Plugged in: energy prices and the link with gas

Plugged in: energy prices and the link with gas

Instability in fossil fuel prices, curtailment costs and the rising level of consumer energy bills have been in sharp focus for a number of months (if not years) now.

Gas often sets the “marginal price” for wholesale electricity in the UK and on 21 April 2026, the Government announced a raft of measures to “break influence of gas on electricity prices”, but why does gas set the “marginal price” and will these measures achieve what they set out to do?

Market dynamics are not a typical topic for a lawyer but this discussion is hard to ignore. So, I’m going back to my original studies in economics, layering on my legal studies and dusting them off with my energy sector experience.

This blog is a background read on electricity markets and pricing, and why gas sets the marginal price. I’ll get stuck into the Government’s changes in a separate piece.

Back to basics: supply and demand

It’s a while since I studied economics, so let’s go back to basics….in a truly free and frictionless market, the price of anything bought and sold is where the amount that a consumer is willing to consume for a fixed price intersects with the amount that a producer is willing to provide for a fixed price.

Where supply is low or demand is high, price is high. Where supply is high or demand is low, price is low. Supply is typically priced at marginal cost – so for a given number of units, how much does it cost to produce one extra unit. Demand is priced at marginal benefit – so for a given number of units, what is the additional benefit a consumer gets from consuming one extra unit. The idea is that where a level of demand and a level of supply cross, that is the price that both sides of the transaction are willing to pay.

In the below example, we can see that the producer will offer 9 units for a price of 24, and that the consumer will buy 9 units for a price of 24.

So, if we know the last unit of supply is priced at marginal cost why does gas often set the marginal price in the UK market? For this, we need some history and some more economics!

A history of UK generation

In 1953, Britain’s first 275kV supergrid was switched on for the first time – it overlaid a high-voltage transmission system above the more localised and at capacity 132kV grid. Transferring power at long distance through transmission was seen as a cheaper way of moving energy than by physically transporting coal. At the time, coal made up almost 90% of supply.

The 1970s brought the discovery of North Sea oil and gas and when the 1973 oil crisis saw oil prices quadruple, the market started shifting towards gas. The 1990s saw the “dash for gas” driven by privatisation, the relaxation of restrictions on use of gas in electricity generation and the relative efficiency of combined cycle gas turbine technology. Between 1990 and the early 2000s, gas increased from next to nothing up to around 40% of electricity supply, surpassing coal in 1999 before coal was ultimately phased out in 2024 with the closure of the last coal-fired power plant at Ratcliffe-on-Soar.

(Retrieved from: https://ourworldindata.org/grapher/share-elec-by-source?country=~GBR [online resource] on 27 April 2026)

In 1990, the Government introduced the Non-Fossil Fuel Obligation, being the first direct subsidy for renewable energy generation, but it wasn’t until the introduction of the Renewables Obligation (RO) in 2002 that renewable energy generation started to accelerate. This was followed by the Feed-in Tariff for small-scale projects in 2010 and Contracts for Difference (CfDs) for larger projects in 2014. Now, the total potential capacity backed by clean energy CfDs is almost 52GW with renewables having consistently produced a larger share of electricity generation in the UK than fossil fuels from 2023 onwards.

(Retrieved from: https://ourworldindata.org/grapher/electricity-fossil-renewables-nuclear-line?country=~GBR [online resource] on 27 April 2026)

Why the history lesson? Well, for much of the UK’s electricity generation history, the electricity we produced relied on a fuel input tied to a market price. The more electricity we needed, the more fuel we burned, and the incremental cost of that extra unit of generation was a large part of the marginal cost which felt much more intrinsically linked to the true cost of production. But aside from fuel, there are other costs to consider.

What’s in an electricity price?

In simple terms, a generator will bid into an auction to sell its electricity by saying: “I am willing to sell [X] MW of power in hour [H] tomorrow if the price is at least £[Y] per MWh”.

We know that a generator’s bid should equal its marginal cost. To understand why gas sets the marginal price, we need to delve deeper into the costs of production.

A generator’s costs are divided into fixed costs (which do not influence short term pricing) and variable costs (which do).

Fixed costs are largely those items that are needed whether you produce one unit or ten. It includes things like capital expenditure, fixed operations and maintenance, network charges and most taxes.

Variable costs are instead those items that increase with production and so have a big impact on the short-term cost of producing additional MWh of electricity in a given period. It includes things like fuel (gas, for example), carbon emissions pricing, carbon price support (a tax on fossil fuel energy generation which the Government has indicated it may reform or phase out), variable operations & maintenance, and operational and imbalance risk.

Whilst the price of electricity used to be closely tied to the cost of fuel, with ever increasing renewables, we are moving to a world where the electricity we produce is increasing less reliant on fuel input. For renewables, a marginal cost of an extra unit of generation isn’t reliant on a fuel input price but on the availability of wind and solar radiation which has no fuel cost. But, if the cost of an extra unit of renewable supply is so low, why does gas set the marginal price?

The answer lies not in average generation, but in what happens at the margin when demand is highest or renewable output is lowest.

The electricity market and the merit order

Due to physics (which I’ll definitely avoid!), the demand for electricity must equal supply within a certain tolerance. In Great Britain, it is the responsibility of National Energy System Operator (NESO) to maintain this balance and match supply with demand.

In simple terms, this is achieved by NESO forecasting demand for each 30-minute settlement period and matching it with available generation. Each generating station tells the market how much electricity they can supply and the price (reflecting their marginal cost) for which they’re willing to supply.

To promote cost efficiency, the generating station that is the cheapest gets the first allocation of demand, then the second cheapest, the third, the fourth, and so on. This ranking is known as the merit order, with generating stations ranked by their “merit” – being the lowest price first.

