UK energy bills: explaining how expensive subsidies can help lower power prices

The bills of the British electricity consumer are the topic of much heated debate. High wholesale, balancing and subsidy costs now result in Great Britain (GB) seeing some of the highest energy bills in Europe. The government’s solution to this, the Clean Power 2030 Action Plan, seeks to build a cleaner power system which would, in theory, bring cheaper bills along with it.

That five year horizon may seem a long way out, however when it comes to energy markets, it is anything but. A colossal buildout of renewable and flexibility assets is required to meet Clean Power 2030 targets. Many wonder if the target is really achievable and what the power system could look like in five years, even if the lofty ambitions aren’t quite met.

How the cost of this renewable buildout is met through consumer bills is a tug-of-war. Consumers make savings from cheap power brought into the market by renewable generation, but they also pay for the subsidy mechanisms required to deliver it. The Contracts for Difference (CfD) scheme, GB’s flagship renewable subsidy mechanism, may begin to creak under the weight placed upon it by government generation capacity targets. If buildout were to be as substantial as planned, there would be more periods of renewable generation oversupply, when wind farms all across the country are producing more power than the system can handle and prices drop to negative levels.

When that happens, assets with newer CfD contracts would likely self-curtail, as their subsidies wouldn’t pay out under the negative prices. But as more wind farms come online and apply for contracts, the likelihood of these negatively priced periods occurring increases. Therefore the number of periods in which a wind asset holding a CfD contract would be paid its subsidy also decreases. It may well be the case that assets will therefore want to be paid more in the periods where their contracts will pay out in order to secure investment.

This creates more uncertainty; are higher clearing prices in the CfD auctions a natural consequence of greater generation capacity? If so, will this translate to a net benefit to consumers who will be paying further subsidies, but potentially also making gains from the lower overall wholesale prices?

These are questions the government must answer. In its recent decision around the budget for Allocation Round 7, the latest auction round for the CfD contracts, the government has set a budget of £900 million for offshore wind. In last year’s Allocation Round 6 auction, which took place before the ambitious Clean Power 2030 targets were published, this budget was £1.1 billion. These figures were published in 2024 indexation for Allocation Round 7 and 2012 indexation for Allocation Round 6, perhaps to soften the blow this drop in budget represents.

To many, this reduced budget flies in the face of the government’s previously stated ambitions. While a cautious CfD budget indicates a government only too aware of the growing subsidy costs, the complex relationship renewables can have on the bottom line for consumers means that the final result of this decision on the bill for 2030 remains to be seen.

Wholesale and subsidy costs are far from the only items that make their way to consumers. Balancing the system and ensuring supply and demand are always in sync is a huge cost too - and the way in which renewables are affecting these costs is changing. Many of the existing wind units and the projects in the pipeline are based in Scotland, resulting in frequent downward dispatch (due to oversupply in the area which cannot be handled by the grid infrastructure) and consequential upward redispatch in England (in order to meet demand further South). Each of these actions incurs a cost, as renewables seek compensation for the subsidies they would lose by switching off and assets able to generate power on-demand seek to optimise their revenues when called upon. Further buildout of renewables in Scotland may exacerbate this issue if future grid upgrades such as the Eastern Green Link bootstrap submarine cables between Scotland and England prove insufficient to transport excess renewable power.

Conversely, greater volumes of self-curtailing wind can provide a valuable balancing tool should the system become short during delivery periods. Wind generators that switched off due to financial reasons, rather than physical reasons, can be switched back on as soon as the money starts flowing again. Balancing payments from the system operator can bring self-curtailed wind volumes back online as a cheap option in balancing. There have already been several days this year in which this counter-intuitive phenomenon was seen. More wind on the system could mean it is here to stay.

While the end consumer likely won’t be interested in markets dynamics and mechanisms, they will most certainly be interested in the bottom line for them. Everyone in Westminster knows this, as public support for net zero will be vital if it is to be delivered by 2050. How the market behaves in a renewable dominated system and how much these renewables will cost are not entirely understood yet, but these will prove the essential questions in facilitating the green transition.