Why are GB energy bills going up even for 100% renewable energy contracts?
Summary
Fossil ‘Natural Gas’ prices have gone up around 10 times, driven by post covid economic rebound and by Russia’s invasion of Ukraine.
The way the GB electricity market works means gas generation sets the wholesale market price most of the time.?Every generator can sell at the market price, so even renewable and nuclear generation is traded at this price.
Electricity and gas are traded, hours, weeks, months, and years in advance.?When the market price is high, someone makes a windfall, but it may be a commodity trader who bought today’s production months ago at a lower price, not necessarily the original producer.?This is why it can be hard to target windfall taxes.
The supply companies who sell us our gas and electricity may have contracts in place, of varying lengths, for 100% renewable energy, but as each contract comes to an end and gets renegotiated the next contract will be at the going rate.?To stay solvent, they must put up prices to end customers.?Ofgem, the industry regulator sets a cap on prices for domestic customers on standard tariffs every 3 months.
Newer offshore wind farms pay back when wholesale market prices go above a ‘strike price’ under Contracts for Difference (CfD).?The Low Carbon Contracts Company who administers CfDs forecasts that offshore wind farms will pay back ￡2.9Billion this winter.?Without CfDs our bills would be even higher.
Older wind farms and nuclear don’t have CfDs.?Their production costs have not gone up, so they make more profit when the price is high.?Government is now working on a scheme to transfer older wind and solar farms onto CfDs.?Whether this is a good or bad deal for customers will depend on what strike price is set.
This short summary is explained in more detail below.
Fossil ‘Natural Gas’ prices have gone up around 10 times
The GB market price for gas has been around 45p/therm for most of the last 5 years.?Recently it has risen to a peak of 637p/therm. Over the last few months, the price of gas has averaged around nine or ten times what we were used to.
Last 5 years of GB gas price
Where do we get our gas?
The gas pipeline network is in three separate zones around the world.?Centred on the USA, Europe and Asia.?There are no pipelines connecting between the zones and limited capacity to trade between them, so each has its own gas price.?Gas is harder to transport by ship than oil.?It requires special plants to liquify the gas for transport known as LNG terminals (LNG = Liquified Natural Gas) The US is a net exporter of gas and prices there have only risen slightly.??Europe gets around half of its gas from within the region, mostly Norway.?Europe used to import the rest via pipelines from North Africa and Russia.
Europe’s gas transmission network
The UK has its own source of gas from the North Sea and is connected to Belgium, NL and Norway.?UK gas production has been declining since around year 2000 and is now 1/3 of its peak.?This is enough to meet around 40% of UK consumption.?GB gets another 40% via pipelines mostly from Norway and around 20% as LNG shipments.?The largest LNG supplier countries are Australia, Qatar and the USA.?We export some gas from GB when the price is favourable, so flows on the network are greater than annual demand.?There are interconnectors between Scotland and the combined market in Ireland and Northern Ireland.
UK gas production to 2021
The price quoted for gas at the GB National Balancing Point is normally close to the price on the European Gas Hub.?In recent weeks when the UK had several deliveries of LNG, there was insufficient capacity to export to Europe and the GB day-ahead price was temporarily lower than Europe.
Volumes of gas are traded days, weeks, months ahead.?Producers will sell their gas at the going market rate, whatever it cost them to produce the gas.?When the market price is high, someone makes a windfall, but it may be a commodity trader who bought todays production months ago at a lower price, not necessarily the original producer.?This is why it can be hard to target windfall taxes.
What drove the gas price rise in Europe?
Put simply, demand for gas was up and supply was short.
Before 24 Feb 2022
After the Russian invasion of Ukraine the price rose much higher due to
Recently prices have fallen from their peak but remain around 400-500p/therm, around 10 times what they were in 2020
Wholesale electricity prices have gone up as a result
Where do we get our electricity?
Electricity networks in Scotland, Wales and England operate as a single system.?There is a separate system for the whole island of Ireland.?The two networks have separate markets.?There are two High Voltage Direct Current interconnectors between the two networks and connections from GB to the single European network via France, Belgium, NL and Denmark with more planned to Germany and Norway.?
