In the UK wholesale electricity market generators sell electricity to suppliers. In the retail market the suppliers then sell to customers.
The price paid for wholesale electricity on the ‘spot market’, where some 30% of electricity is sold, is largely determined by the price of natural gas because of the ‘marginal cost pricing’ (MCP) system.
Basically, under MCP, units of electricity are sold at the price of the most expensive unit needed to meet demand at a particular moment in time. Spot market prices also usually serve as the price reference in long-term contracts.
In each half-hour trading period, electricity generator bid the price they'll accept to generate electricity. The bids are accepted in ‘merit order’ until the demand for electricity is met; the cheapest first, and the most expensive last. However, the price of all units of electricity is set according to the bid price of the most expensive unit needed to meet projected demand: this is the ‘marginal cost’.
Renewable generators typically have the lowest costs and so are the first to meet demand. Fossil fuel generators (including gas) often
have the highest costs as they must buy fuel to burn, which also has a carbon
price on it. Gas based generators can also
quickly burn more or less to match temporary spikes in demand for electricity
during a day.
As a result, although most electricity is produced using sources with low marginal costs (42% by renewables and 15% from nuclear), the price that is paid for electricity traded on the spot market is often higher, at the marginal cost of generating electricity with gas. (Gas provides some 40% of electricity generation).
MCP also 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 have therefore announced large profits. To respond to large profits, the Government introduced a levy of a 45% charge on exceptional profits from low-carbon electricity generators, in effect for large generators until March 2028.
In 2022 the UK Government ran a consultation on how to separate electricity prices from gas prices. Some of the proposed changes include:
• Introducing incentives for
consumers to draw electricity from the grid at cheaper rates when demand is low
or more renewable energy is available.
• Creating separate markets
for renewable and fossil-fuel generated electricity, so renewable energy prices
can be set independently from gas.
• Reforming the capacity
market to increase low-carbon flexibility technologies that are more responsive
to changes in demand and supply, such as electricity storage.
In the summer of 2025 the Government set out its conclusions from the consultation, which were, in summary
a) Reform the GB wide wholesale pricing so customers get fair prices, investors benefit from a more stable and predictable framework so costs can be lowered for retail customers.
b) Have a clear plan for the future
power system so locational considerations can be accurately factored into
investment and system planning.
c) Reform planning, seabed leasing
(the process by which new offshore projects are brought forward and sequenced),
network build, the connections regime, and transmission network charging.
More detail on the specific and the delivery programmes for the above three ways forward will be available in the future.
Notes on sources of above info
1) https://commonslibrary.parliament.uk/why-is-cheap-renewable-electricity-so-expensive/
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