The UK boasts the third highest electricity prices in the world, and we’re nowhere near the third highest incomes. Congrats, UK, we’ve won a gold medal in paying too much! Meanwhile, our friends in the United States are paying a third of what we do, even though we generate a good chunk of our power from cheaper renewables. The UK currently has the highest industrial energy prices in the IEA making our manufacturing goods more expensive which, when combined with trade restrictions due to Brexit, makes the UK less competitive. So, what’s the deal? Why is our electricity pricing system as twisted as a politician’s promise?
The root of this absurdity lies in marginal cost pricing. Most countries calculate electricity prices based on an average of all sources. But not us. No, the UK, in its infinite wisdom (thanks, Thatcher), calculates prices based on the most expensive energy source needed to meet demand. That’s like splitting a restaurant bill and insisting everyone pays for the one person who ordered the lobster and champagne. A posthumous hat tip to Margaret Thatcher, whose legacy of “working people last” is still alive and kicking.
Under this system, the wholesale price of electricity is set by the priciest source—typically natural gas. Never mind that renewables are cheaper to produce; their benefits are drowned out by gas prices that spike when demand is high. The current setup ensures we pay through the nose for our energy. Renewables are cheap and getting cheaper. Gas is expensive and getting pricier. Yet, UK electricity prices keep climbing like they’ve got Olympic ambitions. Who loses? Regular people like you and me. Who wins? Well, fossil fuel companies and their shareholders are doing just fine, thank you very much.
Right-wing grifters love to blame this on the green transition, spinning it as a reason to delay renewables and flirt with climate denialism. Meanwhile, this pricing system doesn’t incentivize renewable adoption nearly as much as it could. It just gives natural gas companies a golden parachute every time the market sneezes.
Switching to average-based electricity pricing isn’t rocket science; it’s basic fairness. Transitioning gradually over a few years could reduce electricity bills for households and businesses alike. Lower energy costs would free up money for other parts of the economy, helping everyone from shopkeepers to consumers. True, some savings would pad shareholder pockets, but more affordable energy could still translate into lower inflation, cheaper goods, and—who knows?—maybe even a wage increase or two. (Not holding my breath on that last one, though.)
But don’t expect much action on this. Labour’s leadership lacks the imagination. The Conservatives are practically fossil fuel lobbyists, and Reform… well, let’s just say they’re like that weird uncle who denies climate change and still thinks the earth is flat.
This leaves an open goal for the Liberal Democrats. Energy pricing reform is a winner: it’s practical, tackles inflation, and can shift public opinion on green energy. Plus, with the current mess driving up costs for everyone—especially low-income households and the elderly—a policy like this would have widespread appeal. Done right, it could prove that going green isn’t just good for the planet; it’s great for your wallet, too.
The current system makes no sense for the UK public. So, why are we sticking with it? Oh, right—because the powerful few love squeezing every penny out of the rest of us. Here’s hoping a future government has the guts to flip the switch on this scam.
* Jack Wilkin is a PhD student at the University of Exeter researching past environmental change around the island of South Georgia. He is a registered supporter of the Lib Dems.
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18 Comments
In an otherwise interesting article why did you think it was necessary to make a side swipe at politicians? In my 60 years as a party activist, I have never knowingly made a promise I haven’t kept. Most politicians are like me and not the stereotype you offer.
If renewables are so cheap and profitable, why did the last auction for wind get no bids? Why are the fossil fuel cos not falling over themselves to ditch their oil & gas and build windmills and solar farms?
Economic theory teaches that firms are willing to produce and supply an additional unit of a product if the extra revenue generated is above or equal to the extra cost of producing that unit. If the extra revenue generated is less than the extra cost, then that extra unit would be being produced at a loss. This is the essence of marginal cost pricing.
So why would private sector electricity producers be willing to increase production of electricity at times of extra demand if doing so was losing them money? This is precisely why the electricity sector should be state owned…then average cost pricing will be a political choice that trades of the state owned enterprise making a profit for the wider benefits to society of lower energy costs.
@Josh, do you have any specific proposals for what might replace the marginal cost pricing system? It’s easy to criticise the current system and call for it to be replaced, but unless you have a good idea for a system that would work better….
