Why are Britain’s power prices the highest in the world?

The UK is currently stifled by electricity prices that are among the highest in the world. UK industry is spending 60% more per unit of electricity than any other European nation, but the reasons behind this are complex. Despite renewable energy expanding from 15% a decade ago to over 40% of the grid mix today, the structure of the electricity market means that fossil fuels, and particularly gas, continue to set power prices.

Several factors keep the UK’s electricity prices high. First, Britain’s infrastructure is a barrier. Being an island makes it costly to build interconnectors with continental Europe, limiting their capacity. This isolation limits the ability to import cheaper electricity from overseas when demand is high or renewable output low. Britain also lacks transmission capacity within its borders, so we are spending hundreds of millions of pounds on compensating wind farms that are unable to deliver power due to network congestion. Upgrading and expanding the grid to handle increasing renewable capacity involves significant costs, which are ultimately passed on to consumers.

Consumer electricity prices around the world in 2023, paid for by large industry (left) and medium-sized households (right). Prices in the UK are compared against thirty countries across Europe and other developed nations, inclusive of taxes and converted into GBP. Data from the Department for Energy Security and Net Zero.

Second, there are the costs imposed by energy policies. Around a quarter of a typical UK electricity bill comes from policy costs, including environmental taxes and subsidies. While these measures support the green transition, they also raise prices. Most of these levies are applied to electricity but not to gas, a choice that works against decarbonisation by making electric vehicles and heat pumps less attractive. In addition to the ‘environmental & social’ cost category shown below, policies that charge for carbon emissions lead to higher wholesale prices (and are included in that category).

Support for renewable generators from Feed-in Tariffs and similar schemes falls under ‘environmental costs’. Older generators receive payments on top of the wholesale price, however high it is. More recent wind farms and biomass plants were instead awarded fixed-price Contracts for Difference, meaning they repay the government whenever wholesale prices exceed contract prices. During the 2022–23 price spikes, these renewables were saving consumers money.

The elephant in the room is the wholesale cost, which rose by two-thirds over the last five years, and makes up the largest share of our bills. This is an issue of how we price electricity. Britain’s electricity industry holds an auction every day in which generators bid the price they would be willing to generate for. The highest bid that is needed to meet demand then sets the price for all generators. Some of our gas-fired plants are almost always needed to meet demand, so they set the price and that reflects their costs. This ‘marginal’ price is then paid to all generators, even ones that run 24/7, as the electricity they produce is worth just as much as that from any plant. Most markets work in this way: Saudi Arabia’s oil is cheap to produce but gets a very similar price to higher-cost oil from the North Sea. The underlying economic principle is so widespread that it’s known as the Law of One Price.

The breakdown of the average British household electricity bill. Data from Ofgem, for a standard consumer paying by direct debit.

The irony of gas setting prices when renewables provide most of the energy is not lost on consumers, sparking discussions on pricing reform. Instead, we could pay each generator what they bid into the auction (the ‘pay as bid’ principle). Wind farms and nuclear reactors currently bid low prices into these auctions, as their variable costs (for fuel, maintenance) are low. However, if they only received these variable costs, they could never recover their upfront investment, so developers would not build any new ones. If auctions instead paid each generator their own bid (as has been proposed several times), renewable generators would simply raise their bids to the expected price (justifiably), and it would get much harder to decide which plants should be running. For the time being, the price of gas is going to drive the price of electricity.

Another proposal is zonal pricing, where regions see different wholesale prices based on local generation. Areas with abundant wind, like Scotland and parts of northern England, could see lower prices, and new farms would not be compensated when the grid could not accept their output. Such reforms must be balanced against concerns that smaller markets could increase power price volatility, making generator profits less predictable. The added uncertainty could reduce investors’ ability to secure low-interest financing for renewables, and thus hold back new projects.

While UK electricity prices are high, we are not alone in this situation. Electricity prices rose sharply across the continent in the wake of the Russia-Ukraine war, and similarly they have all begun falling back towards pre-crisis levels. The UK sits roughly in the middle of the pack, with prices rising to a peak of 4.7 times their 2019 average, and now sitting 70% above. Norway and Sweden have seen the smallest rises, thanks in part to their abundant hydroelectric and nuclear resources. Conversely, Ireland has experienced the largest increases, driven by the rising electricity demand from data centre operations (see Article 5). Ultimately, the sharp rise in power prices reflects wider energy geopolitics, rather than an isolated phenomenon in Britain.