Welcome to the first edition of Nesta’s new energy edit.

Every six weeks Andrew Sissons - deputy director of the sustainable future mission - will assess the most important signals and trends underpinning the UK’s energy transition. Andrew is a specialist in climate change and economic growth, as a previous Chief Economist of the Environment Agency and civil servant in the Cabinet Office.

The energy edit is brought to you by Nesta, the UK's innovation foundation - focused on new solutions to society's biggest challenges.

We may have only just left the dark days of January, but we have already had two of the year’s most important announcements on energy policy in Great Britain.

First, we had the results of the seventh round of Contracts for Difference (CfD) auctions for offshore wind, known as allocation round seven or AR7. Then last week came the Warm Homes Plan, the UK government’s long-awaited plan for making homes warmer, cleaner and cheaper to heat.

Between them, AR7 and the Warm Homes Plan tell us a lot about where energy policy is heading over the coming years.

What were the results of AR7 for offshore wind?

AR7 was the biggest and perhaps the most closely watched auction for offshore wind so far. The UK government secured almost 8.5 GW of new offshore wind-generating capacity in total, a record amount. However, the strike price – the inflation-linked price per megawatt-hour (MWh) of electricity those wind generators are guaranteed – rose to £91.20 per MWh (in 2024 prices). That is an increase in both aspects from the last auction, AR6, which secured just under 3.5 GW of new offshore wind at around £82 per MWh.

A big increase in offshore wind capacity

On the one hand, the big increase in offshore wind capacity is good news for the UK government’s Clean Power 2030 plan. As of 2024, there were just under 16 GW of offshore wind capacity installed in total, and the new 8.5 GW is more than half that amount.

Offshore wind is the backbone of Britain’s renewable energy system, because it generates a large amount of power relative to its total capacity - with a capacity factor sometimes exceeding 50%, and usually around 35%. This compares favourably with solar and onshore wind, with capacity factors of 10% and 25%, respectively.

It is unclear how much of the new capacity in AR7 will be operational by 2030, but after the last two auctions added little new capacity, this marks a welcome acceleration of Britain’s offshore wind industry.

A higher price for offshore wind - not enough to raise energy bills, but not likely to reduce them either

On the other hand, the rise in price is arguably a setback, and one which will no doubt be controversial. Some will compare the AR7 price to benchmarks of wholesale prices, which have typically been around £80 per MWh recently, and argue that this CfD auction is baking in higher electricity prices for the long term.

However, comparing CfD prices to current wholesale prices is difficult, for several reasons:

1. The impact of renewables on the wholesale price. Offshore wind and other renewables reduce the demand for gas power plants. This reduces the marginal price of electricity, because it means more expensive gas plants are not required. The Energy and Climate Intelligence Unit estimate that wholesale electricity prices would be around a third higher without wind – and this effect will only get more powerful as more renewables come onto the grid.
2. The cost relative to other new forms of generation. The cost of building all forms of new electricity generation – including gas and nuclear – has risen significantly. DESNZ’s newly published estimates of the cost of electricity generation suggests a new gas power plant would cost over £100/MWh even if used all the time. The forces making offshore wind more expensive broadly apply to the whole energy system, so when you compare it to other new forms of generation, it remains competitive.
3. System costs. Offshore wind imposes wider costs on the electricity system, such as higher balancing costs and transmission costs, which may increase overall energy bills.

Two energy research firms – Aurora and Baringa, both commissioned by offshore wind developers – separately estimated that there is a threshold price of around £94 per MWh below which offshore wind reduces the overall cost of energy. At £91 per MWh, the AR7 auction comes in just below this threshold.

Given the multiple different effects offshore wind has on electricity prices, and the uncertainty over future gas prices in an unstable world, it is hard to say with any confidence whether AR7 will raise or lower energy bills.

Claims to the effect of “locking in higher electricity bills for decades” are not necessarily right – unless gas prices change dramatically – but claims that offshore wind will “slash bills” also look like a thing of the past.

Is AR7 good news or bad news overall?

It’s probably somewhere in between. It is good that Britain’s offshore wind industry seems to have life once again, which is vital both for the climate and energy security. But I had hoped prices would come in slightly lower, given the slight fall in interest rates and the UK government’s policy reforms (including extending CfDs from 15 to 20 year contracts).

