The definitive guide to wholesale energy: How it works, prices and more
The wholesale energy market has a significant impact on the prices you pay for your electricity and gas. That being the case, it’s important that you can understand how it works.
In our definitive guide to wholesale energy, we explain what wholesale energy is, how the market works and how it affects your energy bills, whether you’re a business or domestic customer.
- A brief history of wholesale energy
- What affects wholesale energy prices?
- The difference between wholesale and retail energy
- Charges added to wholesale prices before being sold in retail
What is wholesale energy?
Wholesale energy is electricity or gas that is purchased in bulk with the intention of reselling it for profit. Wholesale energy is typically bought by energy retailers from producers. Retailers include additional charges to cover the cost of distributing the energy to homes and businesses throughout the UK.
Other parties that purchases energy wholesale include financial intermediaries, energy traders and large energy consumers (such as multi-national corporations).
A brief history of wholesale energy
While the concept of buying and selling wholesale is nothing new for things like food and clothing, the introduction of a wholesale energy market is only a few decades old.
The UK was instrumental in kickstarting wholesale markets around the world. Under Margaret Thatcher, the UK government privatised the UK electricity supply industry along with that of several Commonwealth countries, including Australia, New Zealand and Canada.
The purpose of a private wholesale market was the same throughout all of these countries. The reforms were designed to separate energy generation and retailing from distribution in order to create a more competitive landscape. The result was two markets: wholesale and retail.
The wholesale electricity market allowed trading between generators and retailers. These parties could trade the short-term delivery of energy and buy for future delivery periods based on predictions about supply and demand.
How the wholesale energy market works
The wholesale energy market works by allowing utility companies to buy and sell large quantities of electricity to and from one another. In today’s market, smaller independent energy producers are also able to take part, which is stimulating the growth of new energy companies and creating a more competitive market.
Since electricity markets have been deregulated, end-users have benefitted from enhanced reliability, more efficient transmission of electricity and better price transparency from suppliers.
What affects wholesale energy prices?
Like any commodity, energy is subject to fluctuations in supply and demand.
Much of the energy we use is bought by retailers in advance. Energy bought in advance is often sold at different prices, which is called hedging. Hedging allows energy companies to reduce fluctuations in the price of electricity and gas, protecting end-users from big jumps in their energy bills should the wholesale market spike.
But what causes these big changes in wholesale energy prices? Below are some of the key factors that drive prices up and down.
Though Britain used to generate all of its own gas, the North Sea reserves have diminished in recent years. To keep gas in good supply, the UK now imports a significant amount of natural gas. This means it has to pay as much as EU countries to secure gas through European pipelines.
Relying on the EU means the UK is vulnerable to European gas shortages. When pipelines or gas fields in Europe go offline, gas prices for the continent spike. On the other hand, large deliveries of Liquid Natural Gas (LNG) can lead to a short-term oversupply in the market, driving gas prices down for a short time.
Changes in currency value
The UK’s reliance on Europe for gas and electricity means that prices are also influenced by the Pound’s strength relative to the Euro. When the Pound is stronger, gas and electricity prices fall. When the Euro is stronger, however, the prices the UK has to pay increases.
A lot of energy is used for heating, so when temperatures are higher, demand goes down — and prices along with it. These prices are often linked to forecasts because much wholesale energy is bought in advance. This is straightforward in the short term, but long-term planning is more complicated and risky for the seller. They have to rely on a variety of indicators for future weather predictions, but these factors are no guarantee, so prices can sometimes be overinflated or below expectations.
As the EU continues to push energy providers to meet its emissions targets, carbon taxes — charges applied to companies based on the amount of carbon dioxide they use — continue to increase. Energy suppliers that are falling behind these targets will need to pay a higher price, which can have a negative impact on the wider market as a whole by increasing their selling price.
The wholesale energy market is often affected by large geopolitical events in other countries. Conflicts and natural disasters in countries that produce a lot of oil or gas can dramatically increase energy prices all around the world. British markets are extra vulnerable to these changes because they are so reliant on imports.
3. What are wholesale prices like today?
Here’s how the UK’s wholesale electricity price has changed over the past two years.
4. How wholesale prices affect your bills
The difference between wholesale and retail energy
While wholesale energy is used to describe electricity or gas that can be purchased, most businesses buy retail energy. Retail energy is electricity and gas that is sold to end-users by an energy supplier.
The price of wholesale energy is lower than the price of retail energy. This is because various charges must be added to the wholesale price of electricity in order to cover the cost of purchasing energy and delivering it to your home or business.
Charges added to wholesale prices before being sold in retail
Here’s a breakdown of how your electricity bill is calculated, taking into consideration wholesale price.
- Wholesale price (42%) — Just under half of your electricity bill covers the wholesale price of energy that the retailer has paid.
- Distribution (16%) — Retailers add a charge to your bill that covers the cost of getting electricity to your home or business.
- Taxes (24%) — Electricity is taxed highly by the government, particularly if it’s not from a sustainable source. This can add up to almost a quarter of your bill.
- Operating costs (11%) — This part of your bill goes towards paying the suppliers operating costs: salaries, research and technology.
- Profits (7%) — The last part of the bill makes up the profit that a supplier will make on selling you an energy tariff.
Is it time to switch?
Though you may not be directly affected by wholesale prices, some energy suppliers make better strategic purchases than others, which can trickle down in the form of lower prices can secure.