What causes energy prices to go up?

It is often inexplicable to consumers why energy prices continue to rise so dramatically. Current hikes of around 8 to 9 per cent in the UK do not reflect equivalent rises in wages or indeed other household costs. Fixed energy prices are some households’ solution to the problem and can be a good idea. But why do energy prices go up?

What factors influence your energy bill?

To understand why energy prices go up, it is necessary to understand what factors contribute to energy bills in the first place. Firstly, there is obviously the cost of the gas and electricity itself. This accounts for about 50 per cent of your energy bill (Ofgem, 2011). Other costs include distribution and infrastructure, as well as VAT. Then there is profit on top. Infrastructure costs are certainly increasing, which has knock on effects for consumers. This type of cost includes the construction and maintenance of gas pipes and electricity wires, together with pylons and gas pipes. There is also the introduction of renewable technology. However, the main reason that energy prices go up so dramatically is wide and unpredictable fluctuations in the wholesale cost of gas and electricity.

Why has the wholesale price of gas and electricity gone up so much?

Gas prices have been increasing since 2004/2005, when they reached their lowest levels for decades. Crucially, it was at this time that gas imports overtook native gas production in the UK. This means that the country’s energy supply and prices have become more sensitive to external global factors. To obtain gas from Europe, the UK needs to be able to pay as much as the Continent. And because gas prices in Europe have a close relationship with oil prices, oil prices become a major contributing factor to gas price fluctuations in the UK. This also affects electricity prices, because the cost of producing electricity is dependent on fuel costs.

How have worldwide events affected energy prices?

The wholesale price of gas has increased due to many global events. These include rising demand, especially from China and other countries in the Far East, including Japan following the Fukushima nuclear incident; and political upheaval in many regions, notably the ongoing tensions in the Middle East and events of the Arab Spring.

What other factors are at play?

There are also other factors to consider. Environmental targets are becoming an increasingly prominent concern for energy companies. Ofgem estimates that an investment of £200 billion is needed to meet them in the next several years. Yet while environmental targets currently add about 9 per cent to average energy bills, it is envisaged that the increasing use of alternative fuels could help to reduce energy bills in the future by reducing reliance on gas imports. Government policies aimed at households and small businesses to encourage them to install solar panels and similar sustainable technologies also needs to be accounted for, and energy suppliers factor the costs of implementing these policies into the average household bill. Investment is also needed to replace nuclear and coal fired power stations, as they do not meet EU emissions targets, and to improve general infrastructure throughout the energy networks.


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