Introduction to the domestic energy market

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:

• How is the domestic energy market structured?
• How is a typical household energy bill calculated?
• What are the current challenges in the energy supply market?

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.

How is the domestic energy market structured?

In Great Britain, most households are supplied with gas and electricity through the energy system. This system is composed of:

• generation (producing energy)
• transmission and distribution (transporting energy from where it is generated to where it is needed)
• retail (energy suppliers buy gas and electricity from energy generators on the wholesale market and sell to consumers on the retail market)

The Government sets energy policy and the Office of Gas and Electricity Markets (Ofgem) regulates the electricity and gas markets.

How and where is energy generated?

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 2022), 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 2022, 41% of electricity was generated from fossil fuels, 41% was from renewable sources (such as solar power and wind power), and 15% was from nuclear energy.

How is energy transported?

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.

Who supplies energy to 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 March 2023.

Who governs the energy market?

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 Bill 2022-23 aims to ensure a “a cleaner, more affordable and more secure energy system for the long term”.

How are energy bills calculated?

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).

Energy price cap and Energy Price Guarantee

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. Before the EPG, maximum prices for customers on standard variable tariffs (SVTs) were controlled by Ofgem’s price cap.

The price cap and EPG are 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.

What affects the cost of an energy bill?

The cost of an energy bill depends on energy usage, energy supplier and tariff, type of meter, payment method, and location.

Why does the price of gas drive electricity prices?

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.

What are the current challenges in supplying energy?

Wholesale prices rises

Wholesale energy prices started to dramatically increase from mid-2021 to summer 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.

Supplier failure

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.

Loss of competition

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 have meant that most suppliers are selling energy near the maximum tariff possible, the Government’s price cap or Energy Price Guarantee (EPG). This has effectively halted competition as there is no incentive for customers to save money by switching supplier.

Fuel poverty

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.

Energy company profits

Many companies that generate energy (oil and gas producers and electricity generators) have announced record profits because of rising wholesale energy prices.