The GB electricity market has a mix of sources of electricity that has changed over many years.?In the 1950s almost all electricity was generated by burning coal.?Britain’s last coal fired power station was commissioned in 1974.?Nuclear was added from the 1960s, and from 1990 onwards natural gas (fossil methane) joined the mix. ?Since the 2000s we have seen a growing proportion of renewable sources. In 2012 Coal was used for 45% of GB electricity, by 2019 it was less than 3%
GB Electricity sources over last 12 months
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How coal disappeared from the GB system
Why does gas generation usually set the electricity price?
Like natural gas, electricity is traded hours, days, months, or years ahead.?Electricity is hard to store, and most is made and used instantaneously. On the day Suppliers need to buy exactly the right amount of electricity used by their customers.?Imbalances are managed in real time by National Grid Electricity System Operator with a market clearing price set each half hour. There is a complex process over following weeks where the market administrator, Elexon, works out who owes who for each of the 48 settlement periods each day.
NGESO dispatches different generation units in price order each half hour.?Renewable and nuclear generation tend to bid low prices, so they will always be called on to run when available.?The clearing price is set by the ‘marginal’ unit, the most expensive unit called on to run.?This is most often gas generation, even when gas prices were lower.?Gas generates around 40% of our electricity but sets the price over 80% of the time and recently even more often.
Why does the price go up for all types of generation?
Generators will sell to any supplier at the best price they can get.?That is how commodity markets work.?Bilateral contracts for electricity tend towards the prevailing clearing price.?This means even renewable and nuclear generators sell their product close to the price of gas generation.
In recent years nuclear generators complained that the price was often too low for them, especially on windy days when there was little need for gas generation and prices were most competitive. Now, those same generators can sell for more than they expected.
The supply companies who sell us our gas and electricity have contracts in place, of varying lengths, to buy the energy from generators.?As each contract comes to an end and gets renegotiated the next contract will be at the going rate.?To stay solvent, suppliers must put up prices to end customers.?Ofgem, the industry regulator sets a cap on prices suppliers can charge domestic customers on standard tariffs.?The cap is reviewed every 3 months.?There is no price cap for businesses, so their prices are re-negotiated with a supplier at the end of their current contract.
Suppliers who buy 100% renewable electricity have seen the price of even longer-term contracts rising.?The impact on each supply company or renewable generator will depend on how much it bought or sold on longer term contracts and at what price.
Nuclear and older renewable generators costs are fixed, so higher clearing prices mean they make more profit.?However, if they sold their power to a commodity trader months ago it may be the trader rather than the generator who benefits.
How do CfDs help?
Recent offshore wind farms have a market stabilisation mechanism called a Contract for Difference, CfD.?Government held competitions for the lowest ‘strike price’.?When the market price is below the ‘strike price’ generators get a top up, when it is higher, they pay back.?This helped developers to borrow money to build wind farms at lower cost, because their income was more predictable.?The first CfDs were awarded in 2014 at ￡155/MWh.??Prices in recent auction rounds have fallen to ￡37.35*
*All prices are index linked to 2014 prices.?Price shown is for the lowest priced contract start year in each auction.
For wind farms with a CfD recent high electricity market prices mean they are paying back more often than receiving a top up.?The CfD scheme is administered by the Low Carbon Contracts Company who estimate that offshore wind CfDs will pay back ￡2.9Bn in Q4 2022 The precise figure is hard to forecast as it will depend on actual market prices during the period.
Without CfDs, electricity bills would be even higher.
Government is now working on a scheme to transfer older wind and solar farms onto CfDs. Whether this is a good deal for customers depends on the strike price that gets negotiated.?Assuming gas prices fall at some point, so will the wholesale electricity price.?If the strike price is set too high, we will get a small reduction in bills now, but they will be higher in the long term.
What else goes into a bill?
The largest part of a domestic energy bill comes from the wholesale price, especially since recent rises.?However other costs are added to gas and mostly electricity bills.
