Everything is expensive these days. The UK has gone through a period of high inflation, in part driven by the energy crisis. Food bills, rents and mortgages have all gone up, but for different reasons. Similarly, there have been various pressures on electricity prices, some of which are short-term and are already going into reverse, while others are deeper-rooted and could take years to revert, if at all.
In the short-term, electricity prices rose because of the cost of fossil fuels. Gas prices increased six-fold during 2021 as the world emerged from COVID and Moscow started restricting gas supplies to Europe. Then Russia’s war in Ukraine sent markets into turmoil during 2022.
But over the last year, gas prices have fallen back towards normal levels as demand fell and supplies of LNG (liquid natural gas) from America and the Middle East filled the void. Household bills lag behind wholesale prices, not rising sharply until the end of 2022, but then staying high until the second half of 2023. This is because Ofgem sets its price cap based on the previous 6 months of wholesale prices, and so market shifts take time to reflect onto bills.
The average household bill has fallen by 24% over the last twelve months, from £2,074 to £1,568 per year; however, bills are set to rise again in October to £1,717, eating away at those savings.
Energy prices in the UK since 2020. Prices paid by household consumers (shaded pink) have fallen by 24% over the past year, as electricity and gas wholesale prices (lines showing 1-week average) fell during 2023.
In the medium-term, high energy prices feed into the cost of other goods and services. The cost of commodities, everything from timber to tomatoes, rose sharply during the 2020s, with the CPI inflation rate peaking at 9.6% in October 2022. The average plate of fish and chips hit £9 nationwide, in part because of the cost of energy to run the fryers. The same factors affect the cost of building new power stations – especially seen with wind farms as the cost of concrete, steel and other energy intensive materials hit record prices. The capital cost of wind turbines, solar panels and batteries all increased during 2022, and are only just starting to fall.
In the long-term, it is not so much capital cost, but the cost of capital that will push up the price of renewable energy. When buying a house or a car on finance, the borrowing rate drives the monthly repayments. In just the same way, the cost of financing wind or solar farms is the most influential driver on their cost of electricity – as they need no fuel to operate, and maintenance costs are small relative to upfront costs. The Bank of England increased interest rates 14 times between 2021 and 2023 in an effort to quell inflation, ending the decade of ultra-cheap borrowing after the 2009 global financial crisis. This increase in borrowing cost contributed to last year’s CFD auction delivering no offshore wind capacity and recent wind farms projects being cancelled, as developers can no longer deliver projects for under £50/MWh.
The indicative average capital cost of onshore and offshore wind farms in the UK, based on IRENA and ONS data, and the Bank of England base rate as a measure of the cost of borrowing.
These are not UK-specific issues, inflationary pressures and high interest rates have contributed to rising electricity costs around the world. UK interest rates have started to fall as inflation moves back towards the 2% target. However, the 0.25% cut made in August is a drop in the ocean, and interest rates now stand at the range they were for much of the 1990s and 2000s. The average cost of electricity generation from wind (known as the ‘levelised cost’) has risen by 60% in the last three years due to movements in interest rates, exchange rates and turbine capital costs. In response, the administrative strike price for offshore wind in the latest round of CfD auctions has been raised sharply from £44/MWh to £73/MWh, accompanied by a record budget to ensure that it can attract viable bids.
So, although consumer bills are now catching up with falling wholesale prices, further decreases in energy bills may take longer to materialise.