September 11, 2023

Why are gas and electricity prices linked in the UK?

In the UK, there is an intrinsic link between the pricing of domestic natural gas and electricity. This is primarily down to the nation’s energy mix and the way the wholesale markets operate. Understanding this relationship helps explain why British households have seen their energy bills skyrocket in tandem over the past year.

The UK relies heavily on gas for both heating and electricity generation. Around 85% of British homes use mains gas for their heating systems. Gas also generated over 40% of the UK’s electricity in 2021. This means demand for gas directly impacts the electricity market as well. When wholesale gas prices rise, it drives up the cost of operating gas-fired power stations. This feeds into higher wholesale electricity costs as well.

Globally, gas prices in 2021–22 reached record levels following Russia’s invasion of Ukraine. Reduced Russian pipeline gas to Europe tightened supplies, causing prices to spike. As the UK sources around half of its gas from international markets, British wholesale prices were pushed up too. Expensive gas meant electricity generation became costlier for producers.

These higher wholesale costs then flowed through to retail gas and electricity pricing. Although gas and electricity are purchased separately by consumers, their costs are intrinsically linked at the wholesale level. Ofgem’s energy price cap methodology also reflects this relationship in the way it calculates price limits.

The price cap features a single allowance for wholesale energy costs, covering both fuels. This allowance is indexed to the prices that suppliers pay for gas and electricity in wholesale markets. So when wholesale gas prices rose dramatically, it increased the wholesale component of the cap significantly for both gas and electricity.

This is why British households saw the Ofgem price cap rise by 54% in April 2022 for both fuels. The jump from £1,277 to £1,971 reflected spiralling wholesale gas prices, pushing up electricity costs as well. A further 80% increase is now expected in October 2022 as markets remain volatile. Again, this astonishing hike applies to both gas and power.

The specific figures differ slightly between fuels to account for network costs and Obligation levies. But the magnitude remains aligned due to the shared wholesale cost driver. Unfortunately, this means consumers have no way to avoid rising electricity bills, even if they do not directly use gas at home.

Switching electricity suppliers alone also provides little reprieve. All providers pay the same elevated wholesale market rates for a generation. Some green suppliers source electricity from renewables, but the volatility still impacts pricing models. Without fundamental changes to the UK’s energy mix or market mechanisms, retail gas and electricity costs seem certain to remain inextricably linked for British households.

Understanding this relationship helps consumers contextualise the dizzying energy bill increases of 2022. It also clarifies why government interventions to help households, like the Energy Price Guarantee, apply to both fuels. With gas and electricity pricing tied at the hip, ongoing strategies to improve affordability or insulation standards need to holistically target total home energy use. For now, UK households have little choice but to accept the pain of tandem pricing.