How marginal pricing affects electricity costs in Britain
Following the privatisation of the electricity industry in the 1980s and 1990s, marginal pricing was introduced to the wholesale market. The mechanism began in 1990 and has remained in place since then. Marginal electricity pricing is also used in most other European countries.
How marginal electricity pricing works
Marginal pricing is designed to support secure electricity supply and to follow a “merit order”, in which lower-cost generation is used before higher-cost sources. Under this system, the wholesale price of electricity is set by the most expensive generator needed to meet demand in each settlement period.
For example, suppose national demand is 40 GW. In the next settlement period, there is 20 GW of wind power available at £5/MWh, 10 GW of solar at £5/MWh, and 10 GW of gas generation at £30/MWh. To meet demand, all three sources are required. As gas is the most expensive, it sets the market price, and all generators are paid £30/MWh during that period.
Why marginal pricing has been a concern for British consumers
In Great Britain, the marginal generator is often a gas-fired power station. In 2021, gas reportedly set the wholesale price 97% of the time, despite contributing about 45% of total generation.
As a result, electricity prices have frequently been closely linked to gas prices, which can change significantly due to global markets and international events.
This means that when gas prices rise, electricity bills tend to rise as well, even when much of the power being generated comes from low-cost renewable sources. Although renewable generators may receive higher revenues under this system, these gains do not always lead to immediate savings for consumers.
It is also important to note that many renewable generators operate under long-term contracts, such as Contracts for Difference. These arrangements can limit excess profits and help protect consumers from some price fluctuations.
Based on current policy, there appears to be limited appetite for major market reform.
Proposed approaches to reducing electricity costs
A range of approaches has been suggested to address concerns about electricity prices in Britain. Most focus on reducing exposure to volatile gas prices, improving the electricity network, or adjusting how the market operates.
Reduced reliance on gas
One approach is to increase the number of periods in which electricity demand can be met using renewable or low-carbon sources. When this happens, the market price is more likely to be set by these cheaper resources rather than by gas-fired power stations.
For example, France’s large nuclear fleet meant that gas set electricity prices relatively infrequently in 2021. In the UK, current policy places strong emphasis on expanding renewable energy, nuclear power, and energy storage to reduce long-term dependence on gas.
Zonal pricing
Zonal pricing would divide the electricity market into several geographic areas, each with its own wholesale price based on local supply, demand, and network capacity. Regions with high renewable generation, such as parts of Scotland, could see lower prices, while more congested areas could face higher costs.
Some studies suggest potential savings and emissions reductions, such as this analysis by Octopus.
Other research, including work by the UK Energy Research Centre, highlights possible risks such as higher investment costs and increased market complexity.
For this reason, many policy discussions emphasise improving transmission infrastructure alongside, or instead of, major changes to pricing arrangements.
Removal of gas generation from the main market
Another proposal is to separate gas-fired power stations from the main electricity market and place them under a regulated asset base, as proposed by Stonehaven Global.
Under this model, gas plants would mainly act as strategic reserve capacity, with limits on pricing and guaranteed returns.
Supporters argue that this could reduce extreme price spikes and provide reliable capacity at predictable cost. However, this approach would represent a significant shift towards greater public regulation and system planning. It could also affect private investment and would require strong oversight to control costs and performance.
Conclusion
Marginal pricing has been a central feature of the British electricity market for several decades and is widely used in other countries. While it supports efficient use of generation resources, its close link to gas prices has raised concerns during periods of high fuel costs.
Recent increases in electricity prices appear to reflect a combination of global gas market conditions and the UK’s generation mix, rather than market design alone. As a result, current policy debates tend to focus on reducing reliance on fossil fuels, strengthening infrastructure, and improving consumer protection, alongside consideration of possible market reforms.