Why UK energy prices are so high
UK energy prices are higher than almost anywhere else in Europe and stand badly exposed to price swings as a result of the Iran war. What can be done?
What’s happening with UK energy prices?
Energy secretary Ed Miliband is set to approve the first major North Sea oil and gas project in almost ten years, says The Times. The licence to exploit the Jackdaw gas field, 150 miles east of Aberdeen, was granted under the previous Conservative government, but has been held up by legal wrangling.
Giving it the green light would not technically contravene Labour's ban on “new” drilling in the North Sea, but it would be a striking policy shift for Labour, and in particular for Miliband, a net-zero true believer.
Proponents say the energy shock caused by the Iran war has strengthened the case for drilling. Adura, the joint venture that owns the rights to the field, claims it could produce the equivalent of 6% of the UK's future gas supply.
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Is that realistic?
Others are sceptical. Uplift, a lobby group, claims Jackdaw would have zero impact on our bills and do little to increase gas supply. Indeed, even if the UK extracted every last hydrocarbon from the North Sea, it “would not raise this country's long-term output of oil and gas by more than homeopathic amounts” and “would not move the needle on UK energy prices”, says Ambrose Evans-Pritchard in The Telegraph.
Oil is priced off the global market and the gas price would continue to track the international cost of liquefied natural gas – “unless we cut off our European inter-connectors, tore up our EU trade deal and retreated into energy autarky”.
Why are UK energy prices so high?
There are several reasons why UK energy prices are so high (we pay more for electricity than almost anywhere else in Europe). One is that, although 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 negligible compared with the volume needed to affect electricity prices.
Another is geography and climate: while the price of solar power continues to plummet, wind power prices have plateaued, and the network costs of getting the power from the windy places (mostly northern and offshore) to the more populous ones are large. Green levies and other so-called “policy costs” make things worse, accounting for up to 11% of a typical bill for a dual-fuel household and 16% if it's electricity-only.
Another crucial factor is that we're a net importer of natural gas and highly vulnerable to external shocks. Moreover, our electricity prices are priced largely off the gas price, even though renewables now make up more than half the mix in terms of generating electricity.
Why is UK electricity priced off gas?
Because the UK – like almost all other developed, liberalised, economies – uses a “pay as clear” system of “marginal pricing” to match buyers with sellers so the market clears and overall demand is met by sufficient supply. In practice, that means that all power plants available to generate and sell electricity are continuously making “bids” to do so at a particular price. The bids are then arranged in a “merit order stack”, from the cheapest to the most expensive.
Because gas still makes up a big chunk of the mix, it is almost always the provider of the “marginal” unit of energy – the point at which the market clears and supply meets demand. One study found that in 2021, gas set the price of power 97% of the time, even though it generated only 37% of electricity. In France, where the market is dominated by nuclear, gas sets the price just 7% of the time.
Why not change the energy system?
We could, and there are various options. One is to move to a “pay as bid” model, where each power plant is paid the amount that it has bid to supply electricity, rather than the higher marginal price. But the risk there, says Simon Evans for Carbon Brief, is that all bidders (including cheap renewables) would seek to maximise their profit by bidding at the price they expect the market to clear, not at their own generation costs. As such, the system wouldn't lead to lower prices.
A second option would be to create two separate markets: a “green power pool” for renewables and another for conventional sources. This option was considered – and rejected as undeliverable – in the government's 2024 “review of electricity market arrangements”.
What other options are there for lowering UK energy prices?
A third, more radical, option for lowering UK energy prices would be to take gas out of the market completely. The sector would be managed as a strategic national reserve, receiving a regulated return for remaining open and available as a stand-by resource, while the rest of the market continues to use marginal pricing. It's doable, but would be politically very contentious.
The reality is that marginal pricing appears to be the “worst approach to clearing markets apart from all the others”, says Jon Ferris of consultancy LCP Delta. For the UK, where gas still sets the price, that leaves us stranded for now in a very expensive halfway house – bearing the capital costs of building a low-carbon system, while still paying the current fuel costs of the obsolescent fossil-fuel system.
What’s the solution to high UK energy prices?
In the absence of a new pricing mechanism for UK energy, some more pragmatism and less ideology would be a start, says The Economist. More than four-fifths of British homes still rely on gas for heating, far more than in the EU. So at some point, the commitment to hitting 95% clean electricity – renewables and nuclear – by 2030 is going to come unstuck.
In the long run, this is a sensible economic and geostrategic aim: the National Energy System Operator, which designs Britain's grid, projects that the country's energy-related costs (comprising transport, heating and electricity) could fall from 10% of GDP in 2025 to less than 6% by 2050 in a low-carbon world. We'd be much less vulnerable to external shocks. Yet even in 2050, the UK will still need gas as back-up. The government needs to recognise that and allow more North Sea exploration and drilling now. Even though it wouldn't bring down domestic prices, it would increase UK energy security and lend a fiscal hand, too.
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