This briefing introduces the domestic energy market in Great Britain, explains how energy bills are calculated, and what the current challenges are.
Introduction to the domestic energy market (2 MB , PDF)
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The next scheduled update for this paper is in October 2024. The latest data on wholesale gas and electricity prices, the price cap and prospects for changes to prices in the future are all included in the briefing Gas and electricity prices during the ‘energy crisis’ and beyond. |
Domestic energy is energy used in the home. For instance, for lighting, cooking, heating, and powering devices. It is usually provided to households in the form of electricity or gas.
This briefing explains key concepts in Great Britain’s domestic energy market. It aims to answer these questions:
It is a set of Library briefings on domestic energy. Others are Domestic Energy Prices, Gas and electricity prices under the Energy Price Guarantee and beyond and Households off the gas-grid and prices for alternative fuels.
This briefing focuses on Great Britain’s energy market. Northern Ireland has a different energy market, with its own rules and regulations.
In Great Britain, most households are supplied with gas and electricity through the energy system. This system is composed of:
The Government sets energy policy and the Office of Gas and Electricity Markets (Ofgem) regulates the electricity and gas markets.
This is shown in the diagram below.
Energy generation refers to producing gas (from extraction) and electricity (from burning fossil fuels, nuclear or renewables).
Most of the gas consumed in the UK came from domestic production (54% in 2023), with the remainder coming from imports. The UK imports gas through pipelines from Europe and tankers of liquified natural gas (LNG) from various countries.
Most of the electricity consumed in the UK is generated in the UK. In 2023, 41% was from renewable sources (such as solar power and wind power), 36% of electricity was generated from fossil fuels, and 14% was from nuclear energy.
Once generated, gas and electricity are transported through transmission and distribution networks.
Gas is transported across the country by the National Transmission System (NTS). The NTS supplies gas to the eight Gas Distribution Networks (GDNs) that cover different geographical regions of Great Britain and provide gas to households.
Electricity is transported from power stations by transmission networks. Electricity substations are used to transfer high voltage electricity from transmission networks into lower voltage electricity on distribution networks, which supply households.
The supplier buys gas and electricity on the wholesale market and sells it on to domestic consumers in the retail market. There were 21 active suppliers in the domestic gas and electricity retail markets as of quarter 3 2023.
The Government Department for Energy Security and Net Zero sets policy and Ofgem regulates the electricity and gas markets.
Recent Government policy has focused on the energy ‘trilemma’ of sustainability, security and affordability.
The Energy Act 2023 received Royal Assent on 26 October 2023. It aims to ensure a “a cleaner, more affordable and more secure energy system for the long term”.
Customers’ bills are calculated by multiplying the prices per unit (unit rates) of gas or electricity by the amounts used, plus the daily ‘standing charge’.
Tariffs are either fixed for a certain amount of time, typically one year or more (a ‘fixed rate’ tariff) or they can go up or down according to the market (a ‘variable’ tariff).
The energy price cap limits the rates suppliers can charge for the standing charge and for each unit of electricity and gas used. It does not cap individuals’ total bills, which depend on how much energy they use. It is often described in terms of the annual bill for a household with typical energy consumption paying by direct debit, but the actual cost for each household depends on how much energy is consumed.
The Energy Price Guarantee (EPG) was introduced between October 2022 and March 2024 to reduce price increases for domestic customers. Under the scheme, the Government sets maximum prices for gas and electricity and compensates energy suppliers for providing gas and electricity at below cost prices.
The cost of an energy bill depends on energy usage, energy supplier and tariff, type of meter, payment method, and location.
The price paid for wholesale electricity on the ‘spot market’, where around two fifths of electricity is thought to be sold, is set using a system called ‘marginal cost pricing’. The most expensive type of energy used to generate electricity sets the price for all types of energy, including renewables. As gas is often the most expensive energy source, prices of electricity generated by gas effectively set the wholesale price for all generation.
Wholesale energy prices started to dramatically increase from mid-2021 and remained high for much of 2022, both globally and in the UK, after having been stable for a decade. The initial rise in energy prices was mostly because of rising demand after Covid-19 restrictions were lifted, and then because of Russia’s full-scale invasion of Ukraine. Prices have returned to lower levels in 2023 and 2024.
Many suppliers that could not protect themselves against the increase in wholesale prices have traded at a loss, become insolvent and had to notify the regulator, Ofgem, that they can no longer trade.
Ofgem has two main processes for maintaining the supply of energy to customers when a supplier fails: transferring customers to a ‘supplier of last resort’ or establishing a special administration regime (SAR). The costs of supplier failure are recovered through domestic energy bills. This is an indirect cost of higher wholesale prices.
Suppliers operate in a competitive market where they set their own prices, and consumers can choose suppliers based on preferences such as price and service. Increases in wholesale energy prices meant that most suppliers were selling energy near the maximum tariff possible, the Government’s price cap or previously the Energy Price Guarantee (EPG). This effectively halted competition as there was no incentive for customers to save money by switching supplier.
Price rises have a disproportionate impact on lower-income households. There is concern that high energy prices are causing more households to be in fuel poverty, where they must spend a high proportion of their income to keep their home at a reasonable temperature.
In the latest estimates, around 13% of households in England, 25% in Scotland, 14% in Wales, and 24% in Northern Ireland were classed as being in fuel poverty. However, fuel poverty data for different nations are not directly comparable and do not account for the recent rapid increases in domestic energy prices.
Many companies that generate energy (oil and gas producers and electricity generators) have announced record profits because of rising wholesale energy prices.
Introduction to the domestic energy market (2 MB , PDF)
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