What Affects Energy Prices?

The Core Driver — Wholesale Gas Prices

The single most important driver of UK energy prices is wholesale gas.

Gas affects households in two ways:

1. Directly — for homes using gas for heating and cooking

2. Indirectly — because gas often sets electricity prices

The UK electricity market operates under a “marginal pricing” system.

This means:

• Electricity generators bid into the market
• The most expensive plant required to meet demand sets the market price
• Gas-fired power stations frequently set that marginal price

Even if wind or solar generate electricity cheaply, the wholesale market price is often determined by gas generation.

This is why electricity prices can rise when gas prices rise — even if renewable output remains high.

Global Gas Markets and UK Exposure

The UK produces some domestic gas but relies significantly on imports:

• North Sea production
• Pipelines from Norway
• Liquefied Natural Gas (LNG) shipments

LNG markets are global.

This means UK gas prices compete with:

• Europe
• Asia
• Global industrial demand

When global demand increases or supply is disrupted, prices can spike rapidly.

The 2021–2022 price crisis was driven by:

• Reduced Russian gas supply to Europe
• Global LNG competition
• Post-pandemic demand rebound
• Lower storage levels

Because the UK has relatively limited gas storage capacity compared to some European countries, it can be more exposed to spot market volatility.

Weather and Demand Volatility

Weather plays a major role in pricing.

Cold winters increase:

• Heating demand
• Gas consumption
• Electricity demand

Wind output also matters.

Low wind periods require:

• Increased gas-fired generation
• Higher wholesale electricity prices

Seasonal factors also influence storage levels and forward pricing.

Energy markets anticipate winter demand and price accordingly.

Supplier Hedging and Risk Management

Energy suppliers do not buy all energy at the moment customers use it.

They typically:

• Hedge months or years in advance
• Buy energy through forward contracts
• Spread purchases over time

This protects customers from extreme short-term volatility.

However:

• If wholesale prices rise sharply, new hedges become more expensive
• If suppliers hedge poorly, they can face financial stress

During the 2021–2022 crisis, many suppliers:

• Had insufficient hedging
• Relied on spot markets
• Could not absorb wholesale price increases

This contributed to multiple supplier failures.

Networks — The Cost of Delivery

Energy must be transported to homes via:

• Transmission networks (national grid)
• Distribution networks (regional networks)

Network costs include:

• Maintenance
• Infrastructure upgrades
• Grid balancing
• Reinforcement for renewable integration

These costs are regulated by Ofgem and form a significant portion of your bill.

Network investment is increasing as the UK:

• Expands offshore wind
• Electrifies transport
• Deploys heat pumps

Infrastructure upgrades are long-term investments recovered through bills.

Policy Costs and Environmental Levies

Energy bills also include policy-related costs.

These can fund:

• Renewable subsidies (e.g., Contracts for Difference schemes)
• Energy efficiency programmes
• Social support schemes
• Capacity market payments

Some levies are applied to electricity more heavily than gas.

This imbalance can influence heating economics (e.g., gas vs electric heating).

Policy costs evolve over time and can shift between taxation and bill-based recovery.

The Capacity Market and Security of Supply

The UK operates a Capacity Market.

This system pays generators to be available during peak demand.

It ensures:

• Backup generation
• Grid stability
• Reserve capacity

Capacity payments are ultimately recovered through consumer bills.

They form part of the structural cost of ensuring reliable supply.

The Energy Price Cap — What It Does and Doesn’t Do

The Energy Price Cap limits the maximum price suppliers can charge customers on standard variable tariffs.

It:

• Is set by Ofgem
• Is updated quarterly
• Reflects estimated wholesale costs and other components

However:

• It does not control wholesale prices
• It does not guarantee lowest possible price
• It does not apply to fixed tariffs

If wholesale prices rise sharply, the cap rises.

If wholesale prices fall, the cap can fall — though with a lag.

Why Prices Sometimes Fall Slowly

There are structural reasons why price reductions can lag:

• Suppliers hedge in advance
• The cap is updated periodically, not instantly
• Infrastructure and policy costs do not fluctuate as quickly as wholesale costs

This can create perception that prices “rise fast and fall slowly.”

Global Geopolitics and Energy

Energy is strategically important.

Geopolitical events can disrupt:

• Pipeline supply
• LNG shipping routes
• Production regions

Sanctions, conflicts, and diplomatic tensions can affect supply confidence, which drives futures pricing even before physical shortages occur.

Markets price expectations, not just current supply.

Long-Term Structural Trends

Several long-term trends influence energy pricing:

• Electrification of heating and transport
• Expansion of renewables
• Carbon pricing
• Grid investment
• Decarbonisation targets

Over time, increased renewable generation may reduce exposure to gas price volatility.

However, transition costs can increase infrastructure spending in the short to medium term.

Household-Level Factors

Beyond macro forces, your bill also depends on:

• Your tariff type
• Your usage level
• Your region
• Standing charges
• Payment method

Two households in identical homes can pay different amounts based on tariff structure.