Chapter 10: Electricity Levies - Hidden Costs Everywhere

In the UK, there's been considerable interest of late in high energy prices. While generally true, the reality is more mixed:

1. The standard cost of electricity per kWh is about 25p and is similar for business and residential consumers. This is expensive by international standards, especially for businesses, though not that expensive by European levels and for the residential sector.

2. The standard cost of gas per kWh is much lower, at about 7p. This is relatively cheap by international standards, particularly for residential consumers, though business gas prices are a bit higher because of extra environmental and carbon charges that they face.

There are quite a few reasons why British energy users have such mixed fortunes:

Reliance on Gas for Electricity The UK is particularly dependent on gas not just for heating, but also to generate electricity. Unlike France, Britain has much less nuclear power. Outside Scotland, Britain lacks the geography for much hydropower, at least compared to the Nordics, Alpine countries, Spain or Canada. And compared to Germany, Poland, US, China and India, Britain shifted entirely from coal power, which used to generate nearly all our electricity.

Gas produces about half the CO2 emissions per unit of electricity generated (around 400g CO2/kWh) compared to coal (around 800g CO2/kWh). Even though the UK had well established gas fields in the North Sea, it was considered a premium fuel for heating and industry, and the CEGB (Central Electricity Generating Board) had limited gas-fired generation capacity before privatisation, preferring coal for electricity production. However, there were significant advances in gas turbine technology at power stations in the 1980s and 1990s, and it was cheaper and easier to build new gas-fired power stations. Combined Cycle Gas Turbine (CCGT) power stations became the preference for newly privatised energy companies, and between 1990 and 2010, around 30 major CCGT plants were built around the UK in a "dash for gas".

Investment in new nuclear plants basically stopped after the completion of Sizewell in the 1990s, which had been initiated before privatisation, but which dragged on and was massively over budget. Given the scale and long term risk of nuclear investment, coupled with cheap gas and wholesale power prices privatised utilities were unable and unwilling to invest in new nuclear plants, and the existing plants which were privatised eventually went bankrupt and were sold to the French state utility EDF.

The wholesale price mechanism used in Britain sets the price of electricity at the cost of the most expensive power generator in each half-hourly period. 98% of the time, this is a gas power station. And so wholesale electricity prices in Britain closely shadow gas prices, although there is considerable movement from day to day and hour to hour depending on the level of demand. This is because the most efficient gas power stations in Britain, like the newer CCGT plants, are around 55-60% efficient, while the least efficient gas power stations (often older, simpler gas turbines) are more like 30-35% efficient. This means that the cost of making a unit of electricity at the least efficient gas power stations is maybe double that at the most efficient ones. In turn, this means that the least efficient power stations operate very little, typically only firing up on very cold days midwinter and for the peak late-afternoon and evening periods when demand is highest and all available capacity is needed to keep the lights on. And when the least efficient plants do have to fire up, prices spike!

After 2010, there was a notable increase in wind energy investment, which now contributes a similar share % as gas. Private companies have also continued to build more interconnectors to European neighbours. There are now x interconnectors built, up from one pre-privatisation and in 2024 the UK imported about x% of its power through these cables. Despite both these trends, gas continues to drive the overall market and prices, even if it only accounts for about one-third of the power used.

Why does this matter for prices? Well gas is quite an expensive fuel. It creates half the carbon of coal, and is much cleaner to burn, meaning there is vastly less local air pollution. And power stations have to buy carbon permits, which operate like a tax on natural gas that domestic and many business users don't have to pay when they burn gas in boilers or cookers. These carbon permits add about x% (or £x/tonne) to the cost of the gas.

Accounting tricks Starting in 2010, when the coalition government got serious about the pace of expansion of renewable generation, they needed to finance a substantial expansion of Britain's wind, solar and biomass generation at a time of public expenditure restraint (austerity). The private companies developing these projects needed subsidies through ROCs (and later CfDs). Unlike longstanding government support such as agricultural subsidies, export guarantees or student loans, which are treated as public expenditure and inflate the size of the recorded deficit and national debt figures, renewable energy subsidies were structured to avoid this accounting treatment.

The key innovation was the Levy Control Framework (LCF), which allowed the government to commit to long-term subsidy payments without these liabilities appearing on the national balance sheet. ROCs and CfDs are essentially contracts between the government and private companies, but they're financed through levies on consumer bills rather than direct government spending. This means that while the government is legally committed to paying these subsidies for 15-20 years (in the case of CfDs), the total liability - which could run to tens of billions of pounds - doesn't count towards the official national debt figure.

This accounting treatment was crucial politically, as it allowed the coalition to claim it was reducing the deficit while simultaneously committing to massive long-term spending on renewable energy infrastructure. It's a classic example of "off-balance sheet" financing - the economic reality is that British consumers are paying for these subsidies through their electricity bills, but the government can claim it's not adding to the national debt.

Putting additional levies or charges onto energy bills to fund these costs was preferable to tax rises for political reasons. Given the levies are mandatory, they could be described as a stealth tax.

Sharing the cost evenly Given the decision to finance renewable subsidies off energy bills, the Government was then faced with the decision of which energy bills to target. At the time, only around 85% of households and a smaller 60% of businesses had a gas supply, while nearly 100% of homes and businesses have an electricity supply. The decision was taken to finance the bulk of subsidies and supports for renewables from levies and charges to electricity bills. It was felt that the burden of these charges would then be felt broadly in proportion to how much electricity they used. By raising the levies off a single fuel i.e. electricity rather than a mix of different fuels, it was felt that the administration would be simpler. As the levies would not be traditional excise duties like road fuel (petrol and diesel) the Government could also avoid presenting them as tax rises.

