What’s going on with energy prices?
A frog that boils slowly does not notice till it is cooked. Cooking frogs becomes more difficult this October as we once again get to enjoy an energy price rise, with the government mandated price cap rises by approximately 10%. This new level would be an all time record, were it not for the last year. This feels like a new normal. But is it?
These are the new price levels:
| Energy price cap per unit and standing charge – Electricity | Energy price cap per unit and standing charge – Gas | |
| 1 July to 30 September 2024
|
22.36 pence per kWh
60.12 pence daily standing charge |
5.48 pence per kWh
31.41 pence daily standing charge |
| 1 October to 31 December 2024
|
24.50 pence per kWh (9.57% rise)
60.99 pence daily standing charge (1.45% rise) |
6.24 pence per kWh (13.87% rise)
31.66 pence daily standing charge (0.79% rise)
|
Reasons for prices rising – Small ones first.
It is worth acknowledging that there are some sensible reasons why prices are rising for many of us. Ofgem has acted on a government mandate to bring down the price of unit rate of energy for pre-payment metres (which are overwhelmingly used by the poorest among us). The standing charge remains higher. On average it is costing a household paying on receipt of bill, or direct debit £15/£20 a year, or around than 1% of an expected bill. In this price rise the cost of this subsidy rose by about £1. It is worth £35 off the average pre-payment customer bill.
Renewables increasing prices.
Multiple spectator columns are right. Renewables do cost money.
The rises in network costs are an inevitable result of greater renewable generation. As the grid electricity fluctuates more, it costs more to balance it (around £4 a month for average bill), as more energy is needed on standby. There is more need to build out the grid. The lack of grid build out raises cost as some renewables receive payments when they are generating but power not utilised. Additionally, the way renewables and nuclear are paid for is by incentivising investment by giving them a fixed price. The difference between this price and the market price, (if the market price is lower than the fixed price) is paid by LCCC an arms length government body and added back onto energy bills. As variable renewables have throughout the last 5 years had contract prices below the cost of gas generation and are likely to continue to do so this has had the curious effect of variable renewables lowering the wholesale price while rising prices of other elements of the energy bill.
This has led to some arguing that variable renewables are bad value for money and are increasing bills (not taking into energy security and environmental benefits). There is some evidence that pre-crisis, the whole energy system costs of renewables where comparable to those of closed cycle gas generation (again without environmental benefits). There is also modelling suggesting that if we move renewables providing 90% of power today without any changes in: storage, pricing, or transmission then they would cost the system more.
However, at the moment, as table 2 shows, this cost is increasing about £7-9 per household, or about 4.6-5.4% of the increase for non-economy 7 customers. This less than the rise due to VAT. During the energy crisis renewables prices where regularly less than half that of gas and still track below the wholesale price by around 10%. Cornwall insights suggest they have reduced wholesale prices by around 16%. Every modeller including the Committee on Climate Change that has made a projection in this area sees more renewables as bringing wholesale prices down.
This leaves us with the main cause of the price rise.
Table 2: Causes of price increase assuming Ofgem standard household consumption estimates:
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Reasons for the price rises Rising Wholesale price of gas
Energy supply needs to match demand and like in all such markets the price rises until it has attracted enough supply to meet demand and this sets the price. For much of Europe for much of the last decade, that last price setting bit of supply has been a gas generator, whose key determinate of the price they can generate electricity at being the price of gas. However, 95% of the energy price rise 2022-2023 has been driven by rising cost of gas.
This recent second rise is no different, between 76.4%-82.9% of the rise for non-economy 7 customers is explained by rising wholesale costs as seen in Table 2. This is driven by rising price of gas in the UK, the future market for which as risen from a low in February 2024 by 75% into September.
Gas prices rise again
The energy price crisis was kicked off when floods in Chinese coal mines led to a flow of liquid natural gas (LNG) to the Asia Pacific. It was turbocharged by conflict in eastern Europe. Then dry summer and French nuclear maintenance.
Recently prices seemed to be falling – unprecedented capacity of variable generators such as wind and solar came online that will generate a zero marginal cost with fixed prices, new LNG capacity from the USA and weak global growth.
There was a reduction in European energy demand partially driven by energy efficiency and partially by German industrial decline. However, this was just in time for the winter prices to be reversed.
The proximate cause seems to be maintenance on the Norwegian network, now the key supplier for Europe. The EU has once again set high targets to fill its gas storage capacity for winter, demand appears to be growing in China again after a week year and USA fracking once again overexpanded and is now constraining production. Some analysts suggest unprecedented speculative activity, potentially suggesting a crash will need to come in the winter months.
Will this end?
The withdrawal of government support both in terms of temporary cost of living payments, price support and means testing long standing energy reliefs indicate the government believes that this is now a new normal. It is something that we have to cope with despite the vast human cost.
Unfortunately, most projections bear them out. Though with significant uncertainty Cornwall Insight expects European and UK wholesale prices to remain much the same till 2028 when new LNG demand, renewables and nuclear come to the rescue breaking our dependence on gas.
This reflects that gas is a global commodity in an increasingly unstable world. Climate change makes disasters and conflicts more likely increasing the cost of operation and the risk of price shocks that will drive up cost of gas.
The fossil gas sector is also in an increasingly uncertain investment climate. Projects take decades to develop and, as mentioned, by 2028 demand is on a downward trajectory. Increased social pressure further constraints the cost of capital and constraints capacity.
Even allowing for projections that show abated gas being used in a net zero system, short of a dramatic market change gas demand is only decreasing and overall, the price is only increasing.
Is there a way out of the new normal?
There are a number of solutions that could lower prices in the medium term- many expanded on previously in Bright Green. They include: Home insulation, faster infrastructure build out (it is worth noting Hinkley Point C with its 3.3GW of nuclear capacity is currently 10 years behind schedule), storage and more renewables.
In the short term, more cost of living support is needed. Various charitable groups have pushed for a social tariff of lower prices for the vulnerable, while the Green Party proposed an energy allowance of lower prices for first part of energy consumption. Market reforms could allow regional pricing lowering energy prices probably for all of the country.
In the meantime, it seems expensive to experiment with a frog by slowly boiling it. It seems cheaper to slowly freeze the subject and see if happy to accepts its gradually worsening normal.
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