Gas Still Sets the Price of Electricity. The Iran Crisis Shows Why That's a Problem

When missiles started flying in the Middle East and tensions around Iran escalated into open conflict, most people thought about oil. But the more consequential energy story unfolded in a market that most consumers never think about: natural gas. A surge in gas prices triggered by the Iran war caused an immediate, painful knock-on spike in electricity prices, even for households and businesses powered almost entirely by wind, solar, or nuclear. That disconnect, between where electrons actually come from and what consumers pay for them, sits at the heart of one of the most consequential and least understood features of modern energy markets.

The reason gas sets the price of electricity is not a conspiracy or a policy failure in the conventional sense. It is the logical output of a system called marginal pricing, sometimes referred to as the merit order. In most liberalized electricity markets, grid operators rank power sources from cheapest to most expensive and call them up in that order to meet demand. Renewables and nuclear, which have near-zero fuel costs, get dispatched first. But because they cannot always meet total demand on their own, gas-fired plants are frequently the last source called upon to balance the grid. In economic terms, gas is often the marginal producer, and in a marginal pricing system, the marginal producer sets the price for everyone. That means when gas becomes expensive, the entire electricity market reprices upward, even the electrons that came from a wind turbine that cost nothing to fuel.

This architecture made a great deal of sense when it was designed. Marginal pricing creates strong incentives for efficiency, encourages investment in cheaper technologies, and ensures that generators with low operating costs, like renewables, earn healthy profits that can fund future buildout. The problem is that the system was built for a world where gas was cheap and stable. When gas becomes volatile, as it did after Russia's invasion of Ukraine in 2022 and again following the Iran conflict, the transmission mechanism between a fuel that powers perhaps 20 to 30 percent of the grid and the bill paid by every electricity consumer becomes a source of systemic fragility rather than efficiency.

The second-order consequences of this pricing structure are significant and underappreciated. When electricity prices spike because of gas, the political pressure to slow the clean energy transition intensifies, even though more renewables on the grid would, over time, reduce the frequency with which gas sets the marginal price. Voters and politicians experiencing bill shock tend to reach for the nearest available explanation, and that explanation is often framed as the cost of climate policy rather than the cost of fossil fuel dependence. This creates a feedback loop where the very volatility caused by gas reliance becomes an argument against the investments that would reduce that reliance.

There are serious proposals to break this link. One approach, already being discussed in parts of Europe, involves moving toward a two-part pricing system that separates capacity payments from energy payments, reducing the dominance of the marginal gas plant. Another is contracts for difference, a mechanism that pays low-carbon generators a fixed strike price and returns surplus revenue to consumers when market prices exceed it, insulating households from gas-driven spikes. The United Kingdom has used this model for offshore wind with considerable success, and it has attracted attention from policymakers across the European Union.

But reforming electricity market design is genuinely hard. Wholesale markets are deeply interconnected with investment signals, grid planning, and cross-border trading. A poorly designed reform can suppress the very price signals that tell investors where to build new capacity. The risk of unintended consequences is high, which is part of why these debates have been ongoing for years without resolution.

What the Iran-driven gas price surge has done, perhaps more usefully than any policy paper, is make the abstract concrete. Consumers who had been told that renewable energy was becoming the cheapest form of new electricity generation found themselves paying sharply higher bills anyway. That experience is politically combustible, and it is also analytically clarifying. The price of electricity is not simply a function of the cheapest electrons available. It is a function of system design, and system design is a choice.

The countries that move fastest to restructure that design, whether through market reform, accelerated renewable deployment, or expanded storage capacity that can displace gas at the margin, will find themselves increasingly insulated from the next geopolitical shock. Those that do not will keep discovering, every time a conflict erupts somewhere near a gas pipeline or an LNG terminal, that their electricity bills are hostage to events they cannot control. The Iran crisis will eventually subside. The structural vulnerability it exposed will not.