Why the UK’s electricity costs are so high – and what can be done about it

London: One of Labour’s key election promises was to cut energy bills by £300 a year by 2030 while making Britain a “clean energy superpower”.

The job is already halfway complete: renewable energy made up more than half the UK’s electricity for the first time last year. So why does Britain continue to have one of the most expensive electricity markets in the world? Industrial users complain those costs are driving companies out of business and discouraging investment in the UK.

The reason behind Britain’s sky-high wholesale energy costs is simple, according to experts. It is down to Britain’s reliance on gas – the price of which was sent soaring by Russia’s invasion of Ukraine – in power plants and home heating.

“Great Britain’s dependency on gas imports has been the most important factor behind higher gas and power prices in the market,” Kate Mulvany, the principal consultant at the energy advisory company Cornwall Insight, said.

Prof Michael Grubb of the UCL Institute for Sustainable Resources said in a recent research paper that, although fossil fuels used to be cheaper than renewable energy sources, “that has turned on its head as gas prices shot up and the cost to produce renewables such as wind and solar power has plummeted”.

He said: “If we actually paid the average price of what our electricity now costs to produce, our bills would be substantially cheaper.”

However, gas-fired power plants in effect set the market price for electricity – meaning costs are substantially higher than they could be. In simple terms: the price in the electricity market on any given day is dictated by the most expensive source of generation available, which in the UK would be its gas-fired power plants.

Under this “marginal pricing” system, the UK’s electricity market price is set by gas 98% of the time, the highest rate across Europe and well above the EU average of just under 40%.

In some cases, the soaring cost of firing up older gas plants to meet an increase in demand can cause market prices to rocket. Earlier this year, two gas power plants were paid more than £12m to supply only three hours of electricity after freezing weather led to some of the highest market prices since the energy crisis began.

This has contributed to higher bills for homes – the average household annual energy bill rose by £111 to £1,849 from this month. Meanwhile, inflated costs have also piled pressure on struggling businesses, and manufacturers, including Britain’s steelmakers, have said that high energy prices have disadvantaged them compared with neighbouring countries. So what can the UK do about it?

Energy industry experts have rallied behind the conclusion that cutting the UK’s reliance on gas is the key to cutting energy costs, too. By generating a greater proportion of the UK’s electricity from renewable energy and nuclear reactors, electricity costs would begin to fall as gas use dwindles.

“There’s no magic number below which bills will suddenly fall lower,” Mulvany said. “But the effect of gas markets on electricity costs would gradually fall,” she said.

In France, for example, where nuclear reactors contribute more than two-thirds of its electricity, market prices tend to be lower because gas plants dictate the market price only 7% of the time. In Germany, where renewables make up more than half of its electricity, gas plants set the market price about a quarter of the time.

By 2030, the UK government hopes to use gas-fired power to meet only 5% of its electricity annually. Plans set out by the National Energy System Operator suggest that in one scenario for the 2030 plan this would mean that gas sets the price in only 15% of hours, insulating consumers from “volatile international gas prices”.

Under the government’s clean power plan, gas prices could still have an outsized impact on overall costs relative to its diminutive role in the future grid by setting the bar for the most expensive source of electricity.

The answer, according to experts, is to intervene in the design of the market to stop the cost of gas plants from setting the price for the whole market.

There are a number of ways that this could be handled. The government could choose to nationalise Britain’s last remaining gas plants so they could be used only when needed and, crucially, without participating in the electricity market and driving up its prices. This was proposed by Adam Bell, the government’s former head of strategy at the Department for Energy Security and Net Zero and now a consultant at Stonehaven.

There are more market-friendly options, too, which could include offering gas plant owners long-term supply contracts at a set price, which would allow them to recover their costs without distorting the market.

The more renewable energy projects that are rolled out, the less expensive gas will be needed in the system. But industry experts believe that more can be done to harness renewable energy to lower costs. The key to making better use of renewable energy is to store it when it is abundant – during windy and sunny periods – and use it when supplies are tight.

A pan-European report by the clean energy thinktank Ember found that by 2030 wind and solar power generation could exceed domestic demand across all EU countries. The report found that could help the EU to avoid gas purchase costs worth €9bn annually.

The energy regulator for Great Britain, Ofgem, hopes to unlock billions of pounds of investment into storage technologies.

These are likely to include pumped hydropower projects – which pump water up into a reservoir when renewables are abundant and then release the water to generate electricity when renewables are scarce. Other technologies include liquid air energy storage, compressed air energy storage and “flow batteries”, which are in development.

Other plans to reform the market include dividing it up into different zones.

Under these plans, the existing market for electricity could be replaced with seven market zones, each with their own prices. Areas in Scotland with high levels of clean electricity generation and low demand could expect lower prices, while urban areas in the south of England with high demand but limited renewable energy projects would have higher prices.

Proponents of the plan believe that this would lower the costs of rewiring the UK’s electricity grids, funded through energy bills, by encouraging high energy users to migrate to areas of ample power supply, and developers to move closer to areas of high demand.

Others fear that upending the market would drive renewable energy investors to countries that offer a more stable regulatory regime, making it harder for big renewable energy projects to be built in the UK before the government’s 2030 target.

Energy bills are made up of more than just the market price – in addition to the cost of upgrading networks they also carry the cost of subsidies to support new low-carbon energy projects.

For years, industry policy experts have warned that adding extra levies to electricity bills makes it more expensive for people to cut their reliance on fossil fuels by taking up electric vehicles or heat pumps.

Instead, the government could move these levies on to gas bills to encourage people to opt for cleaner options or absorb them into general taxation to avoid saddling those who cannot afford to upgrade their car or home heating systems with higher costs.

Lowering the overall demand for gas should help lower wholesale gas prices, which would ease the upward pressure on electricity prices, too.