This is not the first time that global energy markets have been in turmoil. Gas prices on the international market have more than quadrupled in 2021. In their wake, many energy suppliers have gone bankrupt and household bills across Europe are set to soar. Energy prices are driving up the cost of living and inflation, but it’s also time to realize the old adage, “never waste a good crisis”.
Some of the causes of sky-high energy bills are unavoidable – there is little most governments can do about the wholesale price of gas itself. Fossil fuel companies make huge investments that take years to mature, generating periods of subdued prices followed by supply squeezes when prices spike. Gas prices have been falling over the past decade and the arrival of the pandemic in 2020 has lowered demand.
Regions without domestic gas supplies or which have depleted most of their gas reserves in recent decades obtain much of their gas by importing it. Peripheral European countries, including the UK and many parts of the Mediterranean, assumed they could rely on global supplies of liquefied natural gas. But tankers from major gas producers like Qatar can look to Europe or Asia depending on who pays the higher price. Now there is a stampede and Asian demand dominates.
The knock-on effect on energy bills is amplified in the UK and other parts of Europe where electricity is organized through wholesale markets (in which generators offer to operate if the price is right) and where most homes depend on gas for heating. Average household energy bills in the UK, which reached over £1,200 ($1,630) in 2021, are expected to rise by around 50% in 2022. Up to half of the increase will not come from the gas you burn, but the impact gas has on electricity prices.
So why does a gas price crisis affect electricity bills so strongly? After all, gas generates less than half of electricity – less than 40% in the UK and only around 20% in the EU. Renewables generate more than a quarter of the UK’s electricity, nuclear and imports another quarter. The cost of wind and solar power generation has fallen over the past decade globally, dropping by more than 40% for onshore wind and much more for solar and offshore wind.
The last fixed-price government contracts offered for offshore wind power in Britain – barely the cheapest of renewables – were below 5 pence per kilowatt hour (kWh). That’s less than a quarter of the typical household tariff (what most people pay for electricity at home) that consumers will face in 2022. Households pay for their electricity many times what it costs currently to produce and transmit it from the cleanest energy. large-scale sources.
Electrical system design has failed to catch up with the renewable energy revolution. Competitive electricity markets, established in many countries to try to minimize costs, are in fact experiencing the greatest price increases. This is not because governments elsewhere use taxes to subsidize electricity (although some do), but because in wholesale electricity markets the most expensive producer sets the price.
Since renewables and nuclear will always work when they can, it’s fossil fuels – and right now, unequivocally gas, plus the cost of CO₂ pollution taxes – that sets the price almost all the time. time, because some gas power plants are needed most of the time. time, and they will only operate if the price of electricity is high enough to cover their operating costs. It’s a bit like paying the peak price for every train trip you take.
If renewables are now so much cheaper, why can’t consumers buy power directly from them and avoid paying gas and carbon costs?
A new golden age
Energy markets are not designed to deal effectively with sources such as renewables which are expensive to build but much cheaper to operate than fossil fuels. Governments offer long-term fixed price contracts to generators for their renewable energy production. This has been the main driver of investment, while competitive bidding of these contracts, to companies willing to build renewables, has reduced construction costs the most.
By contrast, households and other small consumers can rarely purchase fixed-price contracts more than a year or two in advance, given wholesale price uncertainties and governments encouraging competitive switching. The electricity generated from the renewable energy contracts is fed into the rest of the system, which balances the variable renewable energy production by generating more or less from conventional sources. This adds around 1 pence per kWh to the cost of renewable electricity in the UK and Europe. Even taking this into account, the gap between cheap renewables and expensive final electricity becomes unconscionable.
Ten years ago, many energy experts predicted a “golden age of gas”. Countries will likely continue to burn gas for a few years. But with the drive to reduce emissions and the advent of cheap renewables, electricity is set to dominate the energy system in the future, powering heat pumps, electric vehicles and more. This golden age of electricity cannot happen as long as the price of electricity is determined by fossil fuels and their carbon costs.
What would electricity markets suitable for renewables look like? In research I conducted with colleagues on electricity prices, we proposed a green power pool that would bundle long-term contracts with renewable energy producers and resell the electricity to consumers. The price would be set primarily by producers’ actual investment costs, rather than gas-driven wholesale markets.
When there is not enough renewable energy produced or stored – such as on cold, calm winter days – the green power pool would purchase electricity from the wholesale market for periods and quantities limited. To minimize these costs (and emissions), contracts could give discounts to customers who can use electricity during off-peak hours, or to those with two-way electric vehicle connections who can resell electricity to the network.
It won’t happen overnight. It will not reduce bills tomorrow. But new electricity needs a new market, a market that lowers energy bills while decarbonizing the energy system.