The way electricity prices are determined in the UK is widely misunderstood.
Many people assume the price reflects the cost of producing electricity from the cheapest available sources. It does not. Instead, the price is commonly determined by the most expensive generator required to meet demand, which, in the UK, is very often gas.
That arrangement is usually justified by reference to economic theory. It is said that electricity markets operate on “marginal pricing”, which supposedly reflects sound microeconomic thinking. But once you look at the theory being invoked, and then look at the reality of the electricity system, it becomes obvious that the justification is extremely weak.
Let me explain why.
First, the marginal pricing model used in electricity markets is rooted in a standard microeconomic theory of the firm. In that theory, firms maximise profit by producing up to the point where marginal cost equals marginal revenue. In a competitive market, the price that emerges is therefore determined by marginal cost, which is the cost of producing the last unit required to meet demand.
Second, electricity market regulators borrowed this idea. Electricity generators bid into the system, starting with the cheapest sources and moving upward until demand is met. The price paid to all generators is then the price offered by the final generator required to meet demand, which in near enough 97% of cases in the UK in the last year was a gas-fired power station.
Third, the result is that gas frequently sets the price for all electricity, even when much of the electricity is produced by much cheaper methods such as wind or solar power.
So far, all of this is theory. The problem is that the electricity market does not remotely resemble the competitive market assumed in that theory.
To begin with, many electricity generators do not sell their output into a competitive market at all.
Most renewable electricity generation in the UK operates under long-term contracts that guarantee a price per unit of electricity produced. These arrangements exist precisely because governments recognised that relying on volatile wholesale prices would not deliver the investment required to build renewable capacity. And, absurdly, it can be the government that profits from the higher prices paid to renewable producers over and above the price that the government has guaranteed them, which is a fact that no minister ever wants to acknowledge. In other words, the price that renewable producers receive is often not determined by the market in the first place, but the fact that they settle for a fixed price guarantee is not reflected in the price that we as consumers, or businesses as bulk buyers, are offered for electricity.
The same is true of nuclear power. New nuclear projects are built only because governments guarantee long-term prices that make those investments viable. The government is, again, the risk taker in these situations, and we, the consumers, see our benefit.
Next, investment in electricity generation is not determined by market competition either.
Electricity systems are heavily regulated. Governments determine the framework within which investment takes place. Planning systems, grid access, capacity markets, subsidy schemes, and carbon pricing all shape which technologies are built and how much capacity exists.
In other words, the electricity system is a regulated infrastructure system, not a free market. This makes the reliance on textbook marginal-cost pricing not just rather odd, but downright bizarre. The theory being invoked assumes a competitive market populated by profit-maximising firms responding freely to prices. But the electricity system is characterised by guaranteed prices, long-term contracts, regulated investment frameworks, and natural monopolies in networks.
That is not the market described in microeconomic textbooks. Yet policymakers continue to use pricing rules derived from that theory. The result is predictable. When gas prices rise, the electricity price rises with them, even though much of the electricity is produced from sources whose costs have not increased at all.
Wind turbines do not suddenly become more expensive to operate when gas prices spike. Solar panels do not either. Yet the marginal pricing rule means that electricity generated by those sources is often priced as if it were produced using expensive gas. This creates very large windfall gains for some generators.
More importantly, it imposes unnecessary costs on households and businesses.
Ironically, this outcome runs directly against the logic that the microeconomic theory is supposed to support.
In theory, competitive markets should drive prices down to the lowest sustainable level because firms compete to supply goods more efficiently. Consumers should therefore benefit from lower prices from the logic that the electricity regulator uses, but in practice, the opposite happens. As cheaper technologies such as wind and solar expand, the price paid by consumers can still be determined by the most expensive fossil fuel generator operating in the system. So the benefit of low-cost renewable electricity is not passed through to consumers. Instead, the market design locks electricity prices to gas.
This is not an inevitable feature of energy systems. It is a policy choice. And it is a policy choice based on the inappropriate application of a piece of microeconomic theory to a market that does not satisfy the assumptions on which that theory depends.
