A Guide to Understanding Electricity Prices

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What You Need to Know

  1. Utilities companies buy most of electricity wholesale from outside suppliers. A rise in your bill is normally due to a rise in the price of ‘whole sale’ electricity.
  2. The ‘wholesale’ price of electricity changes every second but long term factors, such as the rising price of oil, are normally responsible for the extra costs that get passed to consumers.
  3. In the UK 99% of the energy market has been cornered by just six companies and experts expect they will all continue raise prices in the foreseeable future.
  4. The ‘big six’ companies tend to copy each other’s pricing, if you notice one company rising prices it can be a good sign to get on a fixed tariff with guaranteed prices.
  5. Always be prepared to switch supplier. This will force energy companies to be more competitive.
  6. You can tackle price hikes and save on energy bills by choosing an online tariff or paying via direct debit.
  7. Switching quickly if the signs point to a coming price rise is advisable, as the best offers are often withdrawn beforehand.

How Are Prices Decided?

Understanding how the utilities companies come up with the figure they put on your electricity bill can help you recognise when price hikes are due and when might be a good time to change supplier.

The running costs that utilities companies face are all pretty similar and don’t tend to change. All of the ‘big six’ energy suppliers (Eon, Npower, British Gas, EDF, SSE and Scottish Power) use a lot of the same infrastructure and so have very similar overhead costs.

However, the prices they pay for wholesale electricity vary greatly (some of the big six produce small portion of their own energy, but the majority is bought from elsewhere and sold on.)

Normally, whenever there is a hike in the price of electricity these companies will pin the blame on a rise in the cost of ‘wholesale’ electricity (the product they buy and then sell on). So what factors effect this wholesale price?

Short and Mid Term Factors

Weather is an obvious factor. Naturally, in cold weather we all tend to use more electricity, not only to keep warm through the use of appliances such as electric heaters, but also in response to the shortness of the days. In mid-winter most households already have the curtains drawn and the lights blazing as early as 5pm.

However, weather also affects factors which may lower the price of electricity by increasing the supply. For example, wind turbines are able to supply more power in gusty weather. Likewise, many hydroelectric power stations benefit from heavy rainfall.

Other changes in demand that routinely effect demand include school holidays. During the summer hundreds of thousands of large buildings, which would normally be full of lit rooms with children using, computers, whiteboards, projectors and other electrical appliances, are empty.

Of course, in the summer there is often a surge for power as people look to keep cool by investing in electrically powered fans and offices turn on the air conditioning up to full blast.

As electricity, unlike almost all other products, cannot be stored, it has to be produced at the exact moment it is required. This means the producer’s wholesale price is a product of the exact conditions that exist at that precise moment. This makes these short term factors much more important than you might expect.

As a result of the wholesale price changing almost every second, energy companies have to use dedicated traders to permanently monitor the electricity market and buy up “contracts" for the delivery of wholesale energy.

The “contract" and it’s price is determined by when the electricity is to be supplied. This might be the next day, the next month or as far as five years into the future.

As this energy is often brought for delivery from overseas even the exchange rate can have a big influence on price. If the pound is globally weak, buying wholesale electricity is relatively more expensive and, if they mount, companies pass these costs on to consumers.

However, as well as these day to day ups and downs there are also long term considerations to consider.

Long Term Factors

The price of electricity is linked to a complex plethora of external variables, however, just like any other product it’s price depends a great deal on how much the ‘ingredients’ that go into it’s manufacture cost.

Despite the increased use of renewable energy in recent years, the vast majority of the electricity which powers the homes and businesses up and down the country is still produced by the conventional method of turbines powered by fossil fuels, such as coal, oil and natural gas.

As a result the price of electricity is inextricably linked to these commodities and, as they become more and more scare it is likely that their cost will keep rising.

At the same time as the reduced supply of fuels, such as oil, is driving the price of energy skyward the rapid development of many countries, especially those in the Middle East, is causing higher levels of demand for electricity than have ever existed before.

Competition

In the UK 99% of the energy market has been cornered by the previously mentioned big six. As these companies provide the sum total of British consumers’ choice it is important that consumers do what they can to try and ensure that the companies have to provide the best price possible to keep people’s custom.

Each company, aside from the considerations of whole sale price, will, as you would expect, be focusing their pricing strategy around making enough profit to please shareholders and keeping prices low enough to undercut some of the competition.

This means consumers should switch as often as possible to make the most of differences in price, as it forces the companies losing custom to keep their prices lower. As there are so few energy companies they tend to act like sheep, rising prices, one after the other (almost an act of implicit price fixing, which has lead Ofgem to investigate the industry.)

Therefore it can be a wise move to switch quickly to a cheaper company as soon as see signs that factors may cause the ‘whole sale’ price of energy to rise, as you can be sure energy companies will pass this on to you.

Finding a fixed rate tariff can also be a great idea if you believe, as many do, that the signs point to prices continuing to rise. This will guarantee prices for you for a set period of time.

Choosing an online tariff can mean you save 10% on the same product, like wise paying by direct debit can save you between 5-10%. The easiest way to pick between tariffs is to compare electricity suppliers online.

Moving quickly is advisable as companies often withdraw their best offers ahead of a price hike. Getting on a contract at the right time can lead to big savings

Further Reading

 

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