npower Business Solutions’ Head of Industry Charges, Stephen Evans, provides us with an overview of this complex area of energy costs.
When it comes to energy costs, most of the recent focus has been on how to reduce the impact of volatile wholesale energy prices on businesses.
However, aside from this, the additional elements added to electricity invoices – the non-commodity costs – are now responsible for a growing share of the overall cost businesses have to pay.
The steady increase in these costs has had a marked impact on businesses, with many of those consulted in npower Business Solutions’ latest Business Energy Tracker saying that reducing or simplifying non-commodity costs needs to be a key priority for the new government.
To help demystify non-commodity costs and what they mean for businesses it’s important to consider what they are and how they are impacting the rising cost of energy.
Firstly though, let’s take a brief step back to look at why these charges became a major part of business energy invoices.
The need to decarbonise
In 2000, plans were set in motion to reduce the UK’s dependence on fossil fuels. However, increasing renewable generation required a huge change to our electricity system – and the costs associated with it. The government encouraged wind generation as an alternative source of power, but the infrastructure was costly to set up.
As a result, subsidies were created to stimulate and incentivise investment, first through the Renewables Obligation (RO) for large-scale wind farms and biomass, followed by the Feed-in Tariff for small-scale solar, in 2010.
In 2014, Contracts for Difference (CfD) was introduced, replacing RO for all new generation in 2017. That said, the RO will continue paying out subsidies for the next 13 years.
Funding the journey to net zero
The truth is that the cost challenges to businesses now are paving the way for future sustainability. And, these subsidies have worked. We now have wind generation that meets almost 30% of the UK’s total electricity demand, and growing volumes of solar and biomass that currently supply around 10% of our electricity.
Some of the other key drivers that are causing a rise in non commodity costs as we adapt our energy system for greener energy include:
- Creating a viable and sustainable infrastructure that will successfully service future generations will take considerable execution. For example, renewable generation sites tend not to be in the same locations as the incumbent power stations, which were not planned around wind or solar yield. Also, rather than having a small number of large generation sites, we now have large numbers of smaller sites and connecting these sites to the central electricity grid requires significantly more transmission and distribution infrastructure to be built.
- Helping power travel further: Offshore wind and solar farms are often miles away from population centres, unlike the power stations of old that were deliberately placed near towns and cities to limit the amount the generated power needed to travel. Transmission and distribution costs for green energy have to rise to meet this key challenge.
- Balancing supply and demand: As well as funding green energy subsidies and transmission and distribution costs, electricity consumers also pay towards the cost of balancing the grid and ensuring security of supply. This ensures we always have exactly the right amount of supply to meet demand. As we transition away from predicable fossil-fuel supply to more intermittent renewable generation, it makes the job of balancing the grid much more complex.
- The price of security of supply: As we rely less on gas-fired power for 24/7 generation, the cost of running these power stations isn’t being met by these ad hoc payments. So they also need a subsidy, which is what the new Capacity Market (CM) delivers, with its focus on ensuring security of supply during periods of peak demand (e.g. over the winter months). But this too is funded via an additional charge added to energy invoices.
Paying now for a sustainable future
The bottom line is that the non-commodity elements added to electricity invoices have risen from around £100 per MWh in Q1 2023, to £112 in Q1 2024 – and are set to jump to around £132 by Q4 2025.
The good news is that these costs will reduce once these key infrastructures are in place. The investment made up front now will ensure a greener and more sustainable electricity system for future generations.
To find out more about non-commodity costs, download npower Business Solutions’ latest guide here.
This article appeared in the September 2024 issue of Energy Manager magazine. Subscribe here.