Energy bills are made up of a fixed standing charge and a variable energy charge.

The standing charge covers all the fixed costs of providing gas and electricity, such as staff costs and maintaining wires, pipes and cables that deliver energy etc. Essentially it is the price for being connected to the grid.

Everyone pays a daily electricity standing charge. Those who are on the gas grid also pay a daily standing charge for gas.

The variable part of a bill is based on the number of kWh of energy the billpayer consumes. People often think about the energy they use in terms of the number of ‘units’; one unit of gas or electricity is equal to 1kWh.

Ofgem, the regulator for gas and electricity markets, defines typical annual consumption as 2,700 kWh of electricity and 11,500 kWh of gas (based on the median figures across Britain).

A typical household’s gas and electricity bills will be similar, even though it will use more than four times more units of gas than electricity. This is because the unit price of electricity is much higher (around 24p/kWh) than the unit price of gas (around 6p/kWh).

In reality, everyone’s bills are different because energy consumption varies between households. This is due to differences in the size of home, its fabric efficiency, the technology used for heating and the lifestyle of occupants.

Prices consist of many components that aren’t directly visible to the consumer. The largest of these is the fuel cost – the gas or electricity price paid by the supplier who then sells it to households. But the final consumer price also pays for things like investments in energy infrastructure, suppliers’ operating costs and profits, and environmental and social schemes.

There are six categories of components: wholesale costs, network costs, policy costs, operating costs, profit to suppliers, and VAT.

The chart below gives an overview of each component’s contribution to annual bills. Some of these are placed on the unit price, some on the standing charge and some on both.

Later we’ll look at what they all mean and why we need to pay for them (1).

The wholesale cost is the actual cost of the energy itself and makes up 36% of an electricity bill and 50% of a gas bill.

For gas that is essentially the wholesale price that suppliers pay on the market. In contrast, the wholesale cost of electricity is more complex.

Electricity is generated through a number of ways – burning gas and biomass, using nuclear reactors or capturing energy from renewable sources such as the sun or wind (2).

While some of these forms of generation use a fuel that has a direct cost (gas, biomass, nuclear), there is no ‘fuel’ for renewable generation. Instead, the ’wholesale’ price for renewable electricity mostly reflects the costs of building the technology that generates the power – the wind turbines and solar panels.

The wholesale cost of electricity also includes the cost of supporting these renewable investments. The government’s “Contracts for Difference” scheme (CfDs) guarantees a minimum price that generation companies will be paid for the electricity they produce, even if prices created by the market fall below. The money for ‘topping up’ prices is collected by the companies supplying electricity through consumers’ electricity bills. If prices rise above the guaranteed price, generators pay back the difference to the fund.

Another added part of the wholesale cost of electricity is the cost of ensuring that there is enough spare capacity when needed. Electricity supply and demand fluctuate over time, so there’s always a risk that demand could exceed supply, leading to blackouts. To prevent this, some companies are paid to maintain capacity that can be activated during demand spikes. This system is known as the Capacity Market, and the cost of maintaining this reserve is also added to consumer electricity bills.

Network costs cover the charges for maintaining and upgrading the grid infrastructure. They make up 24% of an electricity bill and 19% of a gas bill.

These costs vary by region to reflect the fact that building and maintaining these networks is more expensive in some areas than others.

Network costs are made up of three charges:

• Transmission charges pay for installing and maintaining the pylons and pipelines which carry electricity and gas over long distances, from power plants to local distribution networks.
• Distribution charges cover the costs of local distribution networks which deliver gas and electricity directly to homes.
• Balancing Services charges only apply to electricity bills. They cover the costs of making sure electricity supply meets demand at any given time. Though balancing charges are smaller than the other two charges, they are rising. As more and more of our electricity comes from renewable sources, there is a greater need for balancing services, such as paying power plants to stop generating at times of low demand.

Network costs are mainly collected through the standing charge, because networks need to be maintained for all customers irrespective of how much energy they use.

Policy costs are government levies collected to fund environmental and social programs. They make up 16% of an electricity bill and around 6% of a gas bill.

They fall into two categories:

1. Environmental levies cover investments in renewable energy. They currently fund three schemes:
   1. The Renewables Obligation covers previous investments made by electricity companies in renewable electricity generation.
   2. The Feed-in Tariff scheme covers incentives paid to households that installed solar panels and other green technology early on.
   3. The Green Gas Levy funds the production of biomethane as a “green” component of the gas supply.
2. Social levies fund government schemes for fuel-poor households.
   1. The Energy Company Obligation scheme instals energy efficiency improvements for low-income households.
   2. Warm Homes Discount provides low-income households with annual discounts on their energy bill.
   3. Assistance for Areas with High Electricity Distribution Costs is a small levy subsidising network costs in remote parts of northern Scotland.

The majority of these policy costs are on electricity bills. In recent years, Nesta and many others have suggested that a larger portion of levies should be recovered through gas bills instead, to incentivise the transition away from fossil fuels to electrical heat.

Operating costs make up 14% of an electricity bill and 15% of a gas bill.

There are three components to these costs:

• The Core operating costs cover the operational cost of serving customers who are on a Direct Debit contract (the majority of the customer base). These costs include metering, billing, customer service and the like.
• Payment Method Adjustment Allowances cover the administrative costs related to serving customers on other payment methods, namely standard credit and prepayment metres.
• The Smart Meter Net Cost Change funds the nationwide rollout of smart metres.

VAT and a number of other miscellaneous components make up 10% of an electricity and gas bill.

There are three main elements:

• Profit allowance (EBIT) is an additional amount that suppliers earn as profit. It’s set to ensure companies can make a fair return while protecting consumers from excessive charges.
• Headroom allowance and Adjustment allowance are small financial buffers that help suppliers to handle uncertain and unexpected expenses, respectively (such as extreme weather).

Energy bills include VAT (Value Added Tax), imposed on both gas and electricity bills at a rate of 5%.

Even though energy suppliers are free to set their individual tariffs, they are largely influenced by Ofgem, the regulator for gas and electricity markets. Ofgem sets a maximum billable level for all the components of the energy price described above.

The system is in place to maintain fair prices for customers and to create the conditions needed for a transition to a greener energy system (through supporting renewable electricity).

The price limits on the individual components collectively make up the energy price cap. Ofgem updates the energy price cap every three months. Even though the price cap is an upper limit on prices, it has de facto become the price most consumers pay.