Anthony Ainsworth, COO at npower Business Solutions
It is perhaps an understatement to say that the past few months have been volatile in the energy market. As a result, there has never been a more pressing time to understand how the energy we use is generated, traded and supplied.
However, we know that this is not as easy as it sounds. The energy market can be difficult to navigate, particularly as it can change on a daily basis. Combine these things with the headlines we’ve seen recently, and it can seem like a very confusing place, particularly if you’re trying to make an informed decision about your energy strategy.
In this article, I hope to answer a few of the common questions we hear when it comes to energy supply, what is influencing the prices you pay, and some of the key steps to take to protect against the market volatility.
Where does our energy supply come from?
Over the past decade, the UK has dramatically transformed its electricity supply. Back in 2008, around 80% of the UK’s electricity came from fossil fuels. The majority of this was generated by large power stations burning coal, gas and oil. A further 13% was supplied by nuclear power.
Fast forward to 2020, and the picture is very different.
The largest share of our electricity – almost 60% – comes from low carbon sources, including 28.4% from wind and solar, 14.7% from hydro and other renewables and 16.1% from nuclear. The share of our electricity generated by carbon-emitting fossil fuels – mostly natural gas – has reduced to less than 41%. And we imported 8% from other countries via our growing number of undersea interconnectors, of which 66% was from low-carbon sources, for example, from French nuclear and Norwegian hydro.
Do we rely on imports?
Historically, the UK has been relatively self sufficient when it comes to energy, with our own coal mines and North Sea oil and gas fields supplying the fuel we needed. But as these reserves depleted and the government started phasing out coal, we’ve had to import more fuel.
With just over 25% of our energy imported in 2008, this peaked at nearly 48% in 2013. But as the UK’s wind generation capacity has increased – and our overall energy consumption reduced due to increases in energy efficiency and a decline in industrial activity – it’s now around the 36% mark.
If renewables are growing, why are energy prices so high?
In one word, the answer is: gas.
Due to the move away from coal, gas has become our dominant fuel. As well as supplying heat for 87% of UK homes, around 40% of our electricity is generated from natural gas. So, gas is a hot commodity. It’s this dominance that allows the value of gas to influence the price of power. As so much power generation relies on gas, power markets therefore closely track gas markets.
Oil remains the other main global fuel commodity, so changes to oil prices also impact both the gas and power markets. This is despite almost half the UK’s electricity now being supplied by low-cost renewables – where the resources they run on, i.e. wind and sunshine, are free.
And, rather than having separate markets to trade each energy technology separately, or having a combined market that’s adjusted for the wider range of generation types we see today, all generation – regardless of source – is instead bundled together and traded as units of energy (MWh), with gas values influencing the price.
What is driving wholesale prices?
A large range of factors can influence energy prices. Firstly, there arestraight-forward supply and demand dynamics – the balance between what’s being produced and what’s needed. But this is only part of the picture.
Weather is another key factor. As well as seasonal variations, unexpected or sustained colder or hotter temperatures can increase or reduce forecast demand. With our growing volume of wind and solar generation, wind and sun availability are also important.
Political issues can play a big role too, as has been evident with Brexit and is currently a large influence due to the ongoing situation with Russia.
Economic factors also feed into the mix, for example, growing economies in Asia are also creating increased competition for gas.
Does the energy industry need reforming?
Many in the industry believe the energy system is in need of reform. For example, Dieter Helm, Professor of Economic Policy at the University of Oxford and the author of a government-commissioned independent review on the Cost of Energy in 2017, says:
“We should plan for a 21st century energy market structure, not carry on with a fossil-fuel-driven 20th century wholesale market framework.” He advocates changes to the market that bases the price of electricity on its “cost, not on the basis of the cost of the most expensive fuel at any point in time.”
Although not the only factor, the situation in Russia and Ukraine will result in some change – the Business Secretary Kwasi Kwarteng went as far as to say that the UK’s energy independence was a matter of ‘national security’.
Taking action now
So, what can organisations do now to reduce risk in these volatile times?
- Consider your contracts – Those on a fixed contract may want to consider a longer-term contract, as these will offer cheaper rates than expensive one-year supply deals. For flexible purchasers, it is wise to re-evaluate your strategy to ensure it reflects the current level of risk appetite and that electricity and gas budgets are realistic in the current climate.
- Maximise energy efficiency – it goes without saying that the less energy you use, the less you will pay. The recent crisis has brought the importance of energy efficiency to the fore – it really is a no regrets action to take.
- Become more self-reliant – investing in sustainable on-site generation has multiple benefits, not least making your organisation less reliant on the grid. From solar to CHP, there are a variety of options available to organisations who want to be more self-sufficient.
- Consult an expert – working with your energy partner to help you make a strategic plan is more important than ever.
These are unprecedented times in the energy industry, which is why gaining a greater understanding of the UK energy market and the factors influencing our supply is crucial to making an informed decision about your energy strategy.
That is why we have launched a series of ‘Energy Made Simple’ reports, which are designed to provide a straight-forward explanation of all the key aspects of energy that will help you become more informed about the power and gas your organisation consumes..
