Counting the challenging costs of UK energy bills

Only a dramatic policy shift will prevent further sharp rises in UK energy bills. Peter McCusker reports

Rising energy bills are causing concern
Rising energy bills are causing concern

Depending on your news sources or beliefs it’s easy to jump to conclusions on one of the most pressing issues of today – rising energy bills.

Whether it’s wholesale costs, greedy companies or green energy levies, one thing is certain; energy bills are on a rapid upward trajectory.

Since 2007 annual energy costs for UK households have risen from around £950, to £1,250 now, and are expected to rise a further 20% to £1,500 by 2020.

Wholesale energy costs currently account for 45% of an average domestic bill – at around £550.

But this is set to change as third party costs, such as network and transmission costs, supplier costs and green levies, markedly increase.

Analysis by Norfolk-based industry experts Cornwall Energy for Journal Energy highlight how third party charges for large industrial users, such as the Teesside chemical and process industries, have risen by 50% in the last four years.

And a recent report by one of the ‘big six’ UK energy companies German-owned RWE npower highlight how these third party charges for domestic customers are set to rise by over 50% by the end of the decade.

Two weeks ago the bosses of the big six energy companies told the Committee on Climate Change green taxes and wholesale prices were behind recent price rises.

But Stephen Fitzpatrick, managing director of independent supplier Ovo Energy, highlighted that since that since May 2011 wholesale prices had fallen by 5% – a claim supported by the Government’s own figures.

Between 2007 and 2011 the wholesale gas price rose by 50% as the UK became a net importer due to declining North Sea reserves.

With the US now exporting its shale gas, amid moves to develop a global spot market for gas, prices are expected to steady or even fall.

The glut of US shale gas has pushed coal to its lowest price for many years and led to a surge in the use of coal for power generation across Europe – although emissions directives mean most of the UK’s coal-fired power capacity will be closed down in a few years.

RWE npower’s recently published analysis of the UK energy market ‘Energy Explained’ says it expects wholesale costs to rise by 3% over the next few years and then fall.

A Navigant Consulting report for the Department of Energy and Climate Change (DECC) says it expects gas prices to rise by over 10% in the coming years but could fall by over 10% if a UK shale gas industry develops.

By the end of the decade RWE npower believes wholesale energy prices will have fallen to £514 or 35% of the domestic energy bill.

But third party costs are set to rise substantially in the coming years. These can be broken down into three categories:

Supplier costs and profits

MPs have criticised the big six for ‘ripping-off’ the bill payer but market regulator Ofgem’s rolling weekly analysis of the energy market suggests otherwise .

It shows margins steady at 5% over the last two years following a period in 2011 when most of the big six made a loss of £5 per domestic customer. This followed a major spike in the price of gas.

A spokeswoman for RWE npower said: “We have gone from making a loss of £5 per customer to a profit of £59 per customer.

“It is not sustainable to keep making a loss, and a return of 4% to 5% is reasonable in this industry. Our operating costs have increased and we have introduced huge efficiency programmes around the country to reduce costs.”

Suppliers incur costs from billing, sales, customer service and all the other activities that make up a retail business. These plus profit margins of 5% account for up to 20% of a domestic bill.

Network and transmission costs

Npower’s Energy Explained report says network and transmission costs currently 23% of bills at £289 and this is set to rise to £403 or 27% by 2020.

These include the cost of building, maintaining and operating the local gas pipes and electricity wires, which deliver energy to homes and businesses.

Ofgem sets price controls, which limit the total amount of revenue that gas and electricity network companies can earn.

It estimates that the network and transmission companies such as the National Grid and Northern Powergrid, the electricity distribution network operator for the North East and Yorkshire will need to invest over £3bn in the next decade.

This will upgrade and renew Britain’s gas and electricity networks, connect new sources of energy generation and increase security of supply.

A large proportion of this is a forecast increase in gas costs which will arise from having to run the national gas network with less gas.

