Energy bills are a big concern for most of us. The amount we have to pay each month has rocketed over the last couple of years, putting household finances under extraordinary pressure.
Recently Ofgem announced that the energy price cap for the final quarter of the year would drop by 7%, to £1,923 a year based on a typical household’s use. That’s still a huge amount of money, however, and almost double what most paid before the energy crisis hit. So if we are to keep our own energy bills as low as possible, it’s important to understand exactly how they are calculated.
If you’re struggling, see how to get help with gas and electricity bills. But what contributes to an energy bill?
Energy bills explained: wholesale costs
Wholesale costs are what energy suppliers pay for the energy supplied to your home.
Energy suppliers buy gas and electricity from energy producers on the wholesale market, and the cost of doing so can rise or fall depending on a host of different factors.
For example, wholesale energy costs were driven up sharply by the invasion of Ukraine, due to the reduction in supply. The end of the pandemic, and the growth in demand for energy, also pushed up wholesale prices.
As obtaining that energy becomes more expensive, suppliers will tend to ratchet up what they charge their customers meaning higher bills.
Generally energy suppliers try to purchase their energy in advance, sometimes by two to three years. This then gives them a little more certainty over the pricing of their tariffs. It also helps to explain why even though wholesale energy costs have been falling for some time, it took a little while for that to truly feed into the levels of the energy price cap, and before that the Energy Price Guarantee.
Wholesale costs account for around half of our bills.
Energy bills explained: network costs
Network costs cover the gas pipes and electricity cables that bring the energy into your home.
Our energy suppliers don’t actually own these pieces of infrastructure; instead they belong to energy networks.
These networks charge the supplier for using them to supply our homes, and those costs are passed on to us, the customer.
The money we pay goes towards maintaining those networks as well as upgrading them where necessary, and the costs can vary over time, for example if the network wants to carry out specific upgrades.
Ofgem, the energy regulator, oversees these fees to make sure that we aren’t getting ripped off.
The regulator also points out that these network costs include balancing charges. The idea is that the energy networks need to make sure that the right amount of energy is available on the grid to meet demand at any point. Supply and demand is balanced second-by-second for electricity, and over a daily basis for gas, with the costs of overseeing that balancing act added to our bills.
Given the way that supply and demand for energy can change over time, so too will the size of the balancing charges incorporated into our bills.
Around a fifth of our energy bill comes from network costs.
Energy bills explained: operating costs
Operating costs cover the money energy suppliers need in order to carry out their duties, and make up around a tenth of our energy bills.
For example, energy suppliers need to have some sort of customer service team in place, whether over the phone or on live chat ready to answer our questions or help when things go wrong.
There are also administration costs involved with running an energy supplier, like sending out bills or monitoring our meter readings. Part of our bill each month goes towards the costs of effectively running an energy supplier.
Energy bills explained: unexpected costs
Energy suppliers are also able to add a little extra to our bills to cover unexpected costs.
A recent example are the costs incurred by suppliers going bust back in the winter of 2021/22.
This ‘adjustment allowance’ accounts for around £19 of the current £2,074 typical households pay through the energy price cap.
Energy bills explained: social and environmental costs
Energy suppliers are required to contribute to a range of social and environmental schemes, and part of our energy bills helps fund those contributions.
There are a host of such schemes in place. For example there’s the warm home discount, a scheme set up to provide those on certain benefits with a £150 payment over the winter to help cover energy costs.
There is also the feed-in tariff. Though it is closed to new applicants, people who signed up were able to get payments for powering their home through renewable energy. They are still entitled to those payments too.
Under the current price cap, these costs account for around 8% of our bills.
Energy bills explained: VAT
Taxes, and specifically VAT, make up a portion of our energy bills.
VAT on energy bills is levied at 5%. That’s substantially lower than the 20% we pay on other spending that incurs VAT, but nonetheless it does mean an increase to the size of our bill.
Energy bills explained: profit margin
Energy suppliers are businesses and so expect to make a profit from their work.
Suppliers don’t particularly like to talk about this, instead emphasising how important it is for them to give customers a fair deal and support them, particularly when times are tough.
However the reality is that energy suppliers also want to make some sort of profit. As a result when they work out our energy bill, there will also be a portion set aside for their profit margin, typically making up around 5% of the bill. Those profits could then be reinvested into the business, or shared with investors.
Keeping your energy bill as low as possible
If you want to keep your energy bill low then you need to find ways to reduce how much you use. With VAT for example, the amount of tax you pay will go down if you use less energy. Similarly, the more energy you use, the bigger the impact will be if wholesale costs increase.
We have put together a comprehensive round up of the best ways to keep your energy use down, including switching to energy efficient appliances, dropping your thermostat by a degree and changing the temperature you wash your clothes.