The Economy: 15. Energy Market

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Welcome to Understand the Economy, the podcast that takes you back to basics to explain, explore, unpick, and elaborate on how economics affects our everyday lives.

The rising cost of living really brought home how those big global shocks can mean some pretty bad bumps for our individual finances.

And we've covered a lot of those economic issues already.

Just search for understand the economy on BBC Sounds.

But probably the most obvious, immediate and frankly, painful way that global economic events have hit our household budgets is through the price of energy.

In 2022, we saw some really steep hikes in how much we pay for gas and electricity.

In fact, our bills almost doubled, causing the government to step in and guarantee energy prices.

But even with that support, many people are struggling and we're all paying a bit more attention to our bills.

But those bills can often be quite confusing.

Exactly what are we paying for?

Who sets the prices and why are our bills so much higher?

Well, we have an energetic expert to help us understand exactly what's going on.

Mike Watterson is an economist, researcher and academic.

He's Emeritus Professor of Economics at the University of Warwick.

Mike, hello.

Hello, nice to meet you.

Thank you very much for joining us.

Now, we talk about the energy market, and it's such a vague term.

What do we actually mean when we say that?

Actually, there are a number of markets involved, but for most people, it's their electricity and gas and how much they pay for it.

Yes, and we think about our single energy supplier, don't we?

They're the company we pay, they send us our bills, but they're not individually piping that gas or electricity into our homes.

So what is it they are doing?

Well, they're buying electricity in order to sell it to us.

They're engaging in marketing and billing.

And the rest of the activities are done by other companies.

They're actually acting a bit like an insurer, if you like, because sometimes they will have to buy electricity very expensively, other times quite cheaply, but they charge us a given price per amount of electricity per kilowatt hour.

Okay, lots of other companies we will unpick in just a moment.

But first of all, we talk about the wholesale price of gas.

What does that mean?

Well, that's the price that the energy company would have to pay in order to buy their gas, whether they buy it from long term or short term.

So why do they need to buy at different times?

Why do they need to buy ahead?

The electricity company or gas company will say how much you're going to be charged for a period of time.

So they need to ensure that they're not paying too much.

And they'll do that by buying some in advance in order to ensure themselves, if you like.

So there are two different markets really that we're talking about here, aren't there?

There's the global energy market, and that's different from the consumer market here in the UK that we call the retail energy market.

Yes, that's right.

So there's more or less a global market, for example, for gas.

So we get gas from all over the place.

We get gas from the North Sea, but that's a declining amount.

We get gas from Europe through pipelines.

We get gas from Saudi Arabia, Qatar through tankers.

These tankers will move around according to prices.

So, you know, if the price is higher in Rotterdam, they'll go to Rotterdam.

If price is higher in Milford Haven, they'll go to Milford Haven.

Well, if all this talk about prices has whetted your appetite, then the good news is we have an episode on pricing available right now on BBC Sounds worth checking out.

Now, we're going to talk a bit more about how we price gas and electricity in a moment, but first of all, here's our economic historian, Dr.

Victoria Bateman, with a little history about how the markets evolved.

In 1812, while Britain was fighting Napoleon, the British gas industry was born, bringing light to the dark satanic mills, along with the rapidly expanding cities that house them.

By 1827, London was illuminated by a network of almost 70,000 streetlights.

As the century wore on, electricity became the new kit on the block.

In 1878, Cragside House in Northumberland became the first home to be powered by hydroelectricity.

Soon, electricity companies were competing with gas companies to light, heat and energise the nation.

The northeast was well ahead, whereas London really lagged behind.

Stuck with the gas technology was really slow to move on to use electricity and the result was that by 1919 only about six percent of homes across the country had electricity.

The big push really came in 1935 with the establishment of the National Grid and that made electricity cheaper and more reliable.

Mike, it must have been a heck of a moment when they first flicked the switch and fired up the National Grid.

Yes, I think it probably was.

I don't know that they actually said when it was going to happen until after it had happened.

So the National Grid manages the supply.

It's in charge of getting energy from the power stations where they generate electricity and then into our homes.

Is anyone else involved in that?

Yes, the local distribution companies are involved, and they're in charge of the wires that you see in the streets or underground coming into your home.

So National Grid is like the motorways and those smaller companies are the B-roads?

Yes, more or less, but they also might be some A-roads as well.

So who sets the prices?

The prices in normal times would be set by the suppliers, the companies who you buy the electricity from, who are neither National Grid nor the distribution company.

At the moment, because the government has intervened significantly, then the suppliers have a relatively limited role in setting prices.

Mike, why is it cheaper if you agree to pay monthly and by direct debit?

It's essentially the most efficient method of collecting the money.

And people on prepayment meters, usually the people on the tightest budgets, they actually end up paying more.

Yes, that's partly a historical factor, I'm afraid, that prepayment meters are of various vintages and some involve relatively cumbersome methods of payment.

And so, you know, because those methods are cumbersome, they tend to cost more to the companies.

And that's one of the reasons why prepayment people usually end up paying more.

The other reason is that many people have been put on prepayment meters because they have a history of bad credit, and the companies will want to put them on prepayment meters in order to ensure that they get paid and may also impose a charge to do with past debts.

