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What Drives the Price of Electricity

Electricity can't be extracted it needs to be generated

In its simplest form, electricity is made from turbines that are driven by steam. The commodities that are used to make this steam include gas, coal, oil and nuclear fuels.

As a result the cost of generating electricity is in a large part driven by the cost of the commodity used to power the generation.

The wider commodity market influences the price of these raw commodities, and a higher demand for limited supply will push the price of a certain commodity up, or divert investment to cheaper, alternative sources that in turn will place pressure on price.

However beyond the simple headline of supply and demand there are a host of other drivers influencing the cost of electricity.

What drives the cost of electricity?

  • Commodity costs - The commodity markets largely drive the cost of electricity. The fuel markets primarily being nuclear, gas, coal and oil (with oil driving a small element of the gas price and also being used for covering peak demand)
  • Carbon cost - Traditional generation methodologies such as fossil fuel gas, coal and oil or non renewable sources are required to buy a certificate for each ton of CO2 created as a penalty for not utilizing renewable sources. This effective tax on energy has a direct impact on the price of electricity.
  • Demand - Behavior drives demand, and behavioral change in business is not only regular but also substantial. Ramping up the factory, opening up, shutting down, employing more people, laying them off, ramping down production, and closing plant. As demand grows, output needs to match and costs naturally grow as less economic plant is brought on line to meet the new level of demand
  • Weather - The weather impacts both demand and supply, for instance cloud cover drives the need for light, and low sun or wind levels impacts the generation capability of renewable sources like solar and wind. Convergence of these occurrences leads to a stark imbalance in the energy markets, pushing prices up.
  • Supply constraints - The availability of generation to match demand is not only impacted by the absolute level but also the available capacity. Plant outages, especially amongst inefficient, unreliable, old installations are commonplace. Sometimes this is seen as tactical by the generators to drive prices upwards, sometimes it is a genuine reliability issue. Overlaid on this is politics such as the phasing out of nuclear power, soon to affect the UK, and the replacement of that base load with the intermittent contribution of renewables.
  • Time to delivery - In classic economic terms, the greater the demand and the sooner that demand is needed to be met the more it will cost to secure it, the nature of the electricity market with no mass storage capabilities means that such a 'just in time' approach is commonplace.

Where does the UK’s supply of electricity come from?

In 2013/14 the UK fuel mix for electricity generation was:

  • Coal: 34.0
  • Gas: 25.6
  • Nuclear: 21.6
  • Renewable: 16.7
  • Other sources: 2.1

Producing CO2 of 428g/kWh and High Level Radioactive Waste of 0.0017g/kWh

The traditional sources of electricity are Coal, Gas and Nuclear. In recent decades these have been supplemented by renewable generation sources such as:

  • Wind farms (on and offshore)
  • Hydro (water driven turbines)
  • Biomass
  • Municipal and industrial waste (recycling)
  • Landfill gas
  • Tidal (wave power)

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