The energy industry has backed a plan that it says could save households and businesses up to £18bn a year by reducing the price of electricity generated beyond natural gas.
British Energy, the industry’s trade body, said its proposal could cut £18bn a year from energy bills, including £11bn for businesses.
This can save families between £150 and £250 a year.
Business Secretary Kwasi Kwarteng is understood to have met with members of the UK Department of Energy to discuss the proposal and is said to be seriously considering it as an option to present to the next prime minister.
The Conservative Party will announce the results of the vote for its new leader on Monday, with Liz Truss widely expected to win the election.
The voluntary scheme will work by separating the cost of electricity from sources such as nuclear, solar and wind farms from the sky-high prices paid by power stations to burn natural gas to generate electricity.
Natural gas prices more than triple Since Russia began reducing exports to Europe in the months before its invasion of Ukraine.
Currently, electricity auctions are designed in such a way that the price of all electricity is tightly linked to the price of natural gas.
Nuclear power plants and renewable energy generators would be encouraged to sign a new type of contract, under a proposal first put forward by the UK’s Energy Research Centre. These contracts for difference (CfD) mean selling their electricity at a lower price, but the price is fixed and guaranteed for many years.
Many older nuclear, solar and wind turbines have Renewable Obligation (RO) contracts under which they are sold at current wholesale prices.
The structure of the market causes those who enter into RO contracts to benefit from higher prices and thus potentially gain windfall profits. The UK Department of Energy is urging ministers to make RO contracts exchangeable for CfD.
Adam Berman, Deputy Director of the UK Department of Energy, said: “The current energy market does not allow customers to fully benefit from the cheapest form of electricity – domestically produced low carbon generation.
“This plan will be an important first step in decoupling gas from retail electricity prices.
“Removing the link between natural gas and retail electricity prices will be complex and time-consuming, but this solution can quickly address up to 40% of our electricity generation.”
Ofgem, the energy industry regulator, is also looking to reform the market long-term to decouple electricity prices from gas prices. Several European countries are considering similar moves.
Prime Minister Nadim Zahavi said on Thursday that the finance ministry was looking at several options to help consumers this winter. It could also include support from the Bank of England for energy suppliers to hedge costs, which could reduce consumers’ bills.
Energy provider Ovo has proposed an alternative solution that would involve lowering energy prices for households, but only for a limited number of units per household. Energy consumption beyond that level will be charged at a higher price.
Why are electricity prices linked to natural gas?
Typically, electricity prices reflect natural gas prices. That’s because the UK ranks the type of energy needed to generate electricity, with renewables and nuclear taking precedence over coal and gas.
Electricity rates are set every half hour at the marginal cost of the last generator set to meet demand, usually natural gas. When wholesale natural gas prices rise, this pushes up electricity prices.
What is an Energy Contract for Difference?
Under these contracts, power plants are paid a flat rate for products produced over a 15-year period.
The rate is the difference between the ‘strike price’ (the agreed price reflecting green technology investment) and the ‘reference price’ which reflects the wholesale electricity market price in the UK.
If the market price is higher than the strike price, the low-carbon contract company, which is wholly owned by the government, ensures that these savings are passed on to consumer bills. If the market price is lower, the LCCC will make up the shortfall.
The government used the system, launched in 2017, to support the development of low-carbon power projects with high upfront costs and long lifespans to protect developers from fluctuating wholesale prices.
However, only about 15% of renewable energy projects have CfD; most are paid through older renewable energy obligation certificate payments.
What is a renewable certificate of obligation?
Under a renewable energy obligation model designed for wind and solar, generators receive the value of their electricity in the wholesale market, along with additional subsidies. As a result, generators on these contracts have benefited from soaring gas prices so far this year.