Electricity is essential infrastructure. It requires system coordination, regulated networks, long-term investment planning, and guaranteed supply. For those reasons it has always been heavily regulated. Trying to pretend that it behaves like a textbook competitive market is simply unrealistic.
The consequences are now becoming increasingly obvious.
First, consumers remain exposed to volatile gas prices even as the electricity system becomes dominated by renewable energy.
Second, windfall gains are generated for some electricity producers and the government through its price-guarantee arrangements when gas prices spike.
Third, the public understandably wonders why electricity prices remain high even when cheap renewable electricity is expanding rapidly.
And fourth, confidence in the energy transition risks being undermined if people believe that decarbonisation simply means permanently high energy prices.
None of this is necessary.
Electricity markets can be designed differently. Prices could reflect the costs of the different technologies providing electricity rather than the cost of the most expensive marginal unit. Long-term contracts, regulated pricing frameworks, or segmented markets could deliver much more stable and rational outcomes.
But achieving that requires abandoning the idea that a textbook model of marginal-cost pricing provides the right framework for electricity markets. That model was developed for competitive markets for ordinary goods. Electricity is not one of those goods. Continuing to price electricity as if it were is not just economically questionable. It is economically irrational.
What would make rational sense now would be the restructuring of the pricing of the electricity market in the UK to reflect the actual contractual conditions that exist around the generation of power to provide the returns that are actually reasonably required by each of the generators involved, with the goal of reducing to the greatest possible degree the price to the consumer. Technically, this is entirely possible. This would be a proper role for government. The one government has adopted is one that abandons the role of government and pretends, instead, that a faux market exists. That has been the height of irresponsibility..
If Ed Miliband wanted to do something really useful with his time in office, this should be his goal.
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The regional pricing structure is stoopid as well. And unfair. I live in Scotland. My electricity comes from a windfarm 10 miles away. I don’t use gas. It’s a small energy company. But regional pricing means it costs me a lot more than people living in the south of England who also use this energy company (59p vs 43p standing charge; 21p vs 16p unit rate).
There’s another problem with how it works. Since the price consumers pay is linked to the wholesale cost of gas, it essentially reinforces any business activity that creates or maintains wars and conflicts that increase the price of oil/gas.
The WM government has just awarded Musk’s Tesla a licence to supply energy in the UK. Can anyone else see the glaringly obvious issue with this, given what Musk is capable of?
Obvs, I agree 100%.
A detail. Most EU countries & the UK auction capacity for renewables. In the UK they hold “auction rounds” e.g. 1GW of solar, 3GW of off-shore wind etc. Developers then bid in projects and these are sorted on the basis of price. When the bids in terms of GW = the GW amount auctioned the auction closes. Ther auction process does “price discovery” and my/my collectives research sugests that the price of the renewables for a given auction (& at a given time) is very closely coupled to the levelised cost of renewables (LCOEs) for a given tech/at a given time. Thus auctions in 2018 delivered prices which matched 2018 LCOEs, ditto those in 2025 etc. Actions ensure that reneweables deliver pretty good value for money (until they hit marginal pricing sysytems).
Last consideration: given most projects are built using a debt/equity mix of 80/20 one can see the importance of interest rates – differential rates were discused in a recent blog & there is a very good argument for differentail rates for renewables – which would drive down LCOEs which incorporate weighted average cost of capital (WACC).
All noted and thanks
In effect then, Starmer’s government has potential control of the situation but has chosen to do nothing about it. They accept the electricity market as they have ‘found it’.
I’ve been reading ‘The Fraud’. The assertion that the Labour party has been ‘captured’ by vested interests is to me at least incontrovertible.
The dear old CEGB – Central Electricity Generating Board had a statutory duty to produce power at the lowest price, hence a lot of the objections to nuclear were based on price as much as anything else
So why doesnt the same duty exist now on whoever sets the price cap?
An excellent question
Simple answer, it makes life harder for the b’stards to fleece us. It seems as if the whole economy is set up by the fleecers for the fleecers.
Why is the government investing or promoting in nuclear at all? It makes no sense.
