The way electricity prices are set has pushed UK household bills up by £7.2bn over two years, analysis suggests.

Under existing rules, energy suppliers pay the highest price for wholesale electricity no matter how it is made.

Gas-fired power stations are the most expensive way to generate electricity, but only make about 40% of all electricity used by UK homes.

That means homes pay over the odds for power generated any other way, said the Carbon Tracker Initiative.

The think tank said if an average price was used instead the UK’s electricity bill could be much lower, the not-for-profit climate think tank Carbon Tracker Initiative said.

The Department for Business, Energy & Industrial Strategy said it had “already launched a major review” of the electricity market “to radically cut costs” for consumers in the long term.

It said it was consulting on changes that “would stop volatile gas prices setting the price of electricity produced by much cheaper renewables”.

And it has imposed a temporary 45% windfall tax on renewables generators which it said would “help fund energy bill support for households and businesses”.

Rising costs

In the past, electricity prices were linked to gas powered generation because it was the cheapest.

But the cost of gas-fired generation has soared in the past few years due to a surge in demand as economies recovered from the pandemic and the shock to supply due to Russia’s war in Ukraine.

Charging an average price for wholesale electricity would have made the bill in the two years from 2021-22 £7.2bn lower, the Carbon Tracker Initiative said.

According to BBC calculations that’s about £250 per household.

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Under the existing rules, energy suppliers are forced to pay the highest price for wholesale electricity, with that cost passed on in bills.

But because wholesale gas prices have risen sharply since Russia invaded Ukraine, gas powered electricity generation has been more expensive than nuclear power and up to three times as expensive as renewables such as wind farms.

That has also meant windfall profits for firms that make renewable energy, which have been paid much more for their power than it costs them to generate.

For this reason the government also introduced a temporary 45% tax on what it calls “extraordinary returns” from low-carbon electricity generators in the UK.

Lower bills

The Carbon Tracker Initiative (CTI) found that if suppliers had instead paid closer to the average cost of generation across all forms including renewables, the cost of energy to consumers would have been lower.

Jonathan Sims, an energy analyst who wrote the CTI report, said the findings showed how the global gas market over the last two years had skewed British power prices.

He said these prices did not reflect the different technology the UK now uses to generate electricity.

The CTI’s report takes into account the need for sources of power that can be fired up immediately such as gas-fired or nuclear, whereas wind power for example is weather-dependent.

The analysis also suggested Europe’s most gas power-dependent countries, the UK and Italy, had consistently paid the highest prices for electricity during the recent period of gas price volatility.