Why aren’t my prices much lower this year?

Posted February 18, 2016

“Why aren’t my prices much lower this year?”

That’s the question I’ve heard most often from our business customers renewing their electricity contracts this January.

Your expectation is perfectly reasonable. After all, the falling cost of power on the wholesale energy markets has grabbed its fair share of the news recently.

But your experience is different. On the face of it, your new electricity prices don’t fully reflect the falls on the wholesale markets.

There are two reasons for this mismatch between your expectation and experience:

The wholesale cost of power makes up less of your price than it used to. In 2014 the wholesale cost of power – what we call the energy cost – accounted for 60% of your electricity price. Now it accounts for only 40%.
Non-energy costs, which make up the majority of your bill, are rising quickly – offsetting the benefit of falling wholesale energy costs. These non-energy costs (as we like to call them) cover things like your use of the grid and contribution to decarbonising the UK’s electricity supplies.

So while 40% of your price – the wholesale power cost – fell by 20% between January 2015 and 2016, 60% of your price – the non-energy costs - rose by 16%.

That’s the short story. If you have time for a bit more detail, please read on …

Rise and fall: What’s driving your business electricity prices in 2016

1. The changing relationship of the costs within your electricity price

Here’s an easy way to understand what is driving changes to your business electricity price in 2016.

First think of the relationship between the wholesale cost of power and your electricity price like the cost of oil and your petrol price.

The cost of power trades in the energy commodity markets in £/MWh (Megawatt hour) just like oil trades in $/barrel. And your electricity is priced in pence / kWh (kilowatt hour) just like petrol is sold in pence per litre. (You can see all the key energy commodity prices on our Market Insight service for free if you’re an EDF Energy customer).

Now think about how changes to oil prices feed through to petrol prices.

Between September 2014 and January 2015, oil prices fell by 50%. Petrol prices fell by only 16%. That’s because the commodity element – oil – is only a third of the petrol price. The rest is mostly tax.

We’re now seeing electricity prices behave in the same way.

A large drop in the wholesale power price results in a small drop in your electricity price due to the power price falling from a 60% share of your price in 2014, to just 40% in 2016

2. The rise of other ‘non-energy’ costs

There’s another key reason you’re not seeing your electricity price fall as much you’d expect. Most of the other costs (non-energy costs) within your price are rising.

Energy suppliers tend to label everything that isn’t the power cost as a non-energy cost. There are two main groups within the non-energy cost bundle:

Network and system: All the charges for getting your electricity through the grid to your buildings and making sure the grid is stable (constant voltages and frequency).The key ones are Distribution Use of System ( DUoS), Transmission Use of System ( TNUoS) and Balancing Use of System (BSUoS).
Decarbonisation: All the incentives for generators to build new, low carbon electricity production or to keep existing plant running for longer.The key ones are the Renewable Obligation (RO) and Feed-in Tariff (FiT). Two new charges introduced by Electricity Market Reform will grow quickly over the next few years – Contracts for Difference (CFD) and Capacity Market (CM).

As this chart shows, non-energy costs will be 50% higher in 2020 – accounting for 70% of your price. Most of that increase will come from supporting investment in new low-carbon generation, but delivery charges will also rise to pay for maintaining and upgrading the grid.

Why are they rising?

The drive to a low-carbon future is changing the nature of the UK’s electricity generation mix and the way the grid needs to work to accommodate new sources of power.

Five years ago, there were 500 registered generation plants in the UK. Most were large, traditional power stations. Today there are over 600,000 registered generation sites. Most are small, like solar panels on the roofs of homes and businesses.

This pushes up costs in two ways:

Many of these sites receive support from schemes like the Renewable Obligation, Feed-In Tariff or Contracts for Difference. The combined cost of these schemes will double from 2015 to 2020.

Plus many new sites are embedded in the local distribution networks, not the national transmission network. That means the grid needs to be more actively managed to keep the system in balance, as well as upgraded with new wires. That affects delivery costs.

How does that affect your contract?

Whereas the future cost of power is easy to fix in the wholesale power market, non-energy costs are more challenging. They are complicated to forecast.

For instance the cost of the Feed-In Tariff depends on how many homes and businesses install renewable generation like solar panels and their capacity. That’s difficult to forecast. Then the amount of energy they generate is weather dependent. Another forecasting challenge.

So electricity suppliers have different ways of treating this risk of change in their contracts, ranging from:

the supplier takes all the risk (like our Fixed + Peace of Mind contract)
to the customer takes all the risk (like our Fixed + Reflective contract).

And your electricity price will be higher or lower when you sign, depending on which option you choose.

Stay up to date with what’s driving electricity prices

You’ll find our forecasts and more detailed explanations of these cost components on our Market Insight service. Registration is free. Look for the Monitor report in Updates.