How does the energy market affect the cost of your energy bills?

As a business owner, you've probably got bigger things to think about than the UK energy market and how gas and electricity are bought and sold. But you have, at some time, probably wondered why your business energy bill doesn’t always reflect the ups and downs of the wholesale market.

Let's take a closer look at why that is, along with the answers to some other key questions about the UK energy market, pricing mechanics, and the role of key regulators.

What is the UK energy market and how does it work?

The UK energy market connects energy generators, including power stations, wind farms, and solar parks, with gas and electricity suppliers. These suppliers then sell this energy to businesses and households. It’s made up of two main elements:

• Wholesale market: Where suppliers buy electricity and gas from generators, using both day-ahead (“spot”) and forward contracts.
• Retail market: Where suppliers sell energy to end-users, offering different tariffs and contract lengths.

Wholesale market prices are influenced by supply and demand, weather, global events and even politics. Suppliers buy energy at these wholesale costs, before adding network fees, taxes, levies, and their own operating costs, to set prices for customers in the retail market.

Want to know more about different business tariffs? Read our guide to business gas and electricity tariffs.

How do energy suppliers buy and sell electricity and gas?

Suppliers buy energy from the wholesale market. This is done in bulk, and often months or years in advance, through a process called “hedging”. Hedging allows suppliers to lock in prices and protect against sudden spikes, but it doesn’t always mean lower prices for customers, at least not straight away.

Once energy is bought, it’s sold on to you through the retail market. Suppliers set rates by factoring in the wholesale cost, but also include network, transport, environmental levies, and operational expenses. This is why your bill covers much more than just the price of power generation.

Why do my business energy prices not always match falling wholesale prices?

It can be frustrating to see headlines about wholesale energy costs dropping, but not see immediate savings on your bill. Here as some reasons why:

• Hedging contracts: Suppliers buy much of their energy ahead of time. If wholesale prices fall after they’ve already locked in, savings take time to filter through.
• Risk management: Any “safety margin” suppliers build in to save themselves from unpredictable market changes can delay retail price drops.
• Contracts: If you’re mid-way through a fixed-term contract, you’ll only benefit from price reductions at renewal.

If wholesale prices rise, suppliers may pass higher costs on to customers more quickly, especially for variable-rate contracts and out-of-contract rates.

How is energy traded and priced in the UK?

Energy is traded in several markets:

• Day-ahead (spot) market: For immediate delivery; prices can be very volatile.
• Forward market: Where suppliers buy energy in advance, providing some price stability.
• Balancing market: Ensures supply matches demand in real time; National Grid ESO (the Electricity System Operator) uses it to balance the system and keep the lights on.

Most business customers are on fixed-term contracts, which uses wholesale pricing hedged in advance. However, the final retail price also covers VAT, various levies, network maintenance, and supplier profit.

What is marginal cost pricing?

Marginal cost pricing means the price of electricity is set by the most expensive fuel used in generation. This is usually natural gas, especially when demand is high. Even if your energy is from renewables, if gas is the last resource needed to meet demand, its higher cost sets the rate for all electricity in the market.

Why does renewable energy sometimes cost the same as fossil fuel?

Although solar and wind generation costs less to run (despite potentially high initial build costs), their price is tied to the overall electricity market. Because marginal cost pricing is used, any time gas plants are needed to top up supply, it’s gas that sets the market price for everyone.

So, even if you choose a 100% renewable tariff, your bill may still rise in step with gas prices. Decoupling renewable prices from the wholesale cost of gas is under review, but hasn’t yet been implemented.

What additional costs make up my business energy bill?

Your total bill covers more than just wholesale energy. Here's a breakdown of things to look out for:

• Wholesale energy costs: The amount your supplier pays generators for gas and electricity.
• Network and transport costs: The fees charged for transporting electricity and gas, plus grid balancing charges.
• Environmental levies: Used to fund green schemes, such as the Contracts for Difference and Renewables Obligation.
• VAT: Typically charged at 20% for business energy, a reduced rate of 5% is available for qualifying users. If you're VAT-registered, you can claim this back as a business expense.
• Supplier operating costs: Covers meter installations, admin, customer service, and profit margin.

For more details, see our guide to business energy bills and VAT on business energy.

What is the balancing market, and what is the role of National Grid?

Britain can’t easily store large amounts of power, so supply and demand must be matched minute by minute. The balancing mechanism, run by National Grid ESO, manages this.

Generators make bids to supply electricity in half-hourly blocks. The ESO accepts offers to meet demand at the lowest price (“merit order”). This mix can change hourly depending on renewables, weather, and demand.

Other balancing services help ensure grid stability and quality. These don’t directly affect your rates but help keep the whole system working reliably.

When was the UK energy market privatised, and why does that matter?

The shift from a government-owned system to private companies began in 1986 (for gas) and 1990 (for electricity). Privatisation allowed market competition, meaning consumers could choose their supplier.

This competition expanded after 2014, when Ofgem made it easier for new suppliers to enter the market. While this increased choice and sometimes drove down prices, it also led to some suppliers going bust during periods of extreme price volatility.

Who are the regulators for the UK energy market?

• Ofgem (Office of Gas and Electricity Markets): Primary regulator overseeing suppliers and networks, enforcing customer protections and promoting competition.
• Department for Energy Security and Net Zero (DESNZ): Leads policy on energy supply, climate policy, and billpayer protection.
• National Energy System Operator (NESO): Balances electricity in real time to maintain supply and support net zero.
• Competition and Markets Authority (CMA): Ensures markets remain competitive and intervenes in cases of unfair behaviour.
• Environment Agency: Focuses on environmental regulation and climate change impact, especially as it affects the energy sector.

What does Ofgem do and how does it protect businesses?

Ofgem is designed to protect business and domestic consumers in the following ways:

• Licensing suppliers and setting strict rules for fair conduct.
• Monitoring prices, enforcing against mis-selling or unfair practices.
• Overseeing the energy price cap (for domestic users), and ensuring businesses have clear switching rights.
• Supporting greener initiatives and grid investment.

How do Contracts for Difference (CfDs) support green energy?

The Contracts for Difference (CfD) scheme guarantees clean energy generators a predictable price for electricity, encouraging investment. If the market price falls below the agreed CfD level, the government pays generators the difference. If it rises above, generators refund the excess. This is designed to support long-term investment in renewables and helps keep costs stable as the UK moves to net zero.

Why is there no business energy price cap?

Currently, there is a price cap for domestic energy users only. Business energy rates are not capped, so it’s essential to compare regularly, understand your renewal dates, and avoid being rolled onto expensive out-of-contract tariffs. Always negotiate or switch at the end of a fixed deal to ensure you don’t overpay.

Can my business sell energy back to the grid?

Yes, if you generate your own electricity (for example, with solar panels or wind turbines) and produce more than you use, you can sell the excess back to the grid through government schemes like the Smart Export Guarantee.

How to protect your business from market volatility

The energy market has been reasonably stable over the last couple of years, with none of the volatility experienced in 2022. Fixing your rates is a good way to protect against price volatility and keep your bills under control.

To help keep your costs down, compare contracts regularly, track your renewal dates, and seek expert help to fix your rates and protect against price volatility. To start a business energy price comparison, click the "Compare tariffs today" box on the right.