How are energy prices set?
In Britain’s energy market suppliers compete on price and service to win customers. Suppliers face a number of different costs in supplying gas and electricity. In the price they charge consumers they will seek to cover these costs and achieve a surplus. This is their pre-tax margin, out of which they make their profit.
This profit is not an entitlement. Instead, suppliers need to earn it through the service they offer and how efficiently they manage their costs. In line with our duties as set by Parliament, our role is to make sure the market works in the interests of consumers. This is why we have referred the market to the Competition and Markets Authority (CMA) and introduced far-reaching reforms to make the market simpler, clearer and fairer, so consumers can more easily find the best deal. Other reforms also make it easier for independent suppliers to compete with bigger suppliers.
The cost of running the energy transportation networks is the only part of the energy bill that we directly regulate as the companies which run the pipes and wires to deliver gas and electricity are monopoly businesses. We allow these companies appropriate funding to invest in and run their networks while delivering value for money for consumers.
How have energy costs changed?
In Britain energy costs fell from the late 1990s until 2004/5, when we first imported more gas than we produced ourselves. Since then, Britain has had to attract gas imports from around Europe and further afield. This has meant that gas prices in Britain have become increasingly influenced by global events. Other costs have also increased over the past decade.
What is the future for energy prices?
We face a combination of factors which are likely to increase energy prices. These include increasing dependence on gas imports, ambitious environmental targets and the need to replace ageing power stations.
The amount of electricity we produce from gas is likely to increase to around 60 per cent between now and 2020 as coal-fired power stations close. This will come at a time when many European and Asian countries will also need more gas. This could put pressure on wholesale prices, depending on how quickly new sources of supply such as shale gas become available globally. These will all put increasing pressure on bills over the medium and long term. However, energy consumption has generally fallen, in part due to more efficient use, which reduces typical bills.
To further understand the outlook for the costs that make up your energy bill, see our Supply Market Indicator.