Wholesale costs – as discussed above.?The rise in wholesale costs is responsible for 96% of the recent rise in domestic energy bills.
Network costs – the cost of building, maintaining, and operating the national transmission and local distribution networks for gas and electricity.
Social and environmental obligations – a bundle of ‘policy costs’ These include supporting vulnerable customers, schemes for home insulation and the legacy cost of subsidies for earlier wind and solar farms.?In 2020 these costs made up 15% of an annual combined bill (25% on electricity, 2% on gas).?As prices rise, the social costs remain the same and are a reduced part of a bill.?From October 2022 renewable subsidies will be around 3% of a typical bill.
More homes have electricity than gas, so government chose to put most of these costs onto electricity.?That distorts the relative price for gas and electricity which impacts the relative competitiveness of heat pumps vs. gas boilers.
Other direct costs – meter maintenance and installation, managing the settlement system, paying for the regulator etc.
Supplier operating costs and margin – Suppliers compete and are also subject to the price cap on their default tariffs.
Taxes, like VAT.?Currently 5% on energy
Breakdown of typical domestic energy bills in 2020
Supplier failures – some, mostly smaller, energy suppliers were insufficiently hedged against rising gas prices and became insolvent.?28 supply companies failed in the year to June 2022.?Their obligations to customers are passed on to other suppliers, with the cost of the shortfall being spread across all bills.?One supplier, Bulb Energy was too large to follow this process and is being administered by the government.?Total cost of these failures is around ￡2.7Bn according to the National Audit Office.
Review of Electricity Market Arrangements
No electricity market is perfect, and governments often step in when they start to deliver uncomfortable outcomes.?The market operating in GB today was already showing signs of stress before energy prices went up.?As we add more demand by electrifying heat and transport the electricity system will need to grow.?At the same time the location and type of generation is changing and is planned to reach net zero emissions by 2035.?If fewer and fewer gas generating units continued to set the price for everything else, we would see huge swings in wholesale price, which would get further from the actual cost of production.?We also need new price signals to support investment in a range of energy assets including storage, flexibility and grid stability.
New market arrangements will be required by no later than mid-decade.?A review of electricity market arrangements (REMA) was announced in the British Energy Security Strategy and government is working with industry and stakeholders on design of a new electricity market.?This is separate from the short-term interventions announced on prices, but the two are likely to become entangled in coming weeks and months.
Hi Matthew, Thank you for taking the time to write this. I tried to understand the summary, flew over the main article, then came back to the summary. You asked for feedback: would it be possible to actually put in a couple of examples with numbers? Like, the amount a family pays for electricity with the system now., then the amount a family would pay for electricity if the system was not governed by the gas market. Or even, the amount of family would pay with a different system, a fair system for renewable energy pricing. Just an idea. So, basically, the message that I took away was that the system needs changing. Thank you again for writing it and best wishes, Jaquie
Head Of Outcome Based Solutions at Siemens plc, Digital Industries
2 年A super explanation from Matthew Knight. Some good arguments for splitting renewables - although the current system does emphasise the benefits of reducing consumption #energyefficiency
Yes. Thanks for this, but I can't follow it. Not your fault; I'm thick! But what I do know is that this is all too complicated, and very foggy. Is this a con? I know that the "suppliers" were put at risk and indeed some went under when the earlier price cap came in below their trade price, but I think the "anyone can sell gas/electricity" thing was risky and counter-productive. I would rather the whole thing was redesigned, and that we aim towards self-sufficiency and efficient management. This is all easy for me to say!
Operations Director at BVG Associates
2 年Thanks Matthew Knight. Most helpful. Prices for onshore wind energy have gone up too. For some projects it helps compensate for the loss of Levy Exemption Certificates (one those measure of “green crap” that went in 2015) but the degree of rise is more evidence of how broken the system is. I note that the reference price for offshore wind in the recent CfD allocation round 4 dropped significantly with time reflecting the challenge of significant offshore wind capacity. Where are the urgent measures for much more distributed storage, more ammonia production, greater grid intergration, greater geographical spread of wind generation, demand reduction and millions of heat pumps?