Energy Price Inflation

Why is gas and electricity always getting more expensive?

Let's start at the beginning: your bill. You cannot have failed to notice that your energy bills are getting more and more expensive. Or else you probably wouldn't have ended up on our website.

You are right of course - your energy bill did go up and now is the time to compare energy prices.

In fact, your bill has not just 'gone up'. If your bill was a rocket into space, it would be on the edge of the Milky Way by now. Just have a look at the graph below. You'll see two lines. The blue one is the actual annual cost of a representative tariff of someone using 16,500 kiloWatthours of gas and 3,300 kWh of electricity (an average profile). We chose British Gas' standard rate for this analysis because that is what many people are on.

What the blue line tells you is that back in 2003 households on this tariff would have paid £534 to fuel their homes. Now roll forward 10 years and that bill has more than doubled! Come rain or shine, boom or bust, the trend is pointing in one direction only.


Now let's add insult to injury and have a look at the pink line. That is what a hypothetical bill would have looked like if the same tariff had gone up in line with the rate of inflation, as expressed by the Consumer Price Index CPI. You would be paying about £700 for your gas and electricity in 2012. Instead it is close to £1,300.

Actual Bill versus hypothetical CPI-adjusted bill
Energy Inflation graph

Ouch indeed.

Do you remember the last time you were sitting in traffic and cursing all the other cars? That's right - you were the traffic. The same goes for the cost of your gas and electricity. Energy does not follow the rate of inflation. Energy is inflation.

OK, so energy is dear. Tell me what's new?

Well, the question is - if inflation is not driving the price upward, then what is? Here we have various leading theories which we'll gladly present to you - but without too much enthusiasm for any of them:

1) Gas and electricity are natural commodities and these are running out.

True. Gas is pumped out of our Earth, and electricity is mostly generated using a mix of fossil fuels like coal, oil and gas. Once we have used it, it is gone. The perception that we are using up a finite resource is driving up the price, in line with the basic law of supply and demand.

Yes, yes. All true. But for this to explain a doubling in price, wouldn't we have had to either double our consumption or halve our production of fossil fuels? The fact is that four out of the last ten years were marked by a biting recession, which has slowed down our production of goods and services and in turn reduced our consumption of energy. At the same time, the technology to find and extract fossil fuels from the ground has significantly improved - so we are pumping more oil and gas than ever out of the ground. And while we are not really sure how much is left, the consensus is that we have consumed less than half of the available fossil fuel resources.

So if supply and demand were the only price-setting factors then we should have seen a much smaller price increase, more in line with CPI. Yet we have been hammered with a far greater increase than that.

2) Blame China

There is an argument which states that China's economic growth is leading to heightened competition amongst nations for natural resources. The theory is that China's voracious appetite for primary energy sources is sucking in oil and coal at an increasing rate, and that this is driving up prices for everyone.

It is certainly true that China is consuming vastly more energy than it did before it set off on its amazing economic growth trajectory - so much more that it has now become the largest consumer of electricity, ahead of the United States. But then again, if the laws of supply and demand are to exist - why has the increase in Chinese consumption not been offset by the fact that energy consumption overall has decreased in the West - as a result of the recession and a marked drive for energy efficiency? Has Chinese demand really meant that there is now less energy for us to heat our homes? We think not.

3) Blame Russia

OK, if not China then what about Russia? After all we have experienced several winters where a billing dispute between Russia and its neighbour Ukraine temporarily threatened to shut down a critical gas pipeline. Each time there was a quarrel, immediate severe short-term wholesale gas price spikes were the result.

Yup, this did happen. Even here in the UK wholesale gas prices spiked, despite the fact that the UK does not use natural gas piped from Russia.

But these are temporary problems, where all the players involved have a real interest in finding long-term solutions. The Germans, for example, built a whole new pipeline through the Baltic Sea to transport gas around the Ukraine. What happened here are short-term supply crises, which cannot serve as an explanation for a ten-year pricing trend.

