Why Is the Cost of Electricity Fixed to the Price of Gas?
|Topic: Energy Price Guarantee
|Read Time: 4 mins
|Landowner type: All
Whether you’ll continue using electricity as normal or have invested in everything you can to tackle rising energy costs this winter, you may be wondering: “WHY is the cost of electricity fixed to the price of gas?”. And you’d be completely justified in asking that question.
We’re always told that renewable energy is far more affordable than gas, that 43.1% of Britain’s energy is renewable as of 2020, and that we’re committed to achieving net zero by 2050. If these things are true, why are we still having to pay through the nose for energy?
If you’re looking to learn more about the current energy conundrum facing the UK at the moment, just keep reading. We’ll be tackling everything from the structure of the UK’s energy market to where these excess profits are going. Now let’s dive in.
Why Electricity Is Linked to the Cost of Gas
Since 2005, the UK has run its energy market as one large market that covers Scotland, England, and Wales. Therefore, there’s just one market price for the whole of Great Britain.
Now, it’s no secret that the UK uses a lot of energy. And to meet the energy needs of everyone, we need to pull from gas, renewables, nuclear, coal, and oil. Because there’s a single market price for energy, the price is fixed to the most expensive form of energy which is currently gas.
It’s an inconvenient truth, but without including gas in the mix, we simply wouldn’t be able to meet our energy needs. At the end of the day, it still supplies 22% of the country’s energy. In short, this means that the price of electricity is linked to the price of gas because this commodity heavily drives up the market price of energy.
If we’re running low on wind energy during certain months, we’ll have to make up the shortfall somewhere. And if gas is always the first port of call during shortages, it will continue to dominate the market price for energy and drive up the overall cost of electricity.
So, regardless of whether wind energy is cheaper to produce, it continues to match the price of gas and explains why the overall cost of energy is so high.
So, Where on Earth Are The Profits Going?
The excess money that renewable energy companies are making is essentially allowing wind farm developers to break even. Although this isn’t the case for older wind farms that were heavily subsidised before 2015, the majority of projects will be focused on recouping their initial investments. As wind farms take approximately 15 years to become profitable, these excess profits will be funnelled through to repay a developer’s initial costs of production instead of being maliciously pocketed.
What Can We Do About This?
If we want to drive down the overall cost of energy, there are a couple of approaches we could take.
Offer incentives to producers
To try and drive down the prices and reduce overall profits for energy companies, the government could offer incentives to encourage developers to sell their energy at pre-2022 prices. But unfortunately, this removes the all-important incentive of profit that encourages renewable energy project developers to risk their capital in the first place. Without the promise of government subsidies, choosing to build new projects is now riskier than ever before.
Split the country up further
The alternative option would be to divide the country into smaller regions. In theory, this would make the entire market more responsive to regional demand and drive down prices in certain areas. For example, Scotland can easily meet its overall energy demands with renewables alone thanks to its surplus of wind farms and lower population count.
Although this would still mean that England would be left paying a higher price based on their access to renewables, the government could effectively subsidise the areas paying the higher cost of energy. It’s tricky to see how this would work in practice, but it’s a viable alternative to the current single market price that we’re currently dealing with.
Should We Be Angry About This?
Well, yes and no. To achieve net zero and make the UK energy independent, we cannot avoid investing in more renewable energy projects that will provide the country with clean and reliable energy for the future. And to do this, we need to provide developers with an incentive to invest their capital and pursue planning permission for wind farms.
As this process can be time-consuming, risky, and extremely arduous at the best of times, allowing them to recoup their wind farm investments a few years early seems a small price to pay.
Although this is easier said than done (as these projects require significant forethought, cash injections, and planning permission to succeed), it will gradually reduce the country’s reliance on foreign gas. The Energy Price Guarantee announced by the UK government will reduce the unit cost of electricity and gas paid by the average household. But until the overall cost of gas is brought down, there’s only so much of a buffer the government can provide without further damaging the economy.
While the excess profits reaped by the energy industry can be difficult to swallow, profitable wind farms aren’t something that we necessarily want to knock. Instead, we should focus on reducing our overall consumption, building more UK power plants to make the country energy independent, and aim to have amenable negotiations with Russia that will bring the Ukrainian conflict to an end.
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