The Cost of Gas in 2.5years of the Gas Crisis

Russia’s meddling in gas supplies starting in autumn 2021 pushed up gas prices, and its invasion of Ukraine drove unprecedented turmoil in international gas markets leading to two-and-a-half years of elevated wholesale prices and significant volatility.

Prices peaked in March and August 2022 at record levels that were at least ten times the typical prices in the years before the crisis. Only towards the end of 2022 did wholesale prices begin to fall, but are still around twice their historical levels, and are forecast to remain elevated for the rest of the decade.

And this is just the start of the problem, with wholesale gas prices causing larger increases in gas bills due to extra costs for losses and balancing, and also driving up electricity bills due to gas power plants usually setting the wholesale price of power.

The cost of the gas crisis has been estimated in various ways, including its central role in energy bills and inflation, and the costs of Government support schemes to help customers manage the impacts. Each of these costs has been driven by the underlying wholesale cost of gas, and that is what this analysis seeks to estimate i.e. the amount that has been paid to gas producers for their product.

This is not a straightforward exercise. Analysts can access data about traded volumes and prices to build up a picture, but they can’t know the confidential details of long-term bilateral contracts. But we can estimate the overall costs, using some reasonable assumptions.

Over longer durations, the average price of wholesale gas approximates to the price paid on the day-ahead market, and this proxy is often used by analysts. This averaged about £15/MWh in 2016-19 before the pandemic and gas crisis, when the UK’s total demand averaged 875TWh/yr (Energy Trends 4.1), giving an estimated cost of over £13bn/yr. This tallies well with estimates by Government that average out at just under £13bn/yr (DUKES 1.2).

The day-ahead price averaged £68/MWh in the six months prior to the invasion, £69/MWh in the first year of the war, and £30/MWh in the second year of the war. Had UK gas demand remained at pre-pandemic levels, the total cost of wholesale gas would have been £120bn over 2.5years, over £85bn extra compared to historical levels.

However, these high prices had a marked effect on demand over the past 2.5years, supressing it far below the averages from years before the pandemic (Energy Trends 4.1). Household gas demand has been over 15% lower than might be expected, much more so than could be accounted for by weather. Industrial and non-domestic customers have used 5-10% less gas in order to save on costs. And the energy industry has used around 15% less gas, in part because of other forms of generation such as renewables, and in part because of customers reducing their electricity demand due to high prices. [1]

Overall, the UK has used around 15% less gas over the past 2.5years than might be expected based on pre-pandemic averages. As a result, the estimated cost based on day-ahead prices would be around £105bn, or £70bn extra compared to historical levels.

These estimates can be validated using more nuanced approaches.

The cost of gas for households can be estimated using data from Ofgem’s price cap model, which is a good proxy for average household costs in most years (Annex 2 of Ofgem’s price cap model). In the four years 2016 to 2019, just before trends were disrupted during the pandemic, and before prices rose in the gas crisis, Ofgem’s estimated wholesale price averaged just over £16 per MWh. So, a household using the average 12MWh of gas per year, would have been paying around £200 a year for wholesale gas, and the 24million homes that use gas paid around £5bn each year on average.

There is a lag between changes in wholesale prices and the price cap, so households were largely insulated from the effects of early Russian meddling, with household wholesale costs in the six months prior to the invasion rising to ‘only’ £21/MWh. But in the first year of the invasion, households were paying £83/MWh. In the second year it had fallen back sightly to £62/MWh, still four times the pre-crisis average.

Had demand remained at higher levels seen before the pandemic and gas crisis, the total cost would have been over £45bn. But with demand being around 15% lower than average, the cost was just under £40bn.

The cost of wholesale gas is less clear cut for other customers: industry, power generators, and non-domestic customers (businesses, charities and public sector).

An initial estimate of wholesale gas costs can be made on the assumption that these customers pay a similar amount to households. This is not normally the case, because larger customers can achieve savings through economies of scale. This method gives an estimated cost of around £10bn at prices before the pandemic. Then, at prices seen during the gas crisis, it gives an estimate of almost £80bn for levels of demand seen before the pandemic, and almost £70bn for the lower levels of demand seen in the crisis.

A more nuanced estimate can be made by examining data for retail unit rates in p/kWh, based on surveys of around 600 customers covering non-domestic, industrial and power generation (Quarterly Energy Prices). This data confirms that other sectors do ordinarily pay lower prices than households.

Household unit rates (in p/kWh) before the gas crisis were split half-and-half between wholesale gas and other costs. If we assume, as a first approximation, that this also applied to other sectors’ unit rates, then we can estimate the average price paid for gas in p/kWh and translate this into a wholesale price in £/MWh. That is, we assume that each sector’s unit rate was 50% wholesale gas. This approach gives an estimated cost of £5bn/yr before the pandemic.

We can then use the fact that wholesale gas costs were responsible for virtually all of the increases in gas unit rates for all sectors. So, for any quarter during the gas crisis, we can estimate that the price paid for wholesale gas was 50% of the pre-crisis unit rate plus all of the increase in the unit rate compared to the pre-crisis average. This method gives a total of over £55bn at pre-crisis levels of demand, and almost £50bn at the actual demand levels seen in the crisis.

Each of these approaches, plus the Government’s estimate (DUKES 1.2), shows that the UK spent £10-15bn/yr on wholesale gas before the pandemic, with the range being due to variations in price and demand, within relatively narrow ranges. [2]

The three approaches suggest that, in the 2.5yrs of the gas crisis to-date, the UK would have spent in the range of £115-135bn had demand been at historical levels, with a likely figure of £120bn. The range is £85-100bn more than in an equivalent period before the pandemic, with a likely figure of £90bn.

Given the lower demand seen in the gas crisis, the UK probably spent in the range of £100-120bn in 2.5years, with a likely figure of £105bn. This is £70-85bn more than in an equivalent period before the pandemic, with a likely figure of £75bn.

Net imports meet around half of UK gas demand (Energy Trends 4.1), so overseas gas producers have received around £50bn from UK customers during the gas crisis to-date. [3]

Over the same 2.5 year period, the UK’s indigenous gas production reached around 1,000TWh [4]. This is the equivalent amount of gas that could heat 8 billion UK homes for a year, or be transported in over 1,000 LNG tankers. Despite this amount of gas being produced indigenously, prices are set by international markets, with gas from the UK not making any significant difference.