4) Blame OPEC

Oil is the most important ingredient of the world's energy mix, it literally keeps the wheels of industry spinning. The price of oil is therefore a guide price for any other type of energy, including gas and electricity. The 'Organization of the Petroleum Exporting Countries' represents the leading producers of oil. OPEC does not want to sell its oil cheaply (as it did throughout most of the 90s, when the price went as low as $15 a barrel). But OPEC also gets nervous when the price of oil goes too high, for that might choke off the oil-dependent economies of the countries that need their product. And then who'll buy the stuff?

OPEC members work together as a cartel to increase or decrease oil supply, with implications on price. So have they cut supply and is this the reason for spiking energy prices over the last ten years?

Considering that the historical average price of a barrel of oil is close to $25, and that the actual current price is north of $100, one might be led to believe that this is exactly what is going on here: OPEC has us by the short and curlies and they are squeezing us in our hour of need!

Well no.

OPEC have in the past acted to drive up the price of oil by cutting production. But not lately! In fact, current production levels are significantly up on 2011 and the world should be awash in cheap oil. Yet the oil price continues to happily slosh above the $100 line.

So we do know one thing: the price of your gas and your electricity is linked to the high price of oil. But OPEC is not guilty of jacking up the price of oil. Not this time.

5) It's the wars, stupid!

High gas and electricity prices typically coincide with times of conflict and we have been involved in a few of those lately. For example, it is a fact that the current cycle of rising energy prices began with the September 11th, 2001 tragedy. The invasion of Afghanistan, the war in Iraq, the Libyan uprising and the current Iranian crisis are all measurable events in oil price history. Conflict in or near oil-rich countries threatens the supply of energy to the energy-poor industrial nations. And the perception of risk drives up the price.

Markets translate risk into higher prices, sure - but by this much? As a matter of fact, we are abundantly supplied with gas and electricity and have been throughout any of the above-mentioned conflicts. That these conflicts are responsible for doubling our gas and electricity prices - this notion is just too far-fetched to be acceptable.

6) Blame the government!

This leaves us with the final argument -taxes at home are the reason that our bills are going through the roof. And there is meat to this argument. Governments tend not to raise income tax rates, because people don't like it and given a chance will vote them out of office.

So the typical way to get money in the door is through the backdoor. And this is what the UK government has arguably done - it has charged the big energy suppliers to execute on its own long-term energy commitments, whether they be renewable energy targets, making the national electricity infrastructure more efficient, insulating the country's housing stock, reducing carbon emissions, increasing generation capacity or broadening the energy fuel mix to include more environmentally friendly fuels. The government has effectively charged energy suppliers with making it all happen - and the cost of these projects is shared by all UK energy consumers through collective billing surcharges.

But we cannot help but have our doubts. If the cost of executing the UK's grand energy plan is the reason for our sky-high energy bills (and this is what energy suppliers want us to believe) why are these surcharges not shown as separate line items on our bill so we can make up our own mind and choose whether to believe it or not?

In the absence of transparency, UK consumers should be excused for choosing to remain sceptical.

A bill is the sum of its parts.

Scepticism is perhaps the word that brings this piece to its natural conclusion. All the arguments brought together here have contributed to the final, perhaps most powerful reason as to why energy prices are going up: prices are going up because consumers' expectations have been conditioned that way. The energy utility industry is totally unique in how it is able to justify price increases - just read the long list of what we presented up above.

What's our point? Well, can you think of another industry that has so many excuses at the ready when it comes to explaining the exorbitantly high cost of its product - yet at the same time never appears to be quite transparent enough to seem believable?

Don't believe us either? Then think of another utility industry. How much was your mobile phone bill in 2003, and what is it now? It may be just about the same. Except that now you are using a swish smart phone that is infinitely more capable than the brick you used ten years ago, so the service you get is better!

Somewhere along the line, the energy utilities have managed our expectations downward. Prices go up but the service remains the same.

Real change is possible.

But it needs you!

Not enough UK households are switching gas and electricity suppliers to force the current situation to change. About 50% of the UK remain on expensive 'Standard' energy tariffs or switch back to them after the expiry of a fixed price deal. Yet pro-active consumers that switch annually are the lifeblood of a truly competitive energy market. It is what enables new suppliers to come into the market, improves competition and service, drives innovation and ultimately results in a better deal for everyone.

So you know what to do. Start your energy comparison today.

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