The 'Energy costs' problem, why is it happening and what can be done about it

I'll cover this in a video as well, but for those who prefer reading.

Why have our energy costs spiralled out of control?

 Do you want the simple answer or the complex one?

The simple answer is, primarily, the greed of the energy producers, or at least the greed of the companies that produce the gas and oil used to generate energy.

The complex answer is, that it is, of course, a lot more complex than that. 

I will explain:

Firstly it's necessary to cover some background to how UK energy is produced and supplied as it is this that is the crux of the problem, for the UK anyway.

Background: UK Power Generation.

If we look back to, say, the early 1970s, most of our energy (91%) was generated using coal and oil fired power stations, with most of the remainder provided by Nuclear power. The UK was largely self sufficient in coal production and with North Sea Oil so pretty much entirely self sufficient in power generation.

The discovery of Natural Gas in the North Sea slowly added gas to the mix and by 1980 22% of our energy was produced with Gas. In 1979 Thatcher decided that after the years of Industrial unrest and the power cuts of the Winter of Discontent that the UK should drastically increase the scale of Nuclear power.

From the mid 1970s, work started on some Hydro power schemes as well, to serve as emergency load balancing for the Grid in times of peak demand.

Both the provision of new Nuclear power stations and Hydro electric schemes though took a great deal of time.

In the 1990s, after the coal strikes of the 80s, the portion of Gas and Nuclear generation increased as Coal fired stations were taken out of service. 

As the UK production of oil and gas has been declining steadily from 2000 we have had to increasingly import Gas, and then with the establishment of linking supply lines to the Continent, Electricity directly, with the UK no longer, by quite a long way, being self sufficient in our energy production.

The growth of Nuclear power stalled in the 2000s as both the cost and environmental/public protest issues put off investment and the Government of the time didn't see Nuclear as a priority initially, with plans for new Stations not coming to the fore until 2007. Whilst the Clegg/Cameron Government decided to move forward with Labour's plans, construction has been slow and the UK currently has 9 active Nuclear plants generating around 16% of the UK's power.

Wind Power generation has increased drastically since 2010, not being seen as a priority and too costly prior to EU targets being set and agreed in 2009. By 2020 Wind Power capacity in the UK equated to around 25% of power needs. 

Due though, to activism against land based wind turbines, the vast majority of UK wind power installation is offshore. This is costly to build and install and even before the current crisis was actually increasing UK power costs, albeit helping with climate targets.

There is though a major problem with Wind Power which the UK has now experienced. As the proportion of Wind Power to other sources increases so do the likelihood of serious Generation problems. If 25% of your power generation capacity is Wind, then you have a major problem when the Wind doesn't blow. You suddenly have to find that 25% from somewhere else.

When Wind Power represented a small fraction of total power generation, this 'buffer' could be provided by a mix of power storage/hydro-electric and import without causing major issues.

I should explain that because of the way that the Power Grid works, the supply needs to be maintained at a certain level and power frequency to avoid the whole network crashing and causing damage. As such it is vital to have emergency capacity available that can be ramped up instantly to cover fluctuations in demand, such as everyone putting the kettle on at half time in an England World Cup game, or where supply drops due to faults or other external factors.  Currently the UK's 'buffer' is made up of a mix of pump storage hydro-electric schemes which can very rapidly provide a substantial 'boost' and a number of rapid operation Gas burning stations with any remainder being provided by our cable linkages to the Continent.

As the percentage of Wind Power increases so it becomes so much harder to maintain an adequate buffer, and far, far more expensive.

Though the UK now has the potential to provide 25% of our power needs with Wind Power, typically Wind power provides a far lower percentage than that, as at any particular point, it may not be windy enough over the whole of the UK, or indeed it may be too windy.

The UK could never supply all of it's power via Wind, without having also the ability to provide all of it's power from an alternative source.

In the month of August 2022, the breakdown of power generation in the UK was as follows:

Wind        15.9% 

Gas           47.7%

 Nuclear    15.1% 

Solar         7.2% 

Biomass    6.2% 

    Import      4.5%     

Storage     1.3%

Hydro       1.2%

Coal          0.9%

Background: UK Energy Market.

Prior to things like price caps, the UK energy market is a free but regulated market consisting of two elements. The National Grid, who are responsible for National supply infrastructure, the 'grid' itself, transformers etc and who ultimately 'deliver' power to homes and businesses and then the supply companies, who 'supply' power to the Grid. The supply companies are made up of a mix of companies who both generate and supply power and companies who wholly buy power on the open market.

Up until recently there was surprisingly little regulation around who could set up a 'supply' company.

The market is set up like this, supposedly, to encourage supply competition to result in a wide choice for consumers and keep prices low.

Background: Consumer billing.

A consumer's (whether domestic or business) bill, whether on a fixed or open contract is made up of a number of elements. These consist of the wholesale cost of the energy, network costs, operating costs, policy costs, VAT, supplier profit and a small amount covering other various elements.

