Time for a switch 

22 November 2024 – First published in The Mint magazine, ​​​Ellie Standen explains how levies break, dividends divide and it’s time to take back the power industry into the public sector.

Keir Starmer’s Labour Government has promised great things in terms of energy prices – lower bills for good from a zero-carbon electricity system by 2030. It's a fantastic aim that should be possible to deliver, but as with all large-scale systemic changes, it won’t be without its costs or problems. 

So how will they achieve this? In the manifesto, there are commitments to make changes in all market areas (see box Summary of Labour’s energy manifesto). These proposals are in line with a philosophy that harkens to the days of Blair and Brown, with the underpinning belief that the private sector, appropriately regulated, will deliver what is required in partnership with the Government. Key parts of the plan include the creation of Great British Energy, a public investment partner in renewable energy and energy storage. This will need to have far greater levels of investment than previous incarnations, such as the Green Investment Bank. They propose that regulation be more stringent to avoid windfall profits for energy companies and keep bills low. They promise to address the significant issue of delays in connecting new generating capacity to the electricity grid, as projects in the planning stages cannot get connections until the late 2030s.

So, will this be enough to reduce bills, and if not, how else might they be lowered? Current domestic electricity prices are capped by the Government at 22.4p/kWh, with standing charges of 60p/day. Figure 1 shows a breakdown of the cost components contributing to these prices. The three largest cost components are wholesale electricity, environmental and social obligation, and network costs. Let’s look at these components and consider how the Government could reduce consumer costs in each area.   

Fig 1 - Breakdown of a UK domestic electricity bill. Source: Ofgem data portal, retrieved Aug 2024, but based on data from 2021, which is the latest detailed data available. 

Wholesale electricity costs (30%) are affected by many factors (See What determines the wholesale price of electricity?). Still, in simple terms, they represent the cost of electricity production and the balance between supply and demand. Demand reduction and energy efficiency measures will always help with energy costs, so it’s important that the Government continues to support these.

What determines the wholesale price of electricity? Generators sell their electricity on the wholesale market. Energy suppliers who sell customers electricity buy electricity from this market. Electricity is bought and sold half-hourly, with the UK being treated as one zone with one price. The price is set by the cost of the generator, which produces the last unit of energy to meet demand. This is almost always a flexible gas power plant and therefore, the electricity price tracks the gas price closely in the UK (see Fig 2). Fig 2 – Wholesale electricity prices closely track gas prices. Whilst the gas price and the cost of producing electricity from gas dominates the electricity price, other factors also influence the price: Cold weather increases demand. Low winds reduce the supply from wind generators. Power station outages reduce supply.

The market cost for electricity is still dominated by gas prices, which have surged since Russia invaded Ukraine (see Fig 2). The increasing proportion of renewable electricity in the UK grid (in 2023, 46% of the UK’s electricity production was from renewables) has served to keep wholesale prices lower than they would have been, as the cost of wind production in the UK is less than gas-produced electricity. Increasing the amount of renewable energy will, therefore, help keep costs low. To ensure the system can supply electricity when needed a number of energy storage or other technologies will be needed to fill in gaps from intermittent renewable energy sources. 

However, network constraints hamper the ability to increase the amount of renewable energy, energy storage, and other technologies. So, let’s look at network costs, which account for around 23% of bills. These cover the cost of maintaining and upgrading the transmission and distribution lines that transport electricity from generators to consumers. National Grid is the electricity system operator and owns the transmission system. They must tackle the huge backlog of applications for renewable connections, which will be key to delivering increased renewable electricity generation.   

National Grid is a publicly-listed company that paid dividends of £1.4 billion in 2021. In 2019, Labour developed a plan to nationalise the electricity grid and the retailers – the Big Five (British Gas, E.ON, EDF, Scottish Power and Ovo), which dominate the retail energy market. Nationalising the grid could be a fiscally-neutral option if shares are traded for Government bonds, as the revenue-generating asset acquired would more than cover the bond yield.

Other options also exist that could better align a utility company’s legal and governance structure with its purpose of serving the public; for example, Welsh Water in 2001 was turned into a company limited by guarantee, designed to serve its customers, with no dividends paid. The performance of Welsh Water compared to other UK water companies was analysed in 2021 and shown to be a sector leader on several indicators, including keeping bills low. This type of structure means that the company remains off the Government balance sheet but that profits can go directly to reducing bills and funding investment in renewables and connections.  

Finally, let's look at the environmental and social obligations. These are obligations that the Government places on large retailers to meet carbon reduction targets and reduce bills through energy efficiency schemes. The retailers can pass the costs of the obligations onto consumers, and therefore, the policy effectively acts as a tax on electricity usage. Taxing electricity is extremely regressive; poorer households spend a much larger proportion of their incomes on electricity than richer households. They also reduce the savings from moving from gas boilers to heat pumps for household heating despite the latter’s significant efficiency gain (see Pumped Up). 

These policies were introduced in the early 2000s and have remained attractive to politicians as a way of funding green policies without having to raise general taxation. They also show the difficulties of placing windfall taxes on energy companies, as shareholder owned companies pass the cost of any taxes or new costs onto consumers. These levies have fallen as a proportion of electricity bills in the last two years, from 25% based on 2021 data to 12% based on 2023 data, and have been fixed by the energy price cap at c.£180 per household in 2024. Whilst it could be argued that there is a justification for charging for energy efficiency schemes that reduce energy costs, most of these schemes will help more with gas bills than electricity bills. There is little justification for funding these Government policies from electricity bills as opposed to general taxation.  

So, several actions could be taken to reduce bills significantly. Taking back ownership of our electricity system would allow the surplus currently paid to shareholders (many of whom are overseas institutional investors) to reduce bills and invest in the system to facilitate renewable energy connections to meet zero carbon targets. Levies on bills for which there would be no reason under public ownership should be scrapped immediately and funded through fairer means. Without a fundamental change in our electricity system, the aims of lower bills and cleaner energy will be very hard to meet. 

First published in The Mint magazine