"It’s certainly possible that in the coming years, the cost of subsidies and government schemes will surpass the cost of the energy component"
In recent years there has been a great deal of emphasis on rising energy costs and what this means for British businesses. The role of wholesale energy costs has formed a large part of this narrative. In order to fully understand long term energy prices though, it is important to drill down further into the make-up of energy contracts.
Firstly, we must understand what proportion of energy supply costs faced by businesses actually comes from the ‘wholesale energy’ component. For medium to large sized enterprises in the UK, roughly 70-90 per cent of their gas bill is accounted for by energy costs. This leaves a remaining 10-30 per cent of the business’s bill being composed of non-gas costs. For electricity, this number is much larger, with non-electricity costs accounting for as much as 55-65 per cent of the bill. This means that less than half the money businesses pay for their electricity contracts covers the wholesale energy price. In both cases, especially that of electricity, it is clear that there are significant non-energy drivers of contract price, which can impact businesses’ bills in different ways.
One major reason for these structural differences between gas and electricity are additional government schemes and green subsidies levied on electricity supplies, including renewable obligation certificates, contracts for difference, the feed-in tariff, and the capacity market. The combined costs of these four subsidies over 2019 will average out at approximately £35/MWh, whilst the wholesale electricity price is £43.60/MWh at the time of writing.
It’s certainly possible that in the coming years, the cost of these subsidies and government schemes will surpass the cost of the energy component.
In addition to the subsidies, the other major costs going into both electricity contracts are related to transmission, distribution and balancing. These costs typically differ from subsidies in that they are meter specific and vary by geographical area meaning it is harder to generalise price movements. Furthermore, for electricity the tariffs are set at a half hourly level meaning that the individual consumption characteristics of a given site have a larger bearing on the overall costs incurred. These costs are currently also subject to regulatory change and uncertainty, with significant regulatory changes already underway or expected across distribution, transmission and balancing.
Energy market changes
The non-energy costs associated with the gas market are far simpler than electricity and are in essence transportation costs from the network operators in addition to metering charges. As with electricity, the gas transportation costs also vary by region and don’t necessarily move in unison.
As the energy market changes, suppliers need to be sensitive to the underlying drivers of energy prices, and aware of the independent ways in which the ultimate prices of gas and electricity paid by the customer can be affected. In some instances, it may be reasonable to expect a gas supply contract price to decrease, whilst electricity prices remain the same or perhaps even increase. What’s clear is that the prices paid by customers are not simply a reflection of wholesale energy prices and one role of the supplier is to communicate these dynamics to businesses and market participants.
Another dynamic that could become more relevant in the current environment is the role played by inflation and specifically the retail price index (RPI). Many of the non-energy costs across both gas and electricity have an RPI linked element that drives future costings. As a result, an economy characterised by higher inflation should also expect to see higher energy prices, although it is most likely to be the non-energy costs will be the primary drivers.
As a supplier to the business market, we have been calibrating our pricing and billing systems to better manage and control fluctuations in both energy, and perhaps more importantly, non-energy prices. A range of strategies can be implemented to provide customers with long-term stability, or short-term flexibility, with predictable and fair pricing. Brook Green Supply is owned by CF Partners, and benefits from added industry expertise and market insight from across a range of European energy markets to provide the best product offering including both fixed and flexible contracts to business customers. The core to any supplier cracking this is a detailed understanding of the drivers of energy supply prices.