Why net zero Britain is battling some of Europe’s highest energy bills

Grant Shapps, the energy secretary, vowed to give Britain the “cheapest energy in Europe” as he set out to overhaul the power system as part of the push to go green.

For struggling households and businesses across Britain, the promise was doubtless a welcome one. But it was also a tacit admission that they have long been saddled with some of Europe's highest bills.

Industrialists including Sir Jim Ratcliffe have bemoaned the huge costs faced by energy intensive businesses, while households have been better off in a raft of countries on the Continent.

Data suggest this has had an outsized effect on the UK economy. Inflation in February was 10.4pc when energy prices were included, according to official statistics – but a much lower 7.6pc without them.

In the eurozone, inflation including energy bills was 8.5pc. But excluding them, it would actually have been higher than in Britain at 7.8pc.

A toxic combination of net zero charges and subsidies means that unfortunately for Shapps, there are few quick fixes if he wants to meet his goal.

Green levies

The energy bills households and businesses pay are split into two parts – for the gas that heats boilers, and the electricity that keeps the lights on. These are very different markets.

The price of each to the end consumer is made up of the wholesale price of the product, as well as fees and taxes lumped on top.

Wholesale electricity prices in Britain had been higher than much of Europe for several years before the energy crisis, in large part owing to a move away from coal in favour of less polluting but more expensive sources of power.

The UK introduced extra carbon taxes – fees paid by a polluter for every tonne of carbon dioxide they emit – in 2013, to push electricity generators away from coal. Meanwhile, in the European Union, the price paid for carbon fell.

It meant UK power generators paid an initial minimum £16 per tonne of carbon dioxide, encouraging them to swap coal-fired stations for lower-carbon natural gas, biomass, or move into wind power generation.

In the EU, carbon costs at one point fell as low as €2.75 (£2.41).

Britain's higher charges have been a success in terms of cutting carbon emissions. The UK generated around 2pc of its electricity from coal in 2021, compared to about 30pc in Germany.

However, the extra carbon taxes have added to wholesale electricity prices as generators were forced to charge more to cover their costs.

For example, in 2021, average electricity wholesale prices in Britain were £113 per MWh, compared to €96 per MWh in Germany.

“Within Europe, wholesale prices have been more expensive in Britain basically because of the higher carbon price,” says Tom Smout, senior associate at Aurora Energy Research.

By the time electricity reaches the consumer, it also includes further levies on top of the wholesale price.

These levies account for about 8pc of today’s UK domestic electricity bills, according to analysis by the Energy and Climate Intelligence Unit – equivalent to £131 per household.

The bulk of these costs have been spent on subsidising wind farms. There are also fees to insulate homes and help vulnerable households with their energy costs.

Britain has resisted calls to remove green levies despite the jump in overall bills.

In contrast, Germany scrapped a controversial renewable energy levy last year, a move expected to save the typical household an annual €200, with subsidies instead funded by public money.

Dependence on gas

Meanwhile, the UK’s reliance on gas has also grown significantly over the past 50 years.

The discovery of oil and gas in the North Sea in the 1970s has helped feed a persistent dependency, with the vast majority of homes heated by gas-fired boilers and many industrial processes depending on it.

Gas also generates more than a third of the UK’s electricity across the year, and sets electricity prices across the market. Overall, gas accounts for just over 39pc of the UK’s energy mix.

That meant the UK was acutely exposed when gas prices began to shoot up in October 2021.

Gas prices in the UK are typically similar to those in the EU. However, Britain’s heavy reliance on the gas means it feels price increases more severely. By way of comparison, more than 40pc of French homes, for example, use electric central heating – where prices have fluctuated far less. About a quarter of homes in Germany use heating oil instead of gas.

Pierre-Olivier Gourinchas, chief economist at the International Monetary Fund, in January pointed to Britain’s heavy reliance on gas as one reason why it had been hit particularly hard by the energy crisis.

“We’ve had a very sharp increase in natural gas prices, energy prices in the UK,” he said.

“And there is a larger share of energy that is coming from natural gas with a higher pass-through to final consumers. And so, that has affected -- there’s been a stronger cost of living crisis, if you want, in the UK.”

Over the long-term, therefore, carbon prices on electricity and the UK’s heavy reliance on gas have added to pressure on energy bills in Britain compared to international peers.  

Subsidies

During the energy crisis of 2022, the dynamics of wholesale prices changed.

Cuts to flows of gas from Russia caused sudden price surges in Eastern Europe. A slump in output from France’s nuclear power stations added to the problems.

Europe was frequently importing gas via the UK from the US, and electricity from the UK as well, pushing up prices in Europe relative to the UK and meaning that for much of the crisis, the traditional position where British wholesale prices were higher was reversed.

Average wholesale prices in Britain were £200 per MWh in 2022, slightly lower than the €235 per MWh paid in Germany according to Mr Smout.

The amount households have been paying over the past year has also been heavily distorted by levels of government subsidy. These vary significantly across Europe.

In the UK, for example, households are currently paying 33.2 pence per kilowatt hour for electricity, far lower than the 51p the energy companies are charging. The government is subsidising the difference, which has brought down the average bill from £3,280 to £2,500.

Although this is generous – and at an estimated cost of £69bn for households and businesses, extremely expensive for taxpayers – other European governments have offered even bigger giveaways.

Ranked by percentage of GDP allocated to energy, the UK is middling at 3.8pc, with Italy ahead at 5.2pc.

In France, President Emmanuel Macron ordered its state-owned nuclear power giant EDF to sell electricity at a lower price to tackle the energy crisis – something Britain has been unable to do.

More costs to come

Still to come is the cost of the transition to a net zero economy by 2050 – estimated two years ago by the Office for Budget Responsibility at £1.4 trillion, a figure it said would be partly offset by £1.1 trillion of theoretical savings through measures such as more efficient insulation.

It is not clear how this huge cost will be met – whether with charges on bills, additional taxes or some combination of both.

But as Mr Shapps looks to develop the “cheapest energy in Europe,” the path ahead is complex.