Debt Raise

In March the incumbent UK Government announced a slew of new gas-fired power plants to deliver spinning reserve to cover the GB grid for those windless winter days with no sunshine. At the time, Energy Secretary Claire Coutinho said: ‘There are no two ways about it. Without gas backing up renewables, we face the genuine prospect of blackouts… There are no easy solutions in energy, only trade-offs… As we continue to move towards clean energy, we must be realistic.’ On the face of it, the argument appears sound, however evidence would strongly suggest otherwise. With increasing penetration of cheap renewables onto the grid, the cost of marginal gas generation will become increasingly expensive and will drag up consumer bills. This is a genuine paradox – more cheap renewables equals higher electricity bills – and is an unfortunate consequence as we advance intermittent green power across a grid system originally designed for dispatchable power sources utilising coal, gas, nuclear and hydro. As Coutinho says, trade-offs are required – but if we want consumers to truly benefit from the cheapest forms of electricity (i.e. renewables), and to get fully on board with net zero, then some new approaches are required.

No one can now dispute that renewables are cheaper than fossil fuel generation as evidenced by the graph below with the LCOE of different technologies – and we now see capacity additions outstripping their fossil fuelled equivalents globally.

By 2025 renewables is on track to overtake coal as the largest source of global electricity generation.

The UK is in the vanguard. In 2023, renewables supplied 47 percent of the country’s power, up from just two percent in 1991. Low carbon nuclear power supplied 13 percent, while the remainder was fulfilled by gas suppling 31 percent, coal circa 1 percent, and 7 percent imported via inter-connectors from the continent.

However, despite the increasing penetration of low-cost renewables, over the last five years the UK socket price for domestic electricity has risen at a compound average growth rate of 12.8 percent.

However, as a result of an increasing share of low-cost intermittent renewables displacing gas to power, there is now greater risk in matching supply with demand. In the event where forecast demand is not matched by generation, National Grid will make a call for power via the balancing mechanism at a premium price (due to lower utilisation – see ‘Balancing Act’ section below) from dispatchable sources which are largely made up from carbon emitting gas fed power generators and the heavily subsidised, inefficient Drax biomass plant (circa £800 million per annum).

These balancing mechanism costs were £2.9 billion in 2023 (compared with £4.2billion in 2022 which can be directly linked to the gas price spike post Russian invasion of Ukraine). The combination of balancing mechanism costs plus constraint payments due to insufficient grid infrastructure are equal to £139 for an average electricity bill payer, representing 11 percent of the annual consumer electricity bill in 2023. (compared with 14.5 percent in 2022).

It is therefore no coincidence the marginal price setter of gas to power in the merit order has a strong influence in the cost of delivered electricity in the UK.

To evidence the cost of electricity to the consumer we have provided a breakdown based on Ofgem data from Q3 2023. Electricity bills are built up from a number of components which vary over time impacted by economic activity (demand for power), inflation, infrastructure spend (e.g. grid upgrades) and commodity price movements from gas to power. The four main elements which make up an electricity bill are:

• Wholesale costs (48 percent) to generate power.
• Grid costs (21 percent) covering transmission, distribution and balancing costs.
• Environmental and social obligations (12 percent) which includes net subsidies to renewables.
• Operating costs (14 percent) are retail energy supplier margins.

In the bar chart below we provide data from the UK Government Department for Energy Security & Net Zero (DESNZ) demonstrating the impact gas to power pricing feeding through into the retail utility bills as the marginal price setter combined with increased gas heating costs shown in blue.

The spike of 2022 was a consequence of the Russian invasion of Ukraine with the panicked switch from piped gas to LNG resulting in abnormal wholesale and balancing systems costs.

The commodity price spike from gas to power led to UK government intervention through the introduction the energy price cap to keep a lid on overall consumer bills. Despite this intervention around 28 energy suppliers collapsed with the liability (£2.7bn) socialised across bill paying consumers.

As renewables take increasing market share in the UK, there will be economic consequences to keep existing and new gas generators online to stabilise the grid as well as provide backup in periods of low wind and solar resources.

Although balancing costs fell in 2023 as gas prices fell, future gas turbines will be required to deliver less primary power and only balancing. This means that not only will the requirements for balancing rise, but the balancing market will have to bear the capital cost of turbines, driving prices much higher.

This problem will only increase as renewables take more market share. As gas to power capacity utilisation shrinks the cost of balancing the grid commensurately rises.

In the following table we show the impact of reducing gas to power utilisation – leading to increased capacity payments to these generators combined with the last unit of demand being fulfilled by the most expensive power delivered.