The spot market is a
blemish on energy bills,
says James Meadway

At the end of a bleak year, there was a glimmer of good news: worldwide energy prices have continued to fall, with natural gas prices on the wholesale market in Europe now below their pre-Ukraine invasion level. This could be good news for hard-pressed households and smaller businesses, who have faced exceptional price increases for their energy over the last year. But will this price drop last – and how long before most of us in Britain see any difference to our energy bills?

The surge in energy prices over the last year was driven by the massive disruptions to global supplies of oil and gas by Russia’s invasion of Ukraine and the ending of Covid lockdown. The rise in the last 18 months or so has been extraordinary, with wholesale gas prices in Europe and Asia increasing to 15 times their January 2021 level in August last year.

Natural gas suppliers, which buy gas on the European wholesale market and sell it to home and business customers, typically passed on at least some of these huge price increases. That helped push inflation across the continent to the highest levels for 40 years.

In Britain, the impact has been particularly dramatic. In April, Ofgem, which is supposed to regulate the privatised energy market and protect consumers, allowed the “typical” household bill to rise by 54 per cent, to almost £2,000 a year. A further, eye-watering rise was scheduled for October, had it not been for the government’s Energy Price Guarantee limiting them.

The problem is that Britain’s nationalised gas supply system, built over many decades up to the 1980s and reliant on long-term contracts for gas supply, was replaced by a privatised system from the 1990s onwards. This made use of short-term supply contracts and the so-called “spot” market. The spot market is the day-to-day market for gas, where prices change very rapidly as demand and supply fluctuates, compared to longer-term contracts that lock in prices over a longer period of time.

The theory was that, freed from longer-term contracts, gas suppliers would be able to buy cheaper gas from many competing sources on the spot market, and so cut prices for consumers. The system seemed to work for a while – with government encouragement, more companies entered the market and consumers paid lower prices. In 2017, the government was so confident in the security of this free-market system that it even allowed the closure of the Rough gas storage facility, off the coast of Norfolk, which accounted for 70 per cent of the country’s gas storage space.

But with North Sea supplies declining rapidly from the late 1990s, gas suppliers increasingly had to rely on European sources. Gas also came from further afield, through liquified natural gas, transported in ships from places like Qatar. Britain became a net importer of gas in the early 2000s, increasingly exposed to fluctuations in worldwide gas prices. And with the whole system so short-term and privatised, profit-chasing energy suppliers would quickly try to pass on price increases to their customers.

This is exactly what started to happen from mid-2021. The ending of Covid lockdowns brought a surge in demand for energy across Europe and Asia, as businesses reopened and people returned to their daily lives. This pushed up prices. UK domestic prices rose; and where gas supply companies weren’t able to pass on increases, they went bankrupt – 35 in the last two years.

Although the UK bought little of its gas from Russia, the invasion of Ukraine caused fears of Europe-wide supply restrictions and therefore more wholesale price rises. Lacking storage capacity, we have to buy gas for immediate use at super-high prices on the spot market. France has 126 days of gas consumption stored. Germany has 108 days. The EU average is 98 days. Britain has enough gas capacity for just nine.

And whilst the Energy Price Guarantee capped further increases in October, it is set to expire in April, exposing the typical household to a forecast bill of £4,000 a year. The Treasury is apparently working on a replacement system.

But surely, if energy prices are now falling across Europe, British consumers should be among the first to benefit? Unfortunately, whilst our energy system is good at turning rising wholesale prices into rising consumer prices, it’s not so good in reverse. Private companies are expected to make a profit and where – as with many UK suppliers – they are loaded up with debt, energy customers are low down on the list of beneficiaries. Shareholders and creditors are prioritised.

An energy system focused on providing a public service first and foremost could act differently, which is why, over the longer term, research finds that publicly owned energy systems have prices 30 to 40 percent lower than privatised.

The obvious solution is to do as the Trades Union Congress has proposed, and bring our mess of an energy system into public ownership. Labour has the good idea of a publicly owned renewable generator, giving the public a stake in future energy production. But we also need the wider supply system brought into public ownership – focused on the long term, putting households and businesses first, and stripping out the short-term profit incentive.

James Meadway is an economist and director of the Progressive Economy Forum, an independent thinktank (progressiveeconomyforum.com)