The wholesale price for all generation (whether from the cheapest supplier or the most expensive unit called upon to meet demand) is then set at the price of the last generating unit required to satisfy demand. This is often described as a “pay as clear” market.

This way of pricing generally works well: it is an efficient way to allocate resources while still offering a return on investment to developers. It is particularly suited to market where many suppliers share common input costs (such as fossil fuels), as it incentivises efficiency and lower marginal costs.

Bringing it all together: why does gas set the marginal price?

There are two principal reasons:

1. Gas has a much higher variable cost (fuel costs tied to global markets, carbon emissions pricing, variable operations and maintenance and start-up costs) than renewables (which have no fuel, no carbon costs and limited variable operations and maintenance); and
2. The relationship between electricity demand, the available supply and the merit order.

I’ve covered why gas is more expensive than renewables. The reason why gas sets the marginal price is rooted in demand, supply and the merit order.

In 2025, the peak demand for electricity in the UK was around 46GW at 5pm on 9 January. By that time, the sun had set, temperatures were low and wind generation was relatively subdued. Demand was met by a mix that included a large proportion of gas generation (43.3%), alongside wind (27.9%), nuclear, imports and other sources. Solar did not feature given the sun had set.

By contrast, the lowest demand in 2025 was around 13GW which occurred at 1:30pm on 25 May. Conditions were mild, windy and sunny, resulting in high levels of wind (46.8%) and solar (29.2%) generation and relatively low reliance on gas (5.8%).

These examples are crude, but they illustrate an important point: even as renewables supply a growing share of total electricity, gas is still required to meet residual demand – whether to replace solar generation after sunset or to top up supply during periods of low renewable output. So long as gas-fired generation is required to meet demand at the margin, gas will continue to influence the wholesale price of electricity.

At a high level, the resulting merit order might look something like this:

What does this chart show? The chart shows how wholesale electricity prices are set in a market that clears on a marginal pricing basis.

First, the supply side. The stepped line rising from left to right is the supply curve, built up from blocks of generating capacity. Each block represents the amount of electricity that a particular technology is willing to supply, and the price at which it offers to do so. Technologies are ordered by their marginal cost, from the cheapest to the most expensive – the merit order. Low‑carbon generation with low variable costs sits to the left; higher‑cost plant sits to the right.

Second, the demand side. The downward‑sloping line is the demand curve. It reflects the economic principle set out at the start: when electricity supply is scarce, consumers are willing to pay more for it, but as more supply becomes available, that willingness to pay falls. Demand does not care which technology is producing (so no low-fossil fuel preference) – it only cares about price and quantity.

Third, where the two meet. The market clears where the supply curve and the demand curve intersect. That intersection occurs at the margin: the point at which the last unit of generation required to meet demand is brought onto the system. In this example, meeting total demand requires gas‑fired generation.

Finally, the price. The horizontal line marks the clearing price. This is the price bid by the marginal (last) generating unit and it is the price paid to all generators that are dispatched, regardless of their own costs. In this case, it’s gas. Cheaper, generation is not paid its own marginal individual cost; it is paid the marginal price of gas supply coming online.

What this tells us. Until either, (1) the supply curve shifts far enough to the right (for example, by adding sufficient low‑cost generation so that gas is no longer needed); or (2) the demand curve shifts down materially (through sustained reductions in demand, such as improved energy efficiency), gas will continue to sit at the margin and will continue to set the wholesale electricity price, even in a system dominated by much cheaper forms of generation.

Decoupling gas from the price of electricity

There are commentators who question whether the merit order now overcompensates certain generators and whether it continues to provide the right incentives in a system where an increasing share of generation is renewable and not subject to variable fuel costs in the same way as fossil fuel generation.

The argument increasingly levelled at renewable energy generators is that they are being over-compensated for their supply – particularly where consumers are seeing bills rise as a result of higher gas prices and renewable generators benefit from those higher wholesale prices. And let’s not get started on curtailment charges.

At the same time, the merit order has played a role in driving investment in renewables, helping to insulate the UK from fuel price volatility and improving energy security. It supported investment (alongside other subsidy schemes such as the Renewables Obligation) when renewable technologies were less mature. Contracts for Difference go further by fixing prices over time and limiting upside where wholesale prices exceed the agreed strike price. And, once you exclude generation tied to gas, the merit order continues to work well across technologies with low to no fuel cost.

In response to the public debate, the Government has promised “decisive action to break influence of gas on electricity prices” so that “families across the country will be better protected from energy crises”. But, given these market and pricing dynamics, will those measures truly succeed in decoupling gas from electricity prices? And, beyond market reform, what other levers exist to weaken that link (hint: more renewables, storage and flexibility)?

I’ll explore all of that in the next blog.

References used to write this blog include:

https://www.nationalgrid.com/stories/energy-explained/history-of-energy-UK

https://www.nationalgrid.com/supergrid-history/technology

https://obr.uk/box/a-history-of-natural-gas-in-the-uk/

https://www.energy-uk.org.uk/publications/closing-the-coal-chapter-how-the-uk-is-leading-the-energy-transition/

https://ourworldindata.org/electricity-mix

https://www.ref.org.uk/ref-blog/390-uk-renewable-electricity-subsidy-totals-2002-to-the-present-day

https://dp.lowcarboncontracts.uk/dataset/cfd-contract-portfolio-status

https://publications.jrc.ec.europa.eu/repository/bitstream/JRC134300/JRC134300_01.pdf?utm_source=chatgpt.com#:~:text=Figure%201%20%E2%80%93%20Generation%20technologies%20marginal,usage%20of%20lower%2Dcost%20technology

https://www.neso.energy/news/britains-energy-explained-2025-review

https://www.neso.energy/data-portal/historic-generation-mix/historic_gb_generation_mix