We should resist the idea that this auction is raising bills, but if we want to substantially lower energy bills, we probably need to look elsewhere. The idea that simply building more renewables will take energy prices back to their pre-2022 levels now looks past its sell by date. What we need instead is a focus on the whole energy bill, including how we use energy and heat in our homes.

Why did prices rise?

It’s always hard to predict exactly what drives CfD prices, because they are set by a competitive auction in which bids are commercially sensitive. But there are some factors that have clearly contributed to the rise in prices:

• Higher interest rates. Offshore wind projects cost a lot to build and very little to run, which means the cost of capital is a huge factor in determining their cost. When the very low-cost AR4 took place in 2022, interest rates had been ultra-low for over a decade. They have since risen substantially, explaining why the AR5 auction failed to attract any bids below the price ceiling, and why AR6 and AR7 have seen substantially higher prices. Interest rate rises came with a big spike in inflation, particularly affecting the construction industry.
• A larger auction. AR7 has seen even further strike price rises than previous rounds, which cannot only be explained through the impact of interest rates and inflation. One possible further explanation is that AR7 bought much more offshore wind capacity – almost 8.5 GW this time compared to under 3.5 GW in AR6. Buying more capacity means accepting more bids – and the auction price is ultimately equal to the highest successful bid. I can’t be sure how much difference that would have made without seeing the full list of bids, but it is likely that a smaller auction would have had a slightly lower price.
• Investor uncertainty. Another possible explanation is uncertainty for investors. The last year has not been an easy one for the offshore wind industry, with: a major backlash in the USA; a breakdown in the political consensus on net zero and clean energy in the UK; as well as Richard Tice MP writing to offshore wind developers stating that a future Reform government would cancel CfDs. On top of that, the industry may still be recovering from the failure of the AR5 auction for offshore wind in 2023 and the gap that it left in pipelines.

The wider benefits of renewables remain

Even if we can no longer count on offshore wind as a major force to reduce electricity bills, it still brings plenty of other benefits.

AR7 will drive a significant amount of investment into Britain’s economy. The UK government has been highlighting the £3.4 billion of private investment that the auction will stimulate. In some ways, this is a natural function of the cost of the auction, given that the cost of offshore wind is mostly in the investment.

But there are two ways this investment may stimulate the economy. First, much of the investment will go into coastal areas of Britain which tend to struggle economically, and should benefit a lot from more investment.

Second, the alternative to this investment is to use more gas, most of which is likely to be imported, taking money out of the UK economy and increasing reliance on other countries. In the wake of recent tensions between the USA and Europe over Greenland, Britain’s reliance on gas imports looks like a significant vulnerability, one which clean energy can help to reduce.

Put it this way: if you were committing to £3.4 billion of spending via our energy bills, would you rather invest in homegrown energy built in places like Hull and Teeside, or spend a big chunk of it importing gas from overseas?

Cheaper electricity is crucial for reducing carbon emissions

The other, very obvious benefit of renewables is reducing carbon emissions. The UK’s achievement in reducing carbon emissions by over 50% since 1990 remains one of the great policy successes of recent decades; renewables played a central role in that. As our rapidly warming planet often reminds us, the job of meeting the UK’s climate targets is far from done, and renewable electricity is the most important tool we have in building a carbon-free economy.

But the next phase of moving towards our climate targets is a difficult one: it involves switching our cars, industry and home heating from fossil fuels to clean energy. The central problem with this next phase of electrification is a familiar one: electricity in Britain is too expensive, both in its own right and relative to gas. That makes clean electric technologies, such as heat pumps, much less attractive and affordable than we need them to be.

What could the UK government do next to make electricity cheaper?

The UK government has already made some important reforms to support offshore wind, and it has the tools to go further on reducing prices at future auctions.