Right, I'm just going to come out and say it.

It isn't actually very easy to understand your energy bill, is it?

You start looking at the numbers and kilowatts per hour.

And in fact, as an experiment for this podcast, I asked a mathematician to explain their dual-fuel bill to me and they couldn't.

So here is my challenge for you, Mike.

Explain our bills.

Well,

that's a big challenge.

I mean, the bill, from our point of view, is made up of how much electricity you use in kilowatt hours and a standing charge, and how much gas you use and a standing charge.

Gas is also measured in kilowatt hours, but actually, as far as the measurement in your home is done, it's measured in cubic meters, which is what the gas meter reads.

And there's a complex conversion of that into kilowatt hours, but in both cases, it's kilowatt hours.

So a kilowatt hour is a measure of how much energy you're using.

And it's not exactly the number of kilowatts you're using per hour.

It is a unit of measurement.

So one kilowatt hour is the amount of energy you would use if you kept a 1000 watt appliance running for one hour.

But the thing you need to remember is different appliances use different amounts of energy.

For example, an alarm clock uses a lot less energy than an electric kettle.

So a 50 watt alarm clock would take 20 hours to use one kilowatt hour.

But if you had a 100 watt bulb, it would take 10 hours to rack up one kilowatt hour.

Still with me?

Mike, in our pricing episode, we talk about the price of pick and mix.

And I have to say, it was a lot simpler than this.

Okay, you mentioned standing charges.

They make up part of our bill.

What are they?

These are the charges effectively for having the wire coming to your home or the pipe coming to your home.

Something else on our bills are green levies.

Now, there was some suggestion these should be dropped when the price was so high.

Can you tell us what they are and what they're for?

Gas is still a major component because it's quite flexible, but we move increasingly towards a system where wind plays a major part and solar plays some smaller part in providing our electricity.

Now, those sorts of facilities, wind and solar, it's still in a relatively early stage, and so many of those wind and solar plants are being subsidized in order to get the industry off the ground, if you like.

Why have prices gone up so much recently?

Well, as you know, there have been a war in Ukraine, and as a result of that, relations between Russia and Western Europe have changed a lot.

Now, Germany was a major consumer of Russian gas.

It took Russian gas for about 40% of its energy needs, and it suddenly had to change that.

And that's had an effect throughout the system.

So although we use relatively small amount of gas from mainland Europe, of course they've bid up the price of gas coming from elsewhere in order to meet some of their needs.

And so that's bid up the price that has to be paid by British companies in order to get the gas that they need.

So Mike, there'll be two different phrases people hear a lot in the news, the energy price guarantee and the energy price cap.

It would be good to understand what those are.

Start us off with the energy price guarantee.

The energy price guarantee is the government scheme to make sure that people in general have been subsidised to some extent through this period in which the prices have gone very high in order to keep prices within manageable limits.

The energy price cap, it's a sort of upper limit on the price that you can be charged.

There's been a lot of information, even government campaigns, about how we can reduce our bills.

Things like unplugging phone charges, turning our boilers down.

How much do those small actions make a difference to our bills?

And do we have any real understanding of how much of a difference?

Turning our boilers down is probably a good idea.

With electricity, some things that you might think would change your consumption a lot don't.

I mean, unplugging your mobile phone charger is hardly going to make a difference at all.

Unplugging your TV when you're not using it may only save you a pound a year or less.

You have to remember that electricity that's used for heating tends to be the most intensive use.

So, you know, when you fill your kettle up to the brim and boil it up when you only really needed a cup or two, that's going to cost you quite a lot if you habitually do that over the year.

So if I'm carefully unplugging my phone charger when it's not in use, but I'm still cranking up the thermostat, I'm I've got it I've got it wrong.

Yes, I'm afraid so.

Right.

I think the question everybody wants to know, what will make prices go down?

Well, I mean, they will go down down from what they are at the moment, but in general I think that unless something really major and unexpected happens, we can't expect prices to be going down much.

Mike, I'm not going to lie, that's not the answer we were all hoping for.

Would you like to have another go?

We do sometimes see in the papers that the price of wholesale gas is falling.

It can be really frustrating to read that and then see that our bills are still massive.

Yes, and that's essentially because the companies will have bought much of it in advance and so it will be a while before those sorts of effects tend to influence our bills.

But they will.

Professor Mike Watterson from the University of Warwick, thank you very much.

Power is sent into our homes so seamlessly that we don't even have to think before we flick a light switch.

Behind the scenes there are a lot of moving parts that make that happen.

And there are also a lot of moving parts when it comes to the price we pay with global geopolitics, competition, even the weather can make a difference.

Energy companies buy their gas in advance, and while that means that it can take a little while for bills to come down, it should even out our bills in the long run.

If you want to listen to all our episodes of Understand the Economy, you can listen again now on BBC Sounds.

And if National Grid is listening, then heads up, I am about to put the kettle on.

Understand the Economy was presented by me, Felicity Hanna, produced by Louise Clark Robotham, the researcher is Beth Ashmead Latham, and the editor is Claire Fordham.

It was mixed by Nikki Edwards.

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