What’s driving energy prices in the UK: decarbonisation and (still) gas dependency

The global energy landscape is in the midst of profound change, with decarbonisation at the forefront of efforts to combat climate change and ensure energy security.

For industries across the UK, this transformation is having a significant impact on energy prices, which have been growing steadily and systematically over the past two decades. But why is this happening? And why, despite the much heralded (and necessary!) growth of renewable energy generation, are we not seeing a substantial reduction in power prices?

Decarbonisation is the driving force behind much of the change in energy systems. As we strive to meet climate goals, the push towards cleaner energy sources has led to a boom in renewable energy production. In the UK, this includes significant investments in offshore and onshore wind, solar power and other sources, making the country a global leader in renewable energy generation. In fact, the UK boasts the second-largest offshore wind fleet in the world.

The growing capacity for renewable energy would lead many to assume that energy prices should fall. After all, the logic suggests that as more, cheaper, renewable energy is produced, there will be a larger supply of electricity, driving prices down. Unfortunately, the reality is more complicated.

The influence of gas on UK power prices

Despite the growing share of renewables in the UK’s energy mix, the price of electricity on the wholesale markets is still largely driven by the price of natural gas. The key factor here is that natural gas is what’s called the marginal fuel in the UK’s power market.

But what does this mean?

The UK power market operates on what is known as the ‘merit order’ principle. This system ranks different sources of electricity generation from the cheapest to the most expensive. Renewables like wind, solar, and nuclear are at the low-cost end of the spectrum, while gas-fired power plants sit at the expensive end. However, natural gas, even though it is the most expensive source of power generation, is still required to meet demand.

Even though renewables often provide a significant portion of the UK’s electricity – often  upwards of 50% – gas plants still set the price for the entire market.

This is because of how our market works, where all electricity is priced at the rate of the final (and most expensive) source required to meet the entire demand. In this system, even though the majority of electricity may be coming from cheaper sources like wind or solar, because gas is used to meet that final portion of demand, its price acts as the price benchmark for the entire market. Everyone gets paid the same amount as the last unit.

Why gas prices are key

The issue lies in the fact that natural gas is a globally traded commodity. As a result, the UK must meet those global prices for gas in order to secure supply. This can cause significant fluctuations in energy prices as global gas prices are subject to international market forces, geopolitical tensions, and supply-demand imbalances.

The glimpse of lower prices: when gas isn’t needed

Despite this reliance on gas, there are occasions where the UK’s power prices dip temporarily, providing a brief respite for consumers. This typically happens when renewable energy generation is so abundant that no gas generation is required at all. During these times, the price of electricity can even turn negative, which may sound unbelievable, but it’s a necessary phenomenon to balance the system.

These price drops are becoming more frequent as the share of renewables increases, and they are a sign that the UK is increasingly able to generate enough renewable power to meet demand without the need for gas. However, these moments are still relatively rare, and the overall price of power remains heavily influenced by gas prices.

The complex reality of energy pricing

As the UK continues to decarbonise and increase its renewable capacity, we may see more instances of negative pricing and lower prices when renewable generation exceeds demand.

However, until there is a significant shift away from natural gas as the marginal fuel, the overall price of electricity will remain susceptible to the volatility of global gas markets.

While the transition to renewable energy is a positive step towards decarbonisation, it’s clear that the path to affordable, sustainable energy will require a broader transformation of the power market and a reduction in dependency on fossil fuels. Until then, gas will continue to be the key factor in setting UK energy prices, no matter how much wind and solar we generate.