The wholesale cost is the cost of the energy, whether supplied by the suppliers generating company or from the open market.

The network costs cover investment in and operation of the Grid itself and associated infrastructure. 

Operating costs cover billing and administration costs of the supply company, meter installation, meter reading etc. 

Policy costs cover things like the Green levy, and more recently levies to cover the cost of covering companies that have gone bust.

VAT and supplier profit should be self explanatory.

Prior to Ofgem introducing price capping, suppliers were entirely free to set the supply cost themselves, though Ofgem fixed some costs such as Network and Policy costs. The cap then set a maximum limit for the supply costs which was set by Ofgem to include/allow for the varying elements.

Typically the wholesale costs, obviously, have been the biggest element, but have made up as little as 50% of the 'consumer' cost, with the other elements making up the rest. As such the 'consumer' cost is not impacted as much by wholesale costs as you might think.

Problem 1 - The UK energy Market.

The first problem is the way that the UK Energy Market operates, this is set by Government and Ofgem. The British Electricity and Transmission Trading Arrangements (BETTA) introduced by the Labour Government in 2005 set costs UK wide.

These costs are made up of a mix of long term contracts, whereby Electricity prices are set for a set period and short term or 'instant' contracts which together set the 'current' price on the UK market (from which all UK suppliers must buy their power) There are some regional variations and then there are a few more local variations whereby some suppliers are allowed special agreements in a very narrow area/region (such as all, or most properties being supplied power from a particular wind or solar farm)

The cost though is not a simple 'average' of the costs of the various supply elements (Nuclear, gas, etc.) but is set by the maximum cost of the marginal supply. This is the last bit of power, almost exclusively purchased on the basis of short term/instant contracts, to fully meet the fluctuating demand of the UK to ensure that supply remains constant. This 'supply' is almost exclusively supplied by Gas generators and explains why UK costs have been so badly impacted by rising Gas costs. It also explains why prices fluctuate so much as demand for Gas across Europe varies. The impact of these widely fluctuating short term costs are somewhat flattened out by the longer term contracts and an 'averaging' across defined periods set by the BETTA but the costs are still included in the bills that we pay.

The market being set up like this has meant that there has been little that any of the supply companies could do regardless of where their actual Electricity supply comes from. You might have chosen one of the 'green' energy suppliers to buy your electricity from, that supplier might advertise that 100% of your Electricity comes from green/renewable sources, so you might be wondering why then your prices have increased the same as everyone else. The reason is the BETTA, the wholesale cost of Electricity from a Wind farm is the same as from any other source as it is set by the BETTA and not set by the actual cost of generating the power.

This is perhaps the biggest problem for UK consumers as it means we are entirely at the mercy of the Worldwide wholesale marketplace.

Which leads into:

Problem 2 - Worldwide demand vs actual supply.

Firstly let's look at UK wholesale prices and how they have varied:

On December 30th 2019, a unit (kWh) of Electricity had a wholesale cost of 4.49 pence.

A unit (kWh) of Gas had a wholesale cost of 1.26 pence.

Then COVID happened and much of the World went into Lockdown from March 2020. This drastically cut the demand for both Gas and Electricity, both directly as factories closed due to the lockdown and then as a result of the demand for Goods and Services reducing which led to reduced production.

As a result, wholesale prices of both Gas and Energy dropped.

Oil and Gas producers shut down production facilities and reduced production to maintain demand and prices recovered quite quickly as a result.

As the World began to emerge from lockdowns and consumer confidence slowly returned, demand for goods and services increased quite rapidly to pre-lockdown levels and in some areas exceeded them.

 Demand for both Gas and Energy thus increased rapidly. The Gas/Oil producers didn't though bring back All their production capacity, preferring to see prices spike sharply.

The Winter of 2020/21 in Europe was particularly cold resulting in many Countries using up most of their Gas reserves.

Accidents/Fires/Explosions at a number of World wide production facilities further reduced production capacity.

Then in March 2022 Russia invaded Ukraine and started using Gas supplies to Europe as leverage. Now of course they are fully cut off.

The UK lost one of it's key interconnectors to the Continent due to a fire at the onshore terminal linking it to the Grid. 

The combination of these factors have seen UK Gas and Electricity wholesale prices spike and continue to rise through much of this year.

These graphs show the variation of UK average wholesale prices (under the BETTA) showing the result of yet another cold Winter in Europe, then the Ukraine War and now expectations of another difficult Winter.

The current UK wholesale price of Gas (as of 6th October) is 14.06 pence per kWh and of Electricity is 32.8 pence per kWh.

The new price limit introduced by the UK Government limits consumer prices at 10.3 pence per kWh for Gas and 34.0 pence per kWh for Electricity.

