Why are energy prices rising so steeply?

Shocking increases in household energy bills are due this Spring – but why are gas and electricity prices rising so fast? TTL’s Kirsten Firth answers some key questions

How much are energy prices set to rise?
The natural gas that heats millions of UK homes is costing five times more than it did a year ago, although the UK’s price cap on energy bills has – up to now – stopped companies from passing all these wholesale costs on to their customers.

The energy price cap means energy companies have to offer gas and electricity to customers at or below a unit price set by the regulator, Ofgem. The cap is due to be revised on 1 April, leading to speculation that it could allow annual households bills to rise above £2,000.

Emma Pinchbeck, the chief executive of Energy UK has warned domestic energy prices are going to go up 45% to 50% this spring. Chris O’Shea, boss of the UK’s largest energy supplier, British Gas, has said rocketing energy prices could last for as long as two years.

Why are prices rising?
Prices are rising primarily because demand is increasing. There’s been a worldwide squeeze on gas and energy supplies over the past year, partly because the world economy is recovering and creating greater demand for energy as the Covid-19 pandemic eases. As a result, wholesale gas prices have risen to unprecedented levels.

The weather affects demand too – a cold winter in Europe in 2020/21 put pressure on supplies. The amount of gas in storage has dropped and hasn’t been fully replenished.

The UK is hit relatively hard-hit because it is one of Europe’s biggest users of natural gas. Around 85% of homes have gas central heating, and gas also generates more than a third of the country’s electricity.

What part does global politics play in all this?
The energy price hikes have shone a light on the complex global market for gas. The UK buys most of its energy on the global market, bringing gas in from the United States, Norway, Europe, Qatar and other places. The declining output of North Sea gas no longer insulates Britain from volatility in the global market.

The vast majority of that gas is imported from Norway. But the gas price in Norway is linked to Europe’s internal gas markets, which are linked through a network of interconnecting pipelines. And gas supplies to Europe from Russia have failed to increase to match the rise in demand this winter.

The head of the International Energy Agency, Fatih Birol, has accused Russia of withholding gas exports to Europe. Russia’s state-owned gas company, Gazprom, sent about 25% less gas than usual to Europe despite the surge in demand. Birol said, “I would note that today’s low Russian gas flows to Europe coincide with heightened geopolitical tensions over Ukraine.” Russia has denied restricting sales.

The UK only gets around 5% of its gas from Russia, but the global market means that gas prices in Britain have been as volatile as those in continental Europe.

The scramble for gas supplies around the globe means Europe is also finding it difficult to secure LNG (Liquified Natural Gas), which is brought in by ship. Much of this is now going to Asia, especially China, which is turning to gas as a replacement for coal-fired power stations. The head of British Gas, Chris O’Shea, has put some of the blame for higher prices on the increased demand for gas as a cleaner ‘bridging’ fuel as the world looks to transition to renewable energy.

Why is electricity getting more expensive, as well as gas?
Around 40 to 45% of electricity in the UK is generated by natural gas, even though renewable electricity from wind and solar is forming an ever-increasing proportion of electricity supplies. So while the cost of electricity from wind, nuclear and solar have not changed, the entire market is setting a price based on gas.

Could other prices rise?
Many businesses face a considerable rise in their bills. Energy-intensive industries are particularly vulnerable, but the problem affects every company that has to pay energy bills – even if it is just to heat an office or shop. This could mean pausing production or passing on increased costs to customers, which could mean prices of food, clothing, eating out, and other goods and services also rise. A combination of rising energy prices, the impact of the pandemic and Brexit already mean prices have gone up at their fastest rate in nearly 30 years.

Who’s benefiting from high energy prices?
The largest oil and gas companies are receiving bumper profits from higher prices. The Guardian reports that 24 top oil and gas companies including Exxon, Chevron, Shell and BP, made $174 billion income between them from January to September 2021. Exxon alone posted a net income of $6.75bn in the third quarter of 2021, its highest profit since 2017, and saw its revenue jump by 60% on the same period last year.

Their shareholders also benefit. Shell’s investors will benefit from Shell’s share buyback scheme this year. BP’s shareholder payout commitments are 2.5 times larger than their tax payments for 2021.

With higher prices, the UK government will receive a larger amount of VAT revenue, which is set at 5% of gas and electricity bills. As prices go up, so will the amount of VAT collected, unless VAT is temporarily cut to limit price increases to bill payers.

A possible silver lining is that the case for developing more renewable wind and solar energy is becoming irresistible.

Would using more renewable energy instead of gas shield the UK from these price rises?
Households on green energy tariffs might have assumed they would not be affected by soaring gas prices. But these renewable electricity prices are also affected by the cost of gas, even if the supplier backs all the power it supplies with investment in renewables, because prices change in line with the wider energy market in which the fossil fuel remains a key driver.

The current situation does reveal how vulnerable the energy market in the UK and elsewhere is to geopolitics and supply chains. Investing in low-cost renewables in the UK, and the network infrastructure to connect it all, would help to decrease reliance on fossil fuels and create a more stable market, protecting the UK from the next energy crisis.