the most expensive source of gas is the one which sets the market price. This should mean windfall profits for Norway, and higher costs for the UK.
Why don’t renewables make UK electricity cheaper?
As in the gas markets, the market price of electricity is determined by the most expensive source of available power generation. In the UK, more often than not, the cost of running gas plants sets the price for the entire system.
Think of it like a football penalty shootout, suggests the supplier Good Energy. A team will select a list of individuals in order of preference, with the best individuals selected first. In the UK electricity system low-cost renewables will be called on first “but when the pressure is on, gas steps up to the spot. And its score determines the result.”
This is known as “marginal pricing”. In the UK, the electricity market price in 2023 was set by gas 98% of the time, the highest rate across Europe and well above the EU average of just under 40% at the time. In France, abundant nuclear power keeps a lid on its demand for gas, and in Spain its virtually all-renewable grid has the same effect.
The UK’s race to roll out renewable energy generation has helped. However, it may take until at least the end of the decade for the UK’s renewables to make a meaningful impact on the overall market price, according to experts.
What is the UK government doing about it?
Government officials have called on older renewable energy projects, now using a legacy subsidy scheme called Renewables Obligation (RO) that makes support payments on top of the market price, to move to a fixed-price contract similar to the one used by newer projects.
This would affect about 35GW worth of older RO projects, or 30% of the UK’s total generating capacity. If they all signed up to a fixed contract this would weaken the link between soaring wholesale gas prices and the cost of electricity.
The government expects the gas market’s influence to wane in the decades ahead as new renewable energy projects are rolled out under fixed contracts, and the legacy deals come to an end. But older projects switching to a fixed price could accelerate this trend, delivering more stable electricity costs sooner.
Legacy renewables companies that do not agree to sign up to new contracts will face higher taxes from 1 July. The chancellor, Rachel Reeves, plans to increase the windfall tax on excess profits made by electricity generators in Great Britain from 45% to 55%, with the proceeds going to support households struggling with their bills.
Chris Hayes, the chief economist at the Common Wealth thinktank, said there remains a “strong case” for removing gas plants from the electricity market and placing them in a strategic reserve. This could mean they run only as a last resort, and at a fixed price.
What does this mean for bills?
The government’s cap on household energy bills is expected to rise to the equivalent of £1,836.84 for the typical annual dual-fuel bill, according to forecaster Cornwall Insight. The measures set out on Tuesday are unlikely to change this, and the government has not set out how it would use the proceeds of the windfall tax to help support households and businesses.
The plan to push more generators on to fixed contracts could also take time to implement. The government has begun a consultation, but it will be wary of striking deals while market prices are high and risk locking in to those higher costs.
In the meantime, ministers want to make it easier for households to adopt low-carbon energy options such as electric vehicle chargers and solar panels to help cut their reliance on fossil fuels.
They aim to pass legislation this summer to allow households to install pavement “gullies” outside their homes to run cables which can charge their cars without planning permission. This should make car charging more convenient and affordable for drivers who don’t have off street parking. The government also hopes to accelerate the uptake of solar power by encouraging plug-in solar which could help to lower bills.
