Broken Britain: Why Are Energy Prices So High and How They Can Be Brought Down
|Author: Travis Benn||Read time: 17 mins|
|Client type: All||Technology: all|
While Liz Truss has promised to soften the blow of skyrocketing energy prices for households with the Energy Price Guarantee, businesses and commercial venues have yet to receive the same comforting news.
In fact, there’s currently no price cap for energy bills on businesses, which may drive companies with even the most favourable profit margins into an untenable position.
Although industry leaders in business may be looking to large-scale renewable energy projects as a long-term solution to the energy crisis, Liz Truss’s movements toward fracking and her disdain for onshore wind farms are unlikely to make this a venture worth investing in.
So, what are businesses to do when faced with potential closures and a looming recession?
It’s no secret that renewable energy is cheaper to produce and sell than natural gas and oil. But with the structure of the UK market forcing all energy to be sold for a single price, something needs to be done by industry leaders like OFGEM to manage extortionate business tariffs before companies are pushed past the point of no return.
In this comprehensive deep dive, we’ll uncover the reasons for Britain’s extortionate energy prices, how it’s impacted by national demand, and how the country can resolve the issue for good.
Now let’s dive in.
Why Energy Prices Are So High: 3 Major Reasons
1. Great Britain has one national price for electricity
Since 2005, Great Britain has used a national pricing model, whereby there is one price for electricity everywhere in Britain at any point in time. This System is also in place in other countries like France, Germany, Greece and Poland. Essentially, the UK government decided to operate Britain as one big energy market. which would cover England, Wales and Scotland. Under this plan, electricity prices would be set by the normal market forces of supply and demand across this combined geographical area.
This means that National Grid has to match everyone who needs electricity to everyone selling electricity across an extremely large geographical area. The National Grid would do this until there is a perfect balance and a single market price emerges at which everyone has received the amount of electricity required. Two benefits of this approach are that Britain’s electricity market can be overseen by a single national operator (the National Grid), and that electricity prices do not differ from city to city.
This is in contrast to other countries such as Australia, Denmark, Italy, New Zealand, Norway, Singapore, Sweden and parts of the USA who have split their electricity market into smaller geographical areas called zones or nodes. In this scenario, each zone has its own separate energy price. A key benefit of this approach is that electricity prices remain low in areas that produce enough energy to meet their local needs. As a result, these spots remain unaffected by higher prices experienced in other regions that import foreign energy to meet their energy needs.
Ultimately, the price of electricity is determined by how much we need and where this electricity comes from.
2. It’s all about where our energy comes from
As we use a large amount of electricity in Great Britain, we need to pool this electricity from a variety of local and foreign sources.
Our breakdown of current sources includes:
- Renewables (43%)
- Gas (36%),
- Nuclear (16%),
- Oil (3%)
- Coal (2%).
These sources have improved significantly over the past 30 years as illustrated in the diagram below.
Over the years, our reliance on coal and oil has fallen by 97% and 52%, respectively and these sources been replaced by renewable energy and gas. In general, renewable energy provides all of the UK’s electricity needs for five months of the year (typically during the warmer months) and gas supplies our electricity for a further four months each year. Although there’s still a decent way for the UK to go on the renewable energy front, this is undeniably impressive.
However, we’re currently unable to meet all our internal energy requirements with onshore sources. And therein lies the problem!
3. Our electricity needs and the cost of supply varies from month to month
As Britain has a single price for electricity (irrespective of the location), its price is determined by how much electricity we need and whichever energy source has the highest cost.
Sometimes we need less electricity. This is usually the case during warm summer months when central heating isn’t required or during lockdown when many energy-intensive businesses were closed.
During periods like these most of our energy needs can be met by a few sources. Typically, we’ll rely on renewables and nuclear which cost £10 and £20 per unit of energy respectively.
The actual price of electricity will be determined by whichever of the two sources utilised has the higher cost of supply. In the example to the right, the price would be £20 per unit of energy because nuclear had a higher supply cost than renewables. Therefore, although we could have received some of our electricity from renewables at the cheaper price of £10 per unit, there simply wasn’t enough electricity available from renewables to meet 100% of our needs. As a result, nuclear was added to the mix which bumped up the electricity price from £10 to £20 per unit.
Strangely, both the company that supplied electricity from nuclear AND the company that supplied electricity from renewable sources received £20 per unit of electricity supplied. This is because Britain operates as one market with a single price for electricity. Although the renewables company would’ve been happy to receive £10 for each unit of electricity it supplied, that’s just the way the cookie crumbles in the British energy market!
Now, imagine that Great Britain has just experienced its coldest and most prolonged winter on record. Our demand for electricity would be extremely high thanks to the increased reliance on central heating and lights. During this period, we would likely need all five sources of electricity “to keep the lights on” as it were.
