Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

These are UK wholesale prices (i.e. the price electricity is sold by producers for delivery on the high voltage grid), which are expected to jump massively this winter in the steps of gas prices.

As you implied, retail prices are the addition of wholesale prices, distribution costs and taxes. In a number of countries they are still regulated closely by the State or public authorities (for instance by public bodies in each individual State in the US).

When wholesale prices increase like this, producers request to pass this on to consumers, and it eventually happens, so Britons should expect significant increases in coming months.

The reason why gas prices determine power prices even though gas power plants only make 30% or so of the production capacity in the UK is simple: they are the marginal plants. By this, I mean that when power demand goes up or down, it is gas fired plants that are turned on or off, because (i) it's the most expensive power source and (ii) it's the easiest to turn on and off. Coal and nuclear are cheaper (and nuclear is hard to stop anyway). Wind is way cheaper when it produces. so these are pretty much always on, thus leaving the adjustment to the gas side. The production cost of the plant turned on or off becomes the price for the whole market. If gas prices go up, so will the clearing price for power.

This is happening on a violent scale in the USD today.

So back to Dodo's point: competition makes producers more efficient, maybe, but it makes prices more volatile. It has also encouraged investment quasi excusively in gas fired plants at the exclusion of everything else because they are the only plants for which you can get a return on less than 10 years (coal and nuclear are cheap also in part because they can be amortised over 40 years or even more) and are thus the only kind to attract private investment.

This has brought the boom and bust typical of many sectors, except that with a product that cannot be stored, it brings about much more brutal price spikes when supply is unsufficient. and it has had unexpected consequences on the gas market which, to put it simply, has not been able to cope with that sudden surge in demand. Thus higher prices, a "normal" market phenomenon which pro-liberalisation politicians seem somewhat embarrassed to acknowledge...

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Oct 12th, 2005 at 04:05:14 PM EST
Excellent additions - to which two of my additions :-)

  1. Another point on why prices first went down, to recap: the pre-deregulation regional monopolists (grid+production) have slowly raised prices prior to deregulation (at least for six months, but maybe three years), and then used this extra profit in price wars that eliminated almost all new upstarts. The newcomers were mostly dead by 2001, just when prices started to move up...

  2. I still think the connection to gas prices should be less strong in Germany, because (a) gas there doesn't come from the depleting North Sea, (b) it's still just under 10% of total production. (Gas prices rise there too, but that may be hitch-hiking; one producer was sued successfully by a consumer group to release its price calculations, which they refused even after the court order.) I don't know where to look for German gas price (or any other) data to check correlation, tough. Maybe someone can help out?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Oct 12th, 2005 at 05:19:28 PM EST
[ Parent ]
  1. I don't know the details in Germany, but it sounds logical enough
  2. Gas prices in all of Europe except the UK are set as moving averages of oil prices (they follow it with a 6 month lag, basically, and much less short term variation). Natural gas prices set the marginal price in the general European market, it doesn't matter if Germany has less gas-powered capacity, the price is still set by gas (unless you have unusual stuff like very high or very low hydro production in Scandinavia, or less nuclear available than usual in France, like during the heatwave two years ago)

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Oct 12th, 2005 at 05:48:56 PM EST
[ Parent ]
Jérôme, I have only recently (in the last couple of days, really) noticed you mentioning the fact that energy prices are set by gas prices because the latter are marginal. While this is elementary once one is introduced to the concept, most people have never heard of it. Given that this was one of the few points that Adam Smith made repeatedly in his Wealth of Nations, public misunderstanding of how marginal sources set the price of commodities must rank up there with people not knowing about Newton's laws of motion (a topic more dear to me personally). I would write a diary about it were it not that you are probably better equipped that I am to write it (including access to hard data), unless you think there is value in having a non-economist write about it and reserving your sharp wit for smoothing out my corners.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Thu Oct 13th, 2005 at 11:07:23 AM EST
[ Parent ]
with my new found fame on dkos, I am taking on so many projects that I fear I will default on all... (not to mention that I do have to work once in a while)

This is indeed an important topic, on which I have already done a number of comments (which I have stupidly not saved in an easily retrievable place), but which certainly deserves a full diary. If you have the time and courage to go for it, I'd be happy to give you my input if you want before posting it. My email is below.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Oct 13th, 2005 at 05:47:17 PM EST
[ Parent ]


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