Electricity levies discourage heat pumps When they were first introduced, electricity levies weren't that significant. In 2012, the cost of electricity for households was around 12-14p/kWh and gas was around 5-6p/kWh, a ratio of roughly 2.5 to 1. However, over time, the levies have grown dramatically. Analysis by Ben James on the excellent Electricity bills shows how such levies have increased far more than expected:

Generation Subsidies per household:

• Renewables Obligation: More than doubled from £39.85 in 2015-16 to £108.18 in 2025 (FYTD)
• Contracts for Difference (CfD): Exploded from just £0.13 in 2015-16 to £31.27 in 2025 (FYTD), though they briefly turned negative during the 2022-23 energy crisis when wholesale prices were high
• Capacity Market: Grew from £0.07 to £28.67 over the same period

Social and Infrastructure Costs per household:

• ECO (Energy Company Obligation): More than doubled from £11.78 to £27.09
• Smart Meter Charges: Nearly tripled from £6.94 when it started in 2018-19 to £19.82 in 2025
• Warm Home Discount: Increased from £6.56 to £10.98

The total burden of these levies per household has grown from around £70 annually in 2015-16 to over £200 today, representing a nearly threefold increase in just a decade. About 30% of household electricity bills are now levies and VAT. This dramatic growth explains why electricity has become so expensive relative to gas, and why the current price ratio is now closer to 4:1 rather than the ratio of 2.5:1 of 2012.

At this level, electricity bill levies are a significant detractor from the effort to sell and install heat pumps (and in some cases EVs). A well installed heat pump is about 350% efficient, and a well installed gas boiler about 90% efficient. But a heat pump is typically 4 times more expensive to purchase (£8,000-12,000) than a gas boiler (£2,000-3,000).

If we didn't have levies on electricity bills, but had instead funded the costs through general taxation, and the cost of electricity were still just 2.5 times more expensive than gas (currently 7p), then heating homes with heat pumps would be around 35-40% cheaper, with a typical saving (assuming annual heating/hotwater use of 12,000 kWh) of £400-550/year, especially if homes ditched their gas connection and avoided £100-150 of standing charges.

Taking this argument further still, if we had instead put the cost of levies onto gas bills rather than general taxation, then the cost of electricity would be about 1.5 times more expensive than gas. At this level, then heating homes with heat pumps would be around 65% cheaper than gas, with a typical saving of £600-750/year. For homes with solar PV and/or a battery, then heat pump savings would be even greater, perhaps £1,000/year. With this sort of savings, many homeowners could have achieved a clear payback in 5-10 years, and heat pumps would quickly have been popular without Government support or major subsidies.

However, because the Government continued with imposing large levies on electricity bills, it has been far more difficult to persuade homeowners of the rationale to install heat pumps. This has meant:

1. The Government is now paying an upfront grant of £7,500 per property (as well as a VAT exemption worth another £2,000 on average). If heat pump installations hit 800,000 a year in 2028 as the Government hopes, these grants will cost £6bn a year. This is a massive figure, for context the total budget for all the primary schools in England is about £6-7bn.
2. Because heat pump installations rely on grant funding that's on an unsustainable path, installers aren't recruiting and training enough new installers. They're rightly nervous given how previous Governments have cut support for Feed in Tariffs (FiTs) and other energy efficiency grants like ECO.
3. Because of the lack of qualified installers, the Government is having to subsidise the training, by offering grants and funding for training programs, creating yet another taxpayer-funded intervention in what should be a self-sustaining market.
4. Only affluent households are installing heat pumps. This means the taxpayer is subsidising the better off to get expensive heating systems they could afford anyway, while poorer households continue to struggle with high electricity bills. Research shows that 70% of heat pump installations are in homes in the top 40% of income brackets, with the average household income of heat pump adopters being £65,000 - well above the UK median of £32,000.

Taxing Gas The obvious solution or remedy to the current mess is to move (or rebalance as it's commonly referred to), levies from electricity and onto competing fossil fuels. At the moment there are very few taxes on natural gas, especially that used in households. On the total retail price of 7p/kWh, levies account for just 0.5-1p/kWh, which is drastically less than electricity, especially as a percentage.

Given most energy companies that supply electricity also supply gas, it would be feasible to move many of the levies onto gas. But while this could plug much of the gap, and many energy users using a mix of electricity and gas might not notice much overall change in their bills, there would still be winners and losers. Levies or taxes might also need to be extended to LPG, heating oil and coal fuels to avoid a perverse incentive for energy users to shift from mains gas to one of these alternatives, all of which have higher carbon emissions and local air pollution. However, doing so would probably require the Government formally creating or increasing excise duties, which are taxes, and this would draw more potentially unwelcome political attention.

The basic rebalancing proposal has been around for a decade, and successive Governments have resisted the suggestion. At the core of its reluctance is the perception that any move which increases the price of natural gas would be considered regressive, and sharply increase the cost of the most basic need for heating in the winter months.

Of course, rebalancing from electricity to gas has a positive effect on both sides of the coin. It doesn't therefore take that much to significantly alter the economics of a home contemplating an investment in a heat pump.

Impact of Electricity Levies on EVs It's true that electricity levies also have some impact on discouraging the adoption of EVs. However, as explained in Chapter 16, petrol and diesel duties remain very significant compared to the minimal levies and taxes on natural gas. For homeowners with a driveway, there's ample incentive to charge at home, with overnight tariffs available as cheap as 6.5p/kWh for charging. The bigger challenge is the cost of VAT on public charging, which mainly affects those without driveways.