@Jennny Reading the HoC report that Josh linked to, I suspect the answer is that renewables have a very low marginal cost to produce electricity, but they have very high fixed costs to get set up in the first place (Building and installing a wind turbine is very expensive, but then each unit of electricity you get out of it is essentially free). It looks to me like the current system would encourage renewable suppliers to bid the very low marginal cost knowing that in practice they are going to get a lot more than that (which they do actually need in order to repay their fixed costs).
I guess an alternative system would be to pay each supplier only what they have actually bid, but if you did that, suppliers would be very much incentivised to bid more than they currently do – so I’m not sure you’d save that much
@Jenny Barnes – the “auction” process involved the Government setting a minimum price for the electricity generated, and inviting bids to supply at that price floor. The price set didn’t result in any bids for *offshore* wind projects, but did receive bids and award contracts for onshore wind, solar, tidal and geothermal projects.
As Simon points out above, the potential bidders said that the minimum price offered by the Government wasn’t enough to cover the high investment required to construct an offshore wind farm, despite the huge potential supply and low generation costs offered once the initial investment is made.
I am very dubious that marginal cost pricing is really the cause of our high electricity bills. I chose to invest a few years ago in a wind farm in Scotland which became operational last July and my share of it theoretically generates 120% of my annual electricity usage. However, while my last month’s electricity bill was £36.09, my saving was only £2.38 (my highest monthly saving has been £3.21). So if only marginal cost pricing were involved, I would expect much higher savings. Someone really needs to be honest about where the true costs of our electricity come from. I believe that I am also paying a compulsory Green Levy despite being 100% Green through my own actions.
So renewable wind power only becomes cheap *after* the windmill has been built? Mmm. I have this bridge for sale…
The root of this absurdity lies in marginal cost pricing.
The idea that the UK electricity market is pay as clear is a complete misdirection. The UK used to have the pool system, which was indeed such a system, but that was before all the subsidies started coming in. Now generators get paid what their sales contracts provide. What renewables get paid depends on their subsidies, and is minimally linked to markets. Final clearing in the Balancing Mechanism is pay as bid for accepted bids, and only on the bid volume, not total generation.
@Jenny Barnes – “So renewable wind power only becomes cheap *after* the windmill has been built?”
This has always been the case – as others here have pointed out, the trouble is the majority of people don’t understand (or want to understand) the subsidy system. I remember a few years back there was a report that on-shore wind was more expensive than the price the government agreed for (Hinckley Point C) nuclear… The challenge is that we are having to move away from well developed, cheap and uncomplicated fossil energy sources: coal, oil and gas (and in a slightly longer timeframe Uranium-based nuclear).
@Laurence Cox – I take it you invested directly in the wind farm and thus your income reflects the price they get for selling to to the grid, which obviously doesn’t include the layers of cost and profit taking that gets added to this to deliver the electricity to the consumer; and which is reflected in your electricity bill. It’s why solar panels on your own roof (combined with batteries) will be cheaper than buying electricity from the grid which has been produced by identical panels in some distant field… Additionally, if space permits, a vertical wind turbine can also be installed…
Could the current reluctance to build offshore wind farms be down to the likelihood that they will be sitting idle for many years before they are connected to the grid.
Most goods and services are sold on a marginal cost basis. Suppliers with high costs will typically break even while those with low costs make profits. This means that the winners from marginal cost pricing are those with the lowest costs such as onshore wind.
What costs the consumer is not that we use marginal cost pricing but that the mark-up on that pricing is high. That is a choice made by the government to make electricity generation profitable and encourage new entrants. Those new entrants are all renewable so high prices speed up adoption of renewables.
One area that causes high prices without any benefit is the fiction that we buy from producers whose branded electrons are merely carried by the grid. A nationalised grid could buy from producers at market prices (which would be marginal cost based) and consumers would buy from the company that actually supplies them rather than the best marketeers.
@Roland
Of course, but my electricity bill doesn’t break down those layers of cost and profit. All I get as a consumer is the standing charge and price per unit. It is all very well saying that I could save all this by installing solar panels and a sufficiently large battery (i.e. go off-grid) but that would be an investment of 10-20x what I invested in my share of the wind-farm (which will generate more electricity than I will use over a year). Added to that, materials for the solar panels (poly-silicon) and battery (rare earths) have to come from China, so looking at it from the point-of-view of the UK as a whole it is not a good deal.