The argument is that it provides power when “the sun doesn’t shine and the wind doesn’t blow”. And, indeed, that can happen on occasion. But in those circumstances nuclear must be able to substantially power the entire grid. And, if nuclear can power the grid, why build renewable at all? Why not just use the nuclear backup all the time?
Nuclear and renewables are in direct contradiction. You need one or the other but not both. And renewables are cheaper, safer, more environmentally friendly, and more robust (more decentralised and not a target for military attack).
Of course we do need renewable storage. This is quite possible in several ways (see, for example https://www.bbc.co.uk/future/article/20251009-the-liquid-air-alternative-to-fossil-fuels).
So nuclear energy makes no sense (and this includes fusion)! It would need to be substantially cheaper than renewable; it isn’t now and will not be in the foreseeable future. There is no point in modular nuclear reactors either.
We do, of course, need renewable storage and investment should be directed there.
I have agreed with this since about 1971.
I can answer that. Wakeham changed the rules to allow gas to be burnt for power, specifically removed the minimum price commitment, and picked up a lucrative directorship with Enron.
The question of how to integrate the independent gas gen stations into the CEGB distribution baffled the DoE civil servants. The CEGB had just been broken into four, so they asked the oil companies for draft proposals, and pretty much built those into policy.
Even then, the gas supply prices were on long take-or-pay contracts, and the generators weren’t too greedy as they all had interests in the domestic gas supply market competing with British Gas, so the marginal ripoff wasn’t really apparent.
Only post-2006 or so did the greed kick in, gas prices shifted to much higher spot prices and LNG import prices, generator profits just went up and up, nobody in govt noticed or cared.
By that time, plenty of other countries had started liberalising their markets, and took this idiocy onboard as a validated practice, with the companies whispering in their ear too.
If I choose to rely on the electricity generated by solar panels or wind turbines on my own property, presumably my only cost would be the initial outlay. Most people don’t have the option of course, but those who do could surely sell their surplus to their neighbours instead of to an electricity company. Could a local council set up such a scheme & bypass the big companies? For a strictly local scheme might the infrastructure be minimal?
I think you’re more find that regulation does not allow you to sell your electricity to anyone else
You could do this if you setup your own energy cooperative but it is complicated. This was the model ripple energy was using (they went into administration last year but the cooperatives that own the power generation are still operating).
The original model was that you owned a share of a wind or solar farm, and would receive wholesale prices for the generation that was achieved. Previously that was applied as a discount on your bill. Given the folding of the company the new plan is to pay directly to the members. I invested some money in this because it seemed a good idea to help build renewables and a useful hedge against rising electricity prices.
It’s unfortunate that ripple energy went out of business, but the thoughtful set up of cooperatives mean that the investment is not lost and we will expect to be receiving payments back for the energy produced later this year. They used it to build several projects, namely Graig Fatha Wind Farm, Derril Water Solar and Kirk Hill wind.
https://www.thenews.coop/ripple-energy-which-worked-with-community-sector-goes-into-administration/
FYI From The Times Why the cost of gas sets still sets the price for our electricity 16.3.26
“With the cost of energy in sharp focus, Bell, a former government official, believes reforms to stop gas setting wholesale power prices should be back on the agenda. He has proposed that gas plants should be removed from the market and placed into a strategic reserve that runs when instructed by the National Energy System Operator; gas plant owners would receive regulated income to cover their operating costs and a fair profit. Bell argues this would be attractive to some utility companies seeking stable returns, although admits there is opposition from trading-focused businesses that enjoy the “frothy upside” of markets.
Although consumers would still end up paying for the running costs of gas plants, he believes the benefits from preventing gas setting the price for other generators would be huge. In analysis commissioned by Greenpeace, Stonehaven estimates that if the reforms were already in place this year, potential power cost savings could be £5.8 billion, or about £75 per household.”
A similar argument put forward at Funding the Future during the Ukraine-Russia conflict.
Thanks
What is proposed would keep the marginal market – which is the problem.