This is someway below the wholesale price and remember that the wholesale price is itself only a portion of the consumer price. 

Gas prices were stabilising and even dropping quite sharply as much of Europe has pretty much fully re-stocked their reserves of Gas and indicated that they have sufficient to get them through Winter, but OPEC+ have announced that they are cutting back production to 'stabilise' prices (at the current high level) which will ensure that prices rise somewhat from where they currently are.

If Europe has another particularly cold Winter, or there are further unanticipated shocks to the supply, then prices will spike further, though UK consumers are now insulated from any price variations over the next 6 months (or 2 years for domestic consumers) with the Government having to meet any price shortfall.

Problem 3 - UK reliance on the Global Market.

This identifies the third major problem, that the UK has to import much of it's Gas, both for heating supply but also for Electricity generation, and also has to rely on electrical interconnectors to provide that last 'topping up' of demand to ensure supply is maintained. Although those interconnectors typically only provide around 4-5% of UK's total demand, it is that 4-5% that sets UK market prices and it is that 4-5% that is the most expensive, being both electricity supplied from Gas burning power stations and tending to be purchased on short term/instant contracts which can be ludicrously expensive as demand fluctuates.

The UK wouldn't have to rely on interconnectors if we had sufficient domestic power generation capacity, if we did that would remove the most expensive part of the cost.

If the UK had sufficient Gas storage capacity we could also smooth out Gas price fluctuations and that would also help to bring UK market gas and electricity prices down.

Successive Governments have made a succession of errors. Failing to replace Coal fired power stations as they were taken out of commission with robust capacity elsewhere. Failing to build Nuclear plants quickly enough. Failing to research and commission alternate 'stabilising' power generation capacity, such as battery storage or similar. Failing to maintain (and even increase) Gas storage capacity.

Problem 4 - Policy costs, SMART meters etc.

A big problem in the UK is that a disastrously mis-specified and mis-managed SMART meter rollout programme has drastically added to the cost of UK consumer bills for very little benefit.

Whilst the concept of SMART meters is not unreasonable, in themselves they don't save energy or costs and there are some huge problems with the rollout.

The initial specification, set in 2009, was disastrously poor, ensuring that anyone who has had a SMART meter fitted from 2009 up until recently will need it replaced (or at least the communication pack replaced) by 2032/33 as the initial specification relied on 2G and 3G which will be turned off by 2033. Even many of the SMART2 standard meters now being fitted will need their comms packs replaced. 

Secondly it is clear that the supply companies are using the rollout programme to make money, fitting meters where they aren't needed or wanted and running highly aggressive programmes to force people to have one fitted, then fitting meters that they know that they will have to replace in a few years. In addition they are needlessly replacing SMART1 standard meters claiming they have to replace them when in fact the vast majority can be upgraded to SMART2 functionality by a simple remote software update. In effect, the supply companies are engaging in widespread fraud, and neither the ombudsman or regulator are monitoring things properly and even when the problems are highlighted won't take any action. 

This means that substantial sums (hundreds of millions of pounds) are being added to UK consumers bills (as Policy and operating costs) entirely needlessly.

A summary of the problem.

The problem thus is that the UK is subject to the variation of prices in the Global market. That the UK wholesale energy market is limited to contract pricing that ensures that the price paid is the price of the most expensive element of electricity production such that costs as a whole are subject to the short term price fluctuations of Global Gas wholesale costs. That the UK hasn't maintained 100% self sufficiency of power generation.

UK regulation of the market, by OFGEM is not fit for purpose, nor is the consumer facing Energy Ombudsman. Neither are properly protecting the Consumer, instead siding with the supply companies. 

The Solution?

So what is the solution?

In the longer term, the UK needs to move towards regaining self sufficiency in power Generating Capacity. The UK needs to do this in a way that maintains climate control targets, something that is ludicrously difficult because of our increasing reliance on Wind and Solar power that are subject to fluctuations of the weather.

The UK needs to immediately remove the BETTA which fixes wholesale costs at the most expensive price and move to a system that more accurately reflects the actual costs of power Generation and supply. Where local supply agreements are in place, people shouldn't then be subject to National costs.

Finally the UK Government has finally stepped in to cap prices, but the price cap has been set too high. Consumers will still face a 27% increase in their bills from April when the Winter support in place for this year (£400 payment to all and additional support for those on benefits) is withdrawn. 

Many people are already struggling to pay bills as they are. They simply won't be able to afford an additional 27% increase.

The Government need to thus lower the price cap, or ensure that the additional support continues next year and as needed.

I also believe that the Government should consider moving back to a Nationalised supply system. 'Free' market competition has neither kept prices low, nor benefitted consumers. I suspect though that the Tories certainly wouldn't consider this and even Labour may be wary under Starmer. Whatever their proposed longer term solution, it needs to be formulated and implemented rapidly.

Data/figures from UK Government Data, the ONS and Ofgem.