How does the price of gas affect business electricity supply prices?
As wholesale gas prices rise, we answer questions about why renewables are affected.
As wholesale gas prices rise, the price of electricity generated from renewable sources rises as well. We answer questions about why renewables are affected, by looking at how energy is traded, and how the Merit Order drives energy prices.
The wholesale market has been volatile in the early months of 2022, with Russia’s invasion of Ukraine acting as the current underlying driver of high prices. As other countries attempt to find alternative sources of gas, the short-term impact will likely see continued high prices for the months ahead – which reached a peak of £8/therm on the 7th March.
Prices have dropped slightly since the start of March, with the UK and Europe moving quickly to boost LNG cargoes from the USA. The EU have also published a plan to reduce the demand for Russian gas by two-thirds before the end of this year. This will be achieved by a mix of actions including diversifying gas supplies, reducing demand via energy efficiency measures, and increasing renewable energy usage.
Why do gas prices affect the cost of electricity?
The price of gas influences prices across the rest of the energy market, even for renewable suppliers like Good Energy, because of something called the merit order.
The merit order is like an order of preference. When every generation type is needed to meet demand, the system decides the order in which they come online.
Fossil fuels have a high marginal cost due to them burning materials to generate energy, whereas the marginal cost for renewables is almost zero. As renewables are the cheapest to run, they are always chosen first if they’re available. It’s logical to meet the demand with the cheapest available option – with the added benefit of reducing carbon emissions.
Electricity prices can fluctuate in each half hour period because they are set by the marginal cost of the last generating unit used to meet demand. This is usually gas, which has a high marginal cost. Natural gas is responsible for 38% of electricity generation in the UK and in times of low wind, for example, more gas generators will be used to curb demand.
What is the impact on Good Energy?
As part of our power purchase agreement (PPA) model, we buy power directly from over 1700 independent renewable generators. The PPAs also provide a natural buffer to market volatility, as their prices tend to be set over a long period.
However a PPA cannot guarantee the weather conditions will be suitable for renewable generation in any given period. In the last five years, we have been able to match the demand from customers to a renewable generation supply in real time 92% of the time on average. This means there are times we have to make short-term trades on the wholesale market, where gas costs set the overall price.
How does this affect businesses?
The impact of high prices in the wholesale market is felt more sharply by businesses – in large part due to the lack of any protection mechanism equivalent to the price cap, which has been in place for domestic customers since 2019.
With fossil fuels driving volatility and higher prices in our wholesale markets, this undoubtedly brings short-term pressures through higher operational costs for businesses, in addition to the challenges of forecasting and budgeting in advance.
In the absence of any government work to reform the wholesale markets, one of the best strategies available for businesses is to install on-site renewable generation where possible to reduce their reliance on the grid. With business rates exemptions due to be removed for renewable energy next year, there is no better time to start investing in on-site renewable generation.
A full reform of the wholesale market is needed in order to change how electricity prices are determined. Ultimately, however the market is structured, we need to diversify the mix of renewable infrastructure. The quicker this happens, the quicker the reliance on volatile fossil fuels to set the price will end.