Cities, where most of the UK population live, are not good places for wind turbines (even vertical ones) and planning law makes it difficult to build anything large enough to produce meaningful quantities of electricity. Better to make use of the electricity grid which is already built and site large wind turbines where the wind is strongest.
@Laurence Cox
I fully get your reticence over solar panels; I’ve spent much of the last 6 months really getting to grips with what’s on the market… basically, you need a supplier and an energy company who is wanting you, the consumer, to do well out of your investment, as the difference can be staggering: a system configured by one of the major energy providers, whilst relatively cheap, had a 12+ year break even point, yet still would require me to purchase significant amounts of energy. The system I’ve drawn up is more than double the price, yet by having a larger battery (48 hours as opposed to 8 hours) an intelligent battery management/sales system, linking to an energy supplier that doesn’t have traditional generation et al and so needs solar energy to sell, my break even point is a conservative circa 8 years(*), on a system with a 30 year guarantee.
Given how important renewables are to our future, the amount of greenwash around solar panels, air heat pumps etc. irritates me. Particularly given the direction of travel is to convert the petrol supply network to electric (ICE to Battery EV) and the gas network also to electric…
(*)Friends who had their systems installed in circa 2021 are looking at breaking even in 4~5 years…
@Laurence Cox – “ Cities, where most of the UK population live, are not good places for wind turbines”
Disagree, but understand your reasoning. Basically, we need to move away from simple ie. Remote largescale thinking to local small scale thinking.
Due to the way we design cities, with long straight avenues/wind funnels, they are actually relatively good for wind turbines, just not the multi MW ones scattered across the countryside.
@Roland
Cities are not good places for wind turbines because of basic physics. Next to a surface the wind speed is zero: this is the boundary layer. Wind speed increases with height above the surface until it reaches an approximately constant value at a sufficiently large height where the effect of ground friction is negligible. Here’s the explanation on the Swiss wind-energy data site: https://wind-data.ch/tools/profile.php?lng=en As you can see the roughness length is much larger for cities and because the energy that can be extracted from wind for a specific size of turbine scales as the cube of the wind speed, even a small reduction in wind speed has a serious effect. Your ‘wind funnels’ only work when the wind is in the right direction, which most of the time it will not be. It is also much more expensive to build thousands of small wind turbines than one large one. We should be planting trees in city streets not wind turbines.
@Laurence “Better to make use of the electricity grid which is already built and site large wind turbines where the wind is strongest.” The grid to cope with uneven sources, replacing gas with heat pumps and electrifying transport does not exist yet. It urgently needs building.
@lauren e
Vertical wind turbines (mor efficient than the propeller style, but don’t scale to the multi MW) tend to be placed on the roofs of high buildings, although I have seen some mounted on the tops of lamp posts.
Yes the economies of scale are attractive, but remember largescale wind (and solar) farms means layers of middle men all wanting their slice…
>” Better to make use of the electricity grid which is already built and site large wind turbines where the wind is strongest.”
Well we know that the wind is strongest and most consistent offshore, unfortunately, the was never designed or built for offshore generation.
Peter is right, the grid worked well when there were few dozen generators, we’ve yet to really start to build the grid that will cope with potentially 25 million small scale generators…
Thanks Jack – excellent article. The devil will be in the detail and I’m unclear how a gradual transition can be made but the current system has been recognised as bonkers for years by most policy makers.
@Jenny the round of wind that gained no bids was thanks to my now thankfully ex MP Grant Shapps who in his infinite wisdom as Energy Secretary refused to raise the price floor for bids despite the massive rise in supply costs (thanks to post Ukraine inflation) that had (temporarily) halted the continued fall in the cost of windfarm costs. I believe there has been another successful round since.
Renewable energy like most new tech benefits from Wrights Law, which posits that for every cumulative doubling of units produced, costs fall by a consistent percentage (thanks Quickonomics). Offshore wind costs have followed this rule less precisely than others – the stand out performers here are solar and onshore wind – but a useful article can be found here https://tinyurl.com/4typt8sf.
Oh, and putting ‘green taxes’ on electricity bills was another genius move from George Osborn as a way to make renewables less popular. Should have been paid out of general taxation or by taxing fossil fuels more.