energy

Why our energy bills are so high

Lots of news about energy prices this week. Most notably, David Cameron hosted an energy summit today, calling in the big energy companies and regulator Ofgem (Office of Gas and Electricity Markets). The government is sending somewhat conflicting messages at the moment, saying that they are determined to bring energy prices down, while simultaneously suggesting that there is nothing that can be done about international prices and that the energy companies are “not the Salvation Army”, in Chris Huhne’s words.

But why are our bills so high in the first place, and is there anything that can be done about it? Here’s a recent history of gas prices. (‘Incumbent’ is used here in the business sense, as the leading supplier)

The UK’s gas supply was privatised under Thatcher and various aspects of the service broken up into smaller companies, including Centrica and National Grid. Those companies held a monopoly until the late 90s, with Ofgem controlling the price. In 1998 the gas market was opened to competition, with electricity following soon afterwards.

Competition failed to drive prices down, mainly because in 2004/05 the UK started importing more gas than it was exporting, for the first time since the late 70s. (The price of electricity is closely tied to the price of gas because so many of the UK’s power plants are gas-fired.) As North Sea reserves decline, Britain has to source a growing remainder on the global markets, particularly in the winter. Since global demand has been pushing the price of gas and coal higher, that translates very directly into higher energy bills:

A few things to note here.

  1. Prices aren’t high because of ‘green taxes’, despite Chancellor Osborne recently lamenting that “environmental laws and regulations are piling costs on the energy bills of households and companies.” The 6% here includes the Feed in Tariff, the renewables obligation, and energy efficiency commitments. Together they added £42 to the average bill (pdf) in 2010, out of around £1,000.
  2. Neither are prices high because of the rise in VAT. Domestic energy prices enjoy a tax break here, and are only charged at a 5% rate instead of the usual 20%.
  3. Corporate greed doesn’t explain high prices either, with a 9% profit margin at present. A lack of transparency makes it hard to see if we’re being ripped off or not, but it’s worth bearing in mind that the price of gas and oil fluctuates dramatically, and at various points in the last two or three years suppliers have made a loss rather than pass on the true price to the consumer. The price that energy generators pay for gas has increased by 90% over the last decade, while bills have risen by 78%, so suppliers are often taking the hit as well as enjoying the windfall when wholesale prices fall again.

Are there any savings to be had in that mix? Well, those network costs are a big chunk of our bills. That’s the cost of getting our gas and electricity to us. When you consider the scale of the national grid, the pipes and wires involved and how well they generally work, that doesn’t seem like an unreasonable price to pay.

Operational and ‘other’ costs, on the other hand, ought to be ripe for cutting down a little. That includes administration, sales, metering, billing and accounting for ‘shrinkage’. Most suppliers offer discounts for e-billing and direct debits, so sign up for those if you haven’t already. The government appears to be focusing its efforts here, simplifying tariffs and making it easier to switch provider.

To cut bills further, some people are arguing for VAT to be dropped from 5 to 4%, but that’s a small difference too. I’m sure the tabloids would love it if some of the environmental measures were stripped away, but turning a blind eye to our fossil fuel dependence would only make things worse further down the track.

Ultimately, the big factor in the rise of energy prices is the wholesale price, at 45% of our bills. Unfortunately that’s something we can’t do much about. Prices are influenced by the state of the global economy, the rate of gas field discovery and depletion, conflict, politics, the weather, and commodity speculation, among other things. Even if we could find savings elsewhere, cut taxes and streamline the system, we will always be vulnerable to price increases.

It’s not over yet, either. Demand continues to rise in China, India, and other growing economies. Countries that are enjoying the healthy profits from their energy exports are raising their living standards and thus consuming more at home, see Iran or Russia. The scare over nuclear power after Fukushima means that more countries are falling back on gas and coal, despite the higher CO2 emissions.

In other words, global demand is going to continue going up, and prices are going to continue to rise too. They may fall back in the short term, as the Middle East stabilises after the ‘Arab Spring’, but the long term looks ever more expensive.

Where does that leave us? Well, the takeaway message is this: the only person who can lower your energy bills in any significant way is you.

12 comments

  1. Whilst I agree that we as individuals can do the most to influence our energy consumption, Jeremy, I wouldn’t underestimate the potential for savings in some other areas. For example the infrastructure, which accounts for 19% of the energy price is dominated by National Grid, which made £2.2 billion declared profit on a £14 billion turnover last year (that’s after 100 or so subsidiaries in tax havens have been sated). Their gigantist approach to power station building has also added unnecessary costs to infrastructure and multiplied the distances that energy has to travel, thus creating avoidable wastage. Remember, profits and dividends must increase year on year by the law of the market, so the figure for infrastructure is likely to rise. Conversely, the small-scale, self-generating approach to networks in some German Lands has created a more beneficial legacy to future generations.

  2. That’s a good point, and since they enjoy the privilege of a monopoly on the infrastructure I see no reason why National Grid couldn’t be compelled to reduce their charges rather than pay out quite so much in dividends. And they should definitely be compelled to pay their taxes!
    The bigger saving, shifting the balance of infrastructure towards more local solutions, will most likely take a generation – all the more reason to start on it as soon as possible.

  3. Nice neat analysis Jeremy

    The bottom line is that fossil energy sources are becoming scarcer, having to come from further afield and are subject to much more competition.

    Historically the UK has benefited from relatively cheap North Sea gas and oil (and coal before that), giving us cheaper energy than most of Europe;

    http://en.wikipedia.org/wiki/Electricity_pricing

    Now that this is coming to an end its going to be inevitable we’ll have to get used to paying more until we’ve succeeded in decarbonising.

    -STEVE-

  4. I just came across this website. Many people in Lubbock, Texas had their electric bills more than double this month. Some are reporting $600-700 bills and having no grocery money for adults after paying and making sure the kids are fed.

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