Why have electricity prices increased over the past two decades?
The news that the price caps for electricity and gas will increase again from April 2025 has attracted the usual amount of media attention. Unfortunately, most of the discussion is shallow at best and seriously misleading at worst. The reason is that politicians and the government’s press machine devote a lot of effort to diverting attention away from policies that are pushing up prices and blaming “market” factors for the increases.
In this article I will focus primarily on inflation-adjusted electricity prices, since it is changes in real terms that matter to both households and businesses. In adjusting for inflation, I have used the GDP deflator as the price index. This is because over 60% of electricity is used by businesses rather than households. The GDP deflator is a price index for value-added in the economy which covers all sources of income and types of economic activity.
While most commentary focuses on what has happened to electricity prices over the last 3-4 years, it is better to consider a longer perspective. The figure shows how average real electricity prices by type of user have changed over the last two decades. The green line at the bottom shows the average wholesale price using Elexon’s market index price. There have been two major spikes in 2008 and 2021-23. Omitting those years the average market price at 2024 prices was £56 and there has been no clear trend in real market prices. The perception that market electricity prices have increased substantially is almost entirely a product of what happened from 2021 to 2023.
If you told that to policymakers, probably 95% of them would be convinced that you were joking or mad. The reason is obvious if you look at the lines for business and household prices. The average real price for medium business users – again excluding the spikes of 2008 and 2021-23 - increased from £105 per MWh in 2005-14 to £156 in 2015-24. Similarly for households the decade average real prices increased from £178 to £232 per MWh. There are very clear and large upward trends in user prices even though market prices have not changed.
This discrepancy has given rise to what I will call the “energy price myth”. This is that the increase in electricity prices is all caused by an increase in gas prices reflected in the wholesale market price of electricity. The story behind the 2021-23 price spike is significantly more complicated than the myth suggests. Even more important the myth is a complete fabrication if one sets aside the two price spikes over 20 years.
The reason for the difference between the view of users and what has happened to market prices can be seen in the figure above. This shows the average real margin between the prices paid by users and the wholesale market price. Setting aside the price spikes, when the margin tends to be compressed, the average margins grew from £49 per MWh in 2005-14 to £101 per MWh in 2015-24 for business users and from £122 to £176 for households. It is the increases in the average margins which have driven up user prices so much over the last two decades.
The price margins are largely determined by regulatory and policy decisions. The three major components of the margins are: (a) levies to cover the costs of subsidies and other policy interventions, (b) system and supplier costs including balancing costs and capacity market levies, and (c) regulated network charges. The upward trend in the price margins is not a recent one, but it has occurred in a series of abrupt steps. The business price margin increased from £25 in 2005-06 to £61 in 2009-10. It stayed roughly constant up to 2018 but then increased sharply to about £100 in 2019-20 and again to £217 in 2024.
It is convenient for policymakers to shift the blame for increases in electricity prices to external factors. Occasional price spikes due to gas prices and other factors, which are a regular feature of energy markets, are a convenient scapegoat. Still, we should not allow such episodes to divert attention from the truth. Over the last two decades, the steady increase in inflation-adjusted electricity prices is largely a matter of self-inflicted harm.
The increase in the real price margin charged to business users is particularly important. It is a tax on all of us. For electricity-intensive industries which compete in world markets that tax can only be covered by reducing either wages or profits. Since workers and investors have been unwilling to accept reductions in their incomes, the result has been that such industries have closed their activities in the UK and moved to countries with less penal policies.
Other business users – offices, shops, school and hospitals – cannot move, so they must pass on the cost of higher electricity prices to their customers. The tax increase is hidden because it appears via higher bills for everything or via a reduction in the services offered.
A different way of understanding the change that has occurred over two decades is to ask: what proportion of the prices paid by businesses and households goes to cover the costs of buying electricity at wholesale prices? In the case of business users that proportion has fallen from an average of 71% in 2005-06 to 29% in 2023-24. For households the proportion has fallen from 41% to 24%.
The conclusion is similar for both types of users. When they pay their electricity bills, the electricity itself comprises a small – and falling – percentage of the total bill. It is the other elements – taxes, subsidies, system and network charges – which have been going up over time. Such charges account for all of the long -term increase in electricity prices over the two decades.
There was a spike in market prices from mid-2021 to mid-2023. Still, we should not allow that spike to mask the major upward trend in the price margin between what users pay for electricity and what it costs in the market. That increase is wholly a consequence of regulatory decisions and other policies.
Data sources
Wholesale market prices are taken from Elexon’s market index price series that is based primarily on data supplied by APX/EEX. It differs from the day-ahead price data from Nordpool which is often used as the indicator of wholesale market prices, but it has the advantage of extending back to the early 2000s.
Electricity prices paid by businesses and household were obtained from the ONS Quarterly Energy Prices database. Business prices come from Table 3.4.1 excluding the Climate Change Levy and other taxes. I have used the prices for medium users defined as those consuming between 2,000 and 19,999 MWh per year. The Climate Change Levy has increased from £1.50 per MWh in 2005 to £7.75 per MWh in 2024. This is clearly part of the policy costs included in the price margin. Average household prices are calculated from Table 2.2.1 by dividing the annual average actual bill by the average actual consumption. This means that any standing charges are pro-rated over total consumption.
The GDP price deflator is taken from the ONS National Accounts dataset.
Thanks for the reply and clarity of debunking the subterfuge that is going on here. There are politicians popping up and questioning the impact of NZ but annoys me that they don't tap into experts like yourself more to hit Milibrain with awkward questions. He wint have the answers but he would have to provide a written response. Instead they want to political point score which achieves nothing.
Gordon I don' t doubt your analysis but as a journalist they would end up or be directed to the OFGEM site for energy price cap and if they can be bothered to read it ( https://www.ofgem.gov.uk/sites/default/files/2025-02/Summary-of-changes-to-energy-price-cap-1-April-to-30-June-2025_1.pdf) the useful (or subterfuge) analysis of this qtrs breakdown. I appreciate this is for domestic consumers only.
That shows wholesale prices being 45% of the price cap vice 43% last qtr. This allowance does include an adjustment for CfD costs but not sure that would account for the almost doubled cost from your analysis?. Although be interesting to know what the costs is ex the CfDs? Also I know suppliers effectively have to fund ROCs and FiTs? but how does that have a bearing on the wholesale cost as is this not the cost at the generators bars? Be nice to see there breakdown table represented to show the true cost drivers.
Then we have other entries like Network costs which include the ever increasing cost of balancing the network or in reality the cost of too much wind on the system. Reality is balancing is still a small part of the costs but constraints are nigh on 70% now. The problem is this still only 10's of pounds and its being swamped by the wholesale cost so doesn't get a look. In terms of traded commodities the price of gas is now down 25% over last two weeks but OFGEM suppress the actual data they use saying its commercially sensitive but on the basis price now remains at current level then that should lead to a complete reversal of this months uplift and of course Milibrain will claim its down to his NZ2030 action plan and so the lie will go on in the press.