The individual cost of supply is as follows:
1. Renewables - £10
2. Nuclear - £20
3. Gas – £40
4. Oil - £50
5. Coal - £60
NB: fictitious numbers used for illustrative purposes only
In this scenario, the price of electricity would be £60 across the UK, because coal had the highest cost of supply at £60.
If we removed coal from the mix, the price of electricity could be brought down to £50 (i.e. the next highest source of supply being oil).
However, without coal there wouldn’t have sufficient electricity available to meet GB’s total demand of 60 million units.
As a result, the National Grid would become imbalanced and the lights would go off for everyone in GB.
Alternatively, you could think of it as a lego bridge made from different colours, with each colour representing a different source of electricity. Before you raise an eyebrow at this analogy, let me explain!
Let’s say we have the following layout for our energy sources:
Although each block might have a slightly different cost of production depending on its colour, ALL blocks are essential to make the bridge work.
Consequently, each block is able to command the same final selling price as the most expensive individual block as they are all essential for completing the finished bridge. It’s not about teamwork per se, but each source is crucial if we want to adequately meet Britain’s intense energy requirements!
Therefore, under GB’s current electricity system, the only way to reduce the price of electricity to a manageable level is to dramatically reduce our consumption of electricity.
In other words, shorten the length of the lego bridge to a level that can be supported by our present capacity of renewable energy and nuclear power stations. Alternatively, we will need to build more power stations to supply more electricity whilst keeping the cost of supply low.
Why have energy prices increased?
Now that we’ve covered why energy prices are high across the UK, you may be wondering why they’ve increased so much in recent months. Well, there are a few reasons for this.
The main reason for the increase in energy prices is down to usage levels. Great Britain currently uses more electricity than is available from renewables, nuclear, oil and coal. In fact, we import foreign gas to cover 36% of our energy needs from regions such as the North Sea, Norway, Russia, Qatar and the US.
The war in Ukraine
Unfortunately, the cost of gas has also skyrocketed in recent months due to the ongoing conflict between Russia and Ukraine. This has dramatically reduced the supply of natural gas as Russia is the world’s largest supplier of this commodity. As we know from economics, when supply reduces, prices will rise - sometimes exponentially! Since we cannot live without electricity, the balance tips in favour of energy suppliers.
As for the Brits? Well, we simply have to pay the price.
So, what does this mean exactly?
Going back to our earlier example, the global shortage of natural gas has also increased the cost of supplying gas in Great Britain’s energy mix.
The current prices are as follows:
1. Renewables - £10
2. Nuclear - £20
3. Gas – £200
4. Oil - £50
5. Coal - £60
Therefore, the price of electricity has increased to a whopping £200 per unit across Great Britain as gas now has the highest cost of supply at £200 per unit.
If we removed gas from the energy mix, the price of electricity could be brought down to £60 per unit, with the next highest source of supply being coal.
However, there simply wouldn’t be sufficient electricity for the whole of GB if we did this. Instead of solving the energy crisis, the National Grid would become imbalanced and the lights would go off for everyone.
To make things more complicated, all other companies that supplied electricity from other sources (i.e. renewables, nuclear, oil and coal) also received £200 per unit, as Britain has one price for electricity.
This happens even though companies supplying electricity from renewables and nuclear would’ve been happy to receive £10 and £20 per unit for each unit of electricity that they supplied!
So, why can’t we just fix GB’s broken electricity market?
The current situation is undeniably frustrating, which begs the question: WHY can’t we just fix Britain’s broken energy market? Well, the UK government is currently considering various ways to fix the electricity market to keep prices low. The government frequently describes this as “decoupling” the cost of electricity from high fossil fuel prices. In reality, Great Britain’s electricity market is working perfectly well! We simply don’t like the current results of the normal market forces which are presently not working in our favour. The existing system is making things incredibly expensive for the average British household, which is causing widespread frustration, hardship, and increased distrust in market forces.
Ultimately, the UK government has failed to invest in enough power stations to meet the energy needs of Great Britain. Instead, it has relied on importing cheap foreign energy (namely gas) to meet its shortfall of energy. Unfortunately, the government was not adequately prepared to deal with the repercussions of imposing sanctions on Russia whilst still being reliant on Russia for essential and indispensable gas supplies. As a result, the country is stuck between a rock and a hard place that’s extremely tricky to resolve without significant government intervention that would cushion the blow for the average Briton.
So, how do we fix it?
To bring energy prices back to reasonable levels, we need to:
1. Have amenable negotiations with Russia to end the current conflict.
2. Significantly reduce our consumption of electricity.
3. Force low-cost energy producers to sell their electricity at pre-2022 prices.
4. A new concept that would innovatively divide the UK into smaller electricity markets with lower regional prices.
5. Build more UK power plants to make the UK fully energy independent.
A Final Thought
Although each of these actions would take significant time, effort, and cash to implement, it has become glaringly obvious that serious investment is required to rectify the problems at hand. The British population can improve the situation by reducing their consumption levels.
But realistically, the government needs to formulate a meaningful plan of action that will set the country up for decades to come.