Gas generator profits rose substantially during crisis

Gas generation revenues tripled last year compared to pre-Covid crisis levels, substantially exceeding increased costs of the fuel, according to a new study by University College London (UCL) researchers.

The report, entitled Where does the money go? An analysis of revenues in the GB power sector during the energy crisis, concludes that electricity consumers in the UK paid £49.5 billion in 2022, £29 billion more than in 2018-19. This increase worked out at about £500 per person.

The report, which draws on publicly available datasets and analyses the structure of revenues for different sources of electricity generation in the UK, says about 70% of the additional £29 billion of revenues went to natural gas plants and renewable energy producers supported by the Renewable Obligation (RO) scheme.

Gas generators tripled their total revenues from about £6 billion in 2018/2019 to £19 billion in 2022, the report estimates.

While this rise predominantly reflected spiralling gas prices over the last two years, the report says there are various indications that they exceeded this rise in input costs, suggesting that profits increased substantially.

These include an eightfold increase to around £40/MWh in average spark spread margins earned by gas generators, calculated by Ofgem, and a 250% increase in ‘balancing mechanism’ payments to correct short-term imbalances between offered supply and demand.

The study also estimates that RO-supported renewables schemes doubled their total revenue from about £7.7bn in 2018/2019 to £15.5bn last year.

The report describes this increase as ‘huge’ because such projects would have seen no ‘significant’ increase in operating and input costs, unlike gas plants.

While the RO system may have helped to spur the rapid expansion of renewables, it says “the sheer scale and volatility of revenues shows the wisdom” of the government’s decision to end the costly system in 2017 when it was replaced by Contracts for Difference (CfDs).

Renewables generators on the current support mechanism made little or no additional revenue from last year’s energy crisis because the nature of CfDs means any excess revenues above an agreed level are returned to suppliers.

However the complexity of the mechanism for recycling CfD revenues means it is not clear that lower consumer prices resulted.

The study also estimates that the government’s Electricity Generation Levy, which came into force at the beginning of this year, would have had a modest impact on low carbon generators’ revenues if it had been in force in 2022.

It calculates the levy would have seen the revenues of non-CfD wind and biomass generators decrease by around 15%

Nuclear and hydro generators, which sold more of their power through forward contracts at prices below the spot price or were less likely to use the RO system, would have seen their revenues decrease by around 12%.

The report concludes that the UK’s highly liberalised electricity system means that since the rundown of coal generation there is no price-based competition for gas because most renewables can only generate when the weather conditions permit.

In addition, planning hurdles and long construction lead in times mean high gas prices do not stimulate meaningful competition for investment, says the report: “Aside from regulatory monitoring, the only significant constraint on gas pricing is competition from other gas, including and predominantly through interconnectors to the continent.

“Given the gas crisis in Europe, in 2022 there was therefore no effective constraint to gas plants substantially increasing their operating margins. It appears that gas generation was itself a major beneficiary of the gas crisis.”

Overall, the report says, the structure of the electricity market has inflated most generators’ revenues and “exacerbated consumer hardship at a time of national crisis”.

The report’s lead author, Professor Michael Grubb of the UCL Institute for Sustainable Resources, said: “The exploding costs to consumers over the last year highlight the need to disentangle the UK’s electricity market from the volatile prices of fossil fuels, and to better embrace the cost predictability and stability that renewable energy can provide.”