What renewables in energy production mean for investments

The percentage of energy in the UK from renewables has grown significantly over the past 10 years from 10.7 per cent in 2014 to 36.1 per cent in 2023.

Projections for 2024 estimate renewables coming in between 37 per cent and 43 per cent.

But the cost benefits have not fed through to lower consumer bills. Why?

There has been a major shift towards a lower carbon electricity system in the past decade when fossil fuels generated most of the country’s energy.

In fact, since 2023, renewables have been the largest source of energy production in the UK.

But, as renewables make up a greater percentage of our energy mix, the simultaneous cost benefits have not fed through to lower consumer bills.

Why is renewable electricity so expensive in the UK?

The predominant reason for this is the way power is priced in the UK.

Due to its market methodology (marginal price-based), gas effectively sets the price for all power sold to the wholesale market.

A report into electricity prices by UCL and Imperial College London identified that gas sets the price in the wholesale market nearly all the time (for example, 98 per cent in 2021).

This means that while gas now only constitutes around 32 per cent of our energy, it is the key factor for determining the price of nearly all energy sold.

As this fuel-based electricity generation sets peak prices, it profoundly affects the wholesale energy prices, which are the largest component of electricity costs for UK consumers.

This correlation can be seen in the chart below.

Even if you are on a fully renewable tariff, your energy cost is very likely to be charged at the rate of gas.

Is it just wholesale gas prices that have made electricity so expensive?

As the UK relies on a large amount of the gas brought in from overseas, currency exchange rates have also had a major impact and represent a significant risk.

After Brexit the pound devalued, resulting in bills increasing. It is estimated that power prices were nearly 18 per cent higher in the UK the year after the EU referendum compared to the previous year.

Now, it is unlikely that we are to see quite the fluctuation in currency that we did in 2016. However the reliance on fossil fuel imports means that currency volatility continues to play some role in energy pricing and this risk factor remains for as long as the UK depends on imports.

Outside of the marginal cost pricing methodology and the exchange rate there are many other costs that go into electricity bills; however, wholesale prices do make up the largest component and therefore can also result in the greatest volatility in bill outcomes.

Is this going to change now renewables make up a greater source of energy in the UK?

Proposed reforms include modifying government support mechanisms that promote decarbonisation to ensure security of supply; implementing location dependent wholesale prices to reduce network constraints; and, most notably, creating options to pass on the low costs of renewables to consumers by separating the wholesale pricing market.

This was reiterated in a November 2024 report from the National Energy System Operator (NESO), the nationalised operator for the electricity and gas distribution systems in the UK.

The report made it clear that the government will be “cutting the link between electricity bills and volatile international gas prices”, and they have placed a large amount of emphasis on ensuring supply chain pressures are alleviated to support this, specifically grid expansion.

This could lead to two pricing systems.

They also present a cost and benefits analysis that by pursuing clean power pathways gas will set the price less frequently, resulting in a reduction in electricity prices.

NESO has also said that moving away from gas as the main price setter for electricity would “greatly reduce” the risk of major price spikes.

The next report by NESO is to be released in March 2025, which will discuss operability strategy and will have more information on the future for our energy system.

As the rollout of the clean power system continues, decoupling the pricing component of renewable energy from natural gas prices will result in more appropriate pricing for consumers.

It may also provide more public support for renewables, as the benefits of their near zero-marginal cost feeds through to alleviating the negative impact of the cost of living crisis.

However, it is important to note that any decoupling of our pricing system is likely to be years in the making, undergoing many rounds of debate, and any positive outcomes to consumer bills will therefore take time.

What could this mean for my investments?

Marginal cost pricing means that the recent increases in the cost of gas have also increased the revenues of other electricity generators, such as some renewable and nuclear generators.

These generators’ operating costs are unlikely to have increased to the same extent.

Many companies therefore announced large profits.

Centrica, which owns British Gas, made £758mn from its electricity generation business in 2022, of which £753mn was for nuclear generation. And if we look to Drax Energy, a 100 per cent renewable energy generator, we note that revenues increased tremendously from 2021 to 2022, benefiting from wholesale gas price increases.

Further, many of these renewable energy generators took advantage of locking in high prices during the wholesale pricing spikes of 2021 (via power purchase agreements or contracts for difference), so were also able to maintain a high, fixed, price for their energy beyond this shock.

To respond to these large profits from this ineffective pricing system, the government placed a levy of 45 per cent on exceptional profits from low-carbon electricity generators, which will continue to be in effect until March 2028.

By decoupling the energy systems, the need for an additional levy is removed/reduced.

36%

The percentage of energy in the UK from renewables has grown from 10.7 per cent in 2014 to 36.1 per cent in 2023.

If the pricing system is decoupled, we could see the popularity for renewables increase while fossil fuels decline, particularly gas. Individuals may choose cheaper tariffs as they can identify cost differences.

This would help encourage greater grid infrastructure and urge solutions to the intermittency issue as more people opt for renewables.

However, for companies like Drax and Centrica, there could be a negative price impact on revenues if the price they achieve for their energy falls.

With that said, volumes may be higher due to greater demand for renewables over fossil fuels.

This balancing act could be feasible if the UK continues to broaden out its energy grid.

Until these changes are made to the current system, it is also important to acknowledge that as consumers we are ultimately already paying for the renewables rollout via our energy bills.

Renewable companies are still making greater profits by benefiting from the anchoring to gas prices, which can then fuel renewable capital expenditure and other upfront costs, which is almost acting as a pseudo-subsidy.

We need to ensure that the incentive for renewables firms to keep generating renewable energy is lucrative enough. Part of this will be ensuring 45 per cent levy is no longer in place if the pricing systems decouple.

Until then it is important to remember that, although the price of utility bills is driven by gas prices, renewable energy cannot only solve energy security issues, but also provides energy generation at a fraction of the cost.

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What renewables in energy production mean for investments

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