• Reducing the cost of capital. Its primary focus should be on reducing the cost of capital for renewables projects. Part of that comes from reducing uncertainty, which this auction should help with, by signalling to the offshore wind industry that Britain is still committed to it. But part of it could involve more direct intervention to make capital cheaper using the UK government’s balance sheet. Through the National Wealth Fund and Great British Energy, the UK government has the tools to do this.
• A larger role for solar and onshore wind. Given the rise in offshore wind costs in recent years, the role of onshore wind and solar may become more important too. Both onshore wind and grid-scale solar were significantly limited by planning constraints in England under the last UK government, and the new Labour government has rightly removed these constraints. The results of AR7 for solar and onshore wind are due out next month, and it will be interesting to see whether that heralds lower costs. DESNZ’s latest analysis certainly suggests it might, with solar and onshore wind both coming in at below £60 per MWh in its estimates.
• Spreading the cost of upgrading the grid. The UK government also needs to look beyond wholesale costs if it wants to lower bills. The bigger issue driving energy bill rises recently has been network costs, as the country invests in a new electricity grid fit for the age of electrification. Rather than loading the costs of this investment onto today’s bills, the UK government could consider spreading these costs over a much longer period of time, again using the tools it has given itself via the National Wealth Fund.
• Further action on levies. Levies on electricity bills remain a persistent problem. The UK government took decisive action in its Budget last year to remove around £130 of levies from bills, but there is still more to do. Pushing the historic costs of making renewables cheaper onto energy bills has been a policy failure, and the UK government should seek to remove the remaining Renewables Obligation and Feed-in-Tariff levies from bills.

The biggest prize: cheap, clean home heating

The best way for the government to lower bills, though, is to look beyond the electricity system. Almost half of a typical household energy bill comes from gas, burnt directly in boilers. There is plenty of scope to reduce the cost of heating our homes with new electric technologies.

Switching more homes to electric heating could also solve one of the electricity systems biggest challenges: by increasing electricity demand, it would spread the high cost of upgrading the grid over more units of electricity, making each unit cheaper.

This is where the Warm Homes Plan comes in. The UK government’s new plan for home heating focuses heavily on electrification - that is, replacing gas boilers with more efficient heat pumps, and helping households lower their bills via solar, batteries and smart tariffs.

Nesta’s analysis suggests that this approach really can lower bills as well as carbon. We estimate that a typical household could save £1,000 a year with solar, a battery, a heat pump and a smart tariff.

The catch, though, is that investing in all of these technologies together has a high upfront cost. The Warm Homes Plan aims to tackle this, setting aside £5 billion to fully fund upgrades in low-income households and £2 billion for a government-backed loan to help better off households.

But the government’s money can only go so far. The Warm Homes Plan envisages up to 1.7 million households being upgraded by these schemes, which in itself may be a stretch. That is around 6% of all households, even with £15 billion of government investment.

Expensive electricity still holds back clean heating…

The way to reach more households with a limited government budget would be to make electricity cheaper relative to gas. If electricity was not so expensive, the need for rooftop solar and batteries would not be so pressing, and it would be much easier for consumers to finance heat pumps themselves.

In Nesta’s work on levy reform, we showed that if the UK government could get the electricity to gas price ratio down to 2.7 - by adjusting levies between electricity and gas bills - getting a heat pump would reduce a typical home’s energy bills by £400. In such a scenario, government subsidies could also go much further and focus more heavily on carbon savings.

Unfortunately, the Warm Homes Plan contained no further measures to lower the cost of electricity beyond those announced in the November 2025 Budget. We expect the price ratio to be around 4.1 in April 2026, which is too high to support mass heat pump uptake.

… and slow uptake of clean heating will raise energy bills

This slow uptake of electric heat has a knock-on effect on electricity bills. We are upgrading the electricity grid ready for an all-electric economy, in which we expect to use two to three times more electricity than we do now. The bill for that upgrade is front-loaded, and is already beginning to raise bills. If the expected increase in electricity demand from heat pumps is delayed, because electricity is too expensive, it could further push up the cost of electricity. Without more decisive government action, there is a risk that our energy system gets caught in a trap, where expensive electricity begets more expensive electricity.

Conclusion

The debate about lowering energy bills will not go away. It is clear, though, that it needs to move on from a simple renewables versus fossil fuels framing and into a consideration of all aspects of energy bills, including network costs, levies and heating. If it takes this wider view of energy bills, there is still a lot more the UK government can and should do to reduce them.

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