What is needed is: market split with CAPEX stuff (RES & nukes & hydro) given priority dispatch & with fixed prices (based on auction strike price – probably need to “grandfather” the nukes wrt price, ditto hydro). Stick the deterministic (fossil) generators at the top of the stack for when RES output << demand. Then set a composite price – which would be real price of RES gen (& nuke+hydro gen) + what is considered OK for gas.
I agree. The consumer price should be a composite of the prices paid by the regulator two energy generators at a fair rate that allows for them to make a reasonable profit merchant. It should never be set by one generator in isolation.
This morning the grid dashboard is showing over 5000MW being exported from Scottish capacity to Englandland.
This will be , in the main, wind generation.
The AGRs are working at around 50% of their origonal installed capacity, this is due to old age, crack inspections and refuelling.
Hunterston B station is now our responsibility as EDF have handed the station back as they no longer run it.
The battery back up stations are becoming the latest wizz, charge with reduced cost energy and sell it back at a nice profit, they are Peak Loppers, they generate for short times.
The HVDC cable systems are very hard to understand, you can find the French cable transmitting to england and then transferring to Netherlands, from my geography they are land connected. Why convert 60 Hz generation to HVDC, convert to 50HZ, convert to HVDC, then back to 60Hz, each convertion has lost energy and hence costs.
There is a total requirement to import energy from Europe to supply the grid.
Taking back control.
I agree, taking back control is essential
europe operates on 50hz the same as us.
its north america that 60hz
What would make rational sense now would be the restructuring of the electricity infrastructure in the UK, to bring it into public ownership under one system. Privatisation has not resulted in cheaper costs due to competition; rather, it has increased costs due to rent extraction, in order to pass yet more wealth to already wealthy shareholders.
Unfortunately, most people are not aware at all of this.
What I find really annoying is that it allows Charlatans to get away with lies.
Here’s one today — BBC front page.
Reform UK has promised to scrap VAT and green levies on household energy bills if the party wins power
At a rally in London, Farage is expected to say: “Labour and the Conservatives have pursued a net-zero agenda that has only led to skyrocketing energy bills for working people.”
The BBC doesn’t question now false this is (or mention any of what you have written above).
They are also trying to buy votes.
Reform is launching a prize draw to promote its announcement, with the party promising to pay the energy bills of the winner and their entire street.
A party spokesman said the competition did not breach electoral law.
https://www.bbc.co.uk/news/articles/cly0j6nnk4zo
This is from the dependence on fossil fuels, oil and gas, party.
Renewables are clearly the cheapest and cleanest option going forward. It is also the only option that offers the best security for the future, provided the state is prepared to take greater control of an essential need, and move away from a system that does not benefit ordinary people.
I fear that many will believe Reform though.
Indeed this is the point I was going to make before I saw your post. We’re in the ludicrous situation where a volatile price for fossil fuels allows the climate change denying cranks to dump all over renewables and the net zero agenda.
Totally agreed
I think Ed Milliband’s hands are tied and that he wants to execute sensible policies but is not being allowed to. He won’t speak out, but I’m guessing he’s very frustrated. As a long term Green I get very frustrated with all the promises made by the major parties that are jettisoned as soon as they get in power. Much as I dislike Reform,they are at least honest with this regard.
I sincerely hope that the Greens start to talk about this one in a big way.
I am rather tired of the amount of green wash in mainstream politics. And the general lack of understanding in society about the environment. People think a bit of recycling will make up for rampant consumerism. Caroline Lucas is amazing and a good communicator, but I’m not sure she ever reached the unconverted. I think she encouraged those of us who already understood.
I remember doing a summer job at the Met Office in 2002 and learning about how climate change would manifest. We are now seeing undeniable climate change. We had Biblical amounts of rain in Devon early February on already sodden ground. The flooding was so bad many schools were closed and even the M5 was closed due to flooding, it it barely made the news.
The elephant in the room is we have to change how we live, which means much less travel, less heating and less consumption and we must relocalise our economies. Is Zack brave enough to share this message?
It is a message we have to talk about. I read the club of Rome report in the early 1970s. I was a teenager. I knew then that the lifestyle that was being sold to us was not sustainable. It is now very long past its sell by date.
