Why are energy bills so expensive in the UK?

Is UK energy really dearer? It is. Last week saw an “awful April” jump in the price cap on domestic energy bills. That’s bad enough. But the deeper fear is that the UK’s continuing high energy costs are crippling whole sectors of the economy – notably manufacturing – and posing a clear threat to future national prosperity.

In the US in 2023 (the last full year for which reliable figures are available), one kilowatt hour of industrial electricity cost about 6.5p. For Sweden, the figure was 8p. For France, 18p. Here, it was almost 26p.

International Energy Agency data (for industrial electricity) shows recent prices in the UK have been more than three times those in the US, nearly double Japan’s, a third above Germany’s and more than double the average in the OECD club of developed nations. We currently pay more than any other comparable rich country.

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Why are energy prices so high?

The UK is a net importer of natural gas and unusually exposed to the volatility in the global market. And in this country, the price of electricity has long been determined mostly by the gas price – far more so than in other similar countries, and even though the role of gas in the overall energy mix is falling.

In 2024, for the first time, renewable energy (mainly wind and solar power) generated most of the UK’s electricity. That’s an important milestone in making Britain a clean-energy “superpower” (one of the government’s stated “missions”).

So you would hope that since renewable energy is far cheaper than fossil fuels, prices would be falling steadily. Alas, of that there is no sign.

Why aren't there signs of energy prices falling in UK?

Two big reasons. First, the auction method by which energy retailers source their supplies. This isn’t a free-for-all auction where producers compete on cost to attract customers. It’s a marginal pricing system – similar to that seen in some commodity markets – where the “wholesale electricity price” for the whole market is set by the most expensive power station needed to meet the overall demand.

This reflects the fact that energy is critical to national security so all players need to be incentivised to keep the lights on. In the UK, gas plants are the most expensive almost all of the time (98% in 2023), whereas the European average for fossil fuels was just 58% – meaning that energy bills are much higher here.

The second reason is that while the UK is getting good at producing renewable energy, it’s terrible at scaling up its storage capacity. Despite improvements in battery technology, the UK’s current capacity is “far too small to store the volumes of energy needed to make a real dent in electricity prices”, says The Economist.

Indeed, the distribution network, National Grid, actually pays wind farms to shut down when it can’t cope with surplus supply. “That lifts network costs, which already account for a good chunk of end-user bills.” The government wants to achieve a carbon-free grid by 2030 by quadrupling offshore wind farms, doubling the number on land and tripling the production of solar power. But those plans are wildly optimistic, says Tom Jones on CapX – and its promises to boost storage even more so.

Meanwhile, the UK is left as a net energy importer – for the first time since the 1970s – in a volatile world where energy security is getting ever more central to geopolitics by the day.

How big a factor is net zero?

Here’s where it all gets highly contested. Jim Ratcliffe, the billionaire chief executive of Ineos, warns that high energy bills are pushing the once-thriving UK chemical industry “to extinction” – and cites the net-zero drive as a key factor. “De-industrialising Britain achieves nothing for the environment,” he says. “It merely shifts production and emissions elsewhere.” The counter view – enacted into law under the May government’s net-zero target of 2050 – is that leading on decarbonisation will save money in the long run by not frying the planet and by fostering new green technologies in the UK.

Even so, green levies and other so-called “policy costs” definitely do add to all our electricity bills. (These include the green gas levy and a vast array of upgrade and insulation subsidies and incentives.)

These costs don’t add up to 25% of our bills, as is sometimes claimed, but they are significant, nonetheless. According to the watchdog, Ofgem, for a typical household on an electricity-only tariff paying by direct debit, policy costs amount to about 16% of the total price cap. For a dual-fuel household, it’s about 11%.

What is to be done?

The chief reason UK bills have soared is that the wholesale price of electricity has long been disproportionately set by gas, says Pilita Clark in the Financial Times. One obvious way forward would be to overhaul that system.

Imperial College professor of energy policy Rob Gross has long argued for a restructuring that would shift older renewables and nuclear plants off wholesale prices and on to long-term fixed-price contracts like those used for newer green energy projects.

A second, more radical, route would be to remove gas from the auction-based system by either nationalising gas plants or shifting them to a long-term pricing model.

Third, GB Energy (the state-owned renewable energy investment body currently being set up by the government) could be allowed to buy and run green generators that bypass the wholesale market and sell more affordable power directly to consumers.

Other ideas that have been floated include burning more gas produced at home, a zonal pricing system to set prices based on local supply and demand, and hence incentivise big consumers such as factories to move to cheaper areas, or to ramp up nuclear power.

What’s the best way forward?

“Each idea is contentious,” says Clark. “Energy markets are complex. But anyone serious about cutting power bills and boosting British industry must grapple with these complexities. Simply attacking net zero is not nearly good enough.”

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