Green Levies

The final element is policy and regulation costs – which are mainly green levies aimed at combating climate change.

These are set to rise from £185 to £329 – from 15% to 22% – between now and 2020, says the npower report. Although DECC says the projected bill for 2020 will be reduced to £1,331 through the impact of some of its domestic energy efficiency schemes.

The Government has a target of ensuring 15% of the UK energy comes from renewable sources by 2020 and to do this it has identified securing 30% of electricity from low carbon generation by that date.

Green levies include the Renewable Obligation scheme which will be replaced by strike prices for low carbon energy sources under the Contract for Difference element of the Energy Bill, which is currently passing through parliament.

They also include the carbon floor price green deal and Energy Company Obligation (ECO) which shifts the burden for domestic energy efficiency schemes on to the energy suppliers.

Janusz Bialek, DONG professor of renewable energy at Durham Univesrity and a world-leading expert in energy infrastructure, believes network and green costs will continue to rise.

“The network is old and needs replacing and there are substantial costs associated with incorporating renewable energy into the grid.”

Despite MPs wanting to encourage new entrants Bialek believes the UK market is a competitive one.

He said: “The energy companies are not making much of a profit and have gone into the negative. Ofgem agrees the profits are not excessive.

“What we really need is people to understand their energy bills more clearly. Perhaps this may help users switch suppliers more readily.”

Henry Edwards-Evans, associate editorial director, at global commodity experts Platts says green levies are likely to lead to significant increases in energy bills, citing the example of Germany, Europe’s renewable standard bearer.

He said: “The wholesale energy cost component in Berlin is only 33% of total final bills, and while German wholesale prices are among the lowest in Europe, end user retail bills are among the highest because of rising energy taxes.

“This demonstrates that the cost of energy transition is going to be high even when you have a huge coal/lignite fleet of power stations to keep wholesale prices low.

“The UK does not have such a huge coal fleet, indeed most of the time the wholesale price reflects the expensive natural gas prices.

“There is no prospect of new coal plant in the UK. More gas capacity is the short-term fix, but this will require capacity payments and is not a cheap option.

“The government’s £92/MWh strike price for nuclear in 2023 gives an idea of where DECC thinks power prices are going.”

James Beard, a spokesperson for the Renewable Energy Association, said: “Importing gas from Russia and the Middle East has become increasingly expensive over the last decade, and this is the main element driving up our energy bills.

“More home-grown renewable energy means less exposure to international gas markets, as well as jobs, investments and tax revenues here in the UK.

“Reducing support for renewables would be a huge mistake from an economic, as well as environmental perspective.

“Renewables and energy efficiency are both vital for preserving a safe environment for future generations, and it is right that they receive public investment. But if there is a case that the funding for these programmes can be raised in a more equitable way than at present, then we are willing to engage with that debate – provided any new measures do not undermine the jobs and investments our industry is delivering for UK plc.”

With energy costs now a matter of overriding public concern the Labour Party wants to freeze bills for 20 months, while the Coalition is looking to cut green levies.

Labour leader Ed Miliband was energy secretary when most of the legislation mapping out the UK’s green energy transition was implemented.

Most commentators say Labour’s price freeze plans are deterring investment in the sector and will lead to price increases, either before or after its implementation.

If the wholesale gas price falls, as some suggest, it may even result in windfall profits.

The most likely short-term measure, which could be announced in Chancellor George Osborne’s autumn statement next month, will shift the cost of the ECO – a levy of around £70 per domestic customer – on to general taxation.

There is also some discussion of bringing in measures to alleviate the costs incurred by the carbon floor price. Introduced earlier this year, it punishes large industrial users and power generators for emitting carbon dioxide and is set to cost business millions of pounds.

But third party costs, many of which are locked in by statute and international conventions, will only fall if the politicians row back from the UK’s green energy commitments.


David Whetstone
Culture Editor
Graeme Whitfield
Business Editor
Mark Douglas
Newcastle United Editor
Stuart Rayner
Sports Writer