Yes, it is a great opportunity for the Greens. If only a debate about this could be had in the media.
I understand that wind turbine owners are also paid to switch off when the grid is over capacity. I would not be surprised if that were the case today, as it is very windy here in East Lothian, and we have a lot of wind turbines. I am wondering how what they get for that equates to how much they are paid to generate? It seems reasonable to assume parity? Can anyone tell me?
I think that Mike Parr is the one to explain this. Mike, please?
Yup, the wind turbines get paid when there is not enough capacity on the Scotland – England interconnectors. NESO (the Nat Grid now gov owned control outfit) hold a weekly “what happened to the system last week” on-line meeting. I often attend. Constraint payments (which is what we are talking about) range from £40m to £80m per week (yup – you read thr right). NESO talk about “thermal constraint” – which makes up the bulk of constraint payments & applies to gas turbines (circa 80%). So yes, wind gets constraint payments, but the gas mob gets paid multiples of what the wind mob get.
A) the gas mob should get zero.
B) the wind mob should be able to pump surplus Scottish elec into e.g. electrolysers (batts don’t scale to the volumes required) which make hydrogen. Gov builds the electrolysers, buys the elec & then sells the H2 (to e.g. the steel industry, the fertiliser industry (which does not now eixst in the UK etc.).
Thanks, Mike
Thanks Mike, that is mind blowing. I am not a fan of hydrogen, it is a bit too easy to blow up. Instead why not freeze air https://highviewpower.com/ They are building a plant at Hunterston in Ayrshire, which already has grid connection as it is on the site of the now defunct nuclear power station. Planned to come on stream next year, long before Hinkley C
So glad to hear the mention of hydrogen. I’m a big advocate for energy storage use of hydrogen but I always get met with ‘it’s so inefficient to create…’ which I always respond with but there is so much surplus ‘free’ energy being wasted from renewables. The match seems perfect. I can only cynically think that hydrogen just gets ignored because it would pose a direct threat to fossil fuels. But perhaps I’m being too cynical.
Am I reading this right? We’re paying wind turbine owners to switch their turbines off and then paying gas power stations to produce more expensive electricity using gas?
This is total utter madness. Surely renewables should always be used first and only gas when not enough is available. I understand you can’t switch nuclear off, but that is another story altogether.
You are reading this right. That is the absurd situation that we have reached because of our dsimal failure to invest in the National Grid
The ticker on the Octopus Energy website shows a running total of the cost of switching off wind turbines. It currently reads as follows and their CEO, Greg Jackson, is a staunch advocate for reform of the electricity marketplace.
In 2025, Britain wasted
£1,467,023,332
switching off wind turbines.
I agree that this is utterly ridiculous, and it represents the cost of failed regulation and a false adherence to micro economic theory
This is a pretty good article:
https://ukerc.ac.uk/news/transmission-network-unavailability-the-quiet-driving-force-behind-rising-curtailment-costs-in-great-britain/
UKERC is pretty reputable & have published reports that tell it the way it is. £1.4bn for wind seems high. But given the data in the article perhaps not so far off the mark. The problem is, the UK assumes: “let’s build more network” – fine – but that is very costly and takes a long time (anybody know what the foundations of a transmission tower look like? I do – lots of steel, lots of concrete – when you see a pylon – you are looking @ the tip of the “iceberg”). Quick solution to constraint & payments – electrolysers. £1.4bn buys perhaps 7GWs of electrolysers – & it would take a year or so to install them. What to do with the H2? One of the Peterhead to South of England gas pipelines could be converted to carry HP H2 (oddly UKERC did a pretty good report on converting sub-sea/North Sea old gas pipelines to carry H2. Not a big problem – cos the pipelines use a relatively low quality steel – yes I know – counter-intuitive as is so much in the energy sphere.)
My father designed the 440kv transmission line that crosses the Fens. 40 old years after he did the work, the pylons are still there. None has sunk. None are leaning over. Everything else in the fens does that. I can recall him telling me how challenging that was.
Message for Sue H.
Hunterston B no longer has grid switchgear to connect, it has been removed.