Energy prices in the UK have dropped back from the heights they reached following Russia’s invasion of Ukraine in 2022, but they remain high, both by historical standards, and in comparison with other nations. This is undoubtedly putting big strain on energy-intensive industries like chemicals and steel production, in turn putting pressure on the UK’s wider manufacturing sector. Manufacturing is already a smaller part of the economy in the UK compared to other nations, as I discussed here a few months ago.
Left axis: manufacturing share of the UK economy by GVA. Dashed line: Data from Bank of England, Millennium of Macro Data. Dotted line: Data from ONS 2025 Blue Book. Right axis: Index of industrial energy costs, excluding climate change levy, corrected for inflation with GDP deflator. Source: DESNZ.
Yet it would be a mistake to blame high energy prices for the historical decline in the importance of manufacturing. My plot compares the manufacturing share of the economy by value with an index of the real cost of energy for industry. It’s clear that manufacturing has been declining in importance in the economy for more than half a century. What’s interesting, though, is that the decade with steepest relative drop was between 1995 and 2005. Far from being a period of high energy prices, this was a period when energy prices were low and falling.
This decade was also the peak of production of North Sea oil and gas. Fossil fuels were cheap and abundant, with the UK being a net energy exporter up to 2005. A consequence of this was a high exchange rate, which severely disadvantaged exporting sectors like manufacturing. This high exchange rate persisted until 2008, when, in the aftermath of the global financial crisis, the pound devalued by of order 20%. I think it’s fair to associate this period of accelerating de-industrialisation with an episode of “Dutch disease”, associated with peak North Sea hydrocarbon production, and a subsequent financial services bubble. In addition, this was a period of low and falling investment in the manufacturing sector, associated with the ascendancy of the doctrine of “shareholder value”, together with the corporate misadventures that led to the fall of major innovation-intensive manufacturing conglomerates like ICI and GEC.
Counterintuitively, the period after the global financial crisis saw the manufacturing share of the economy start to stabilise, albeit at a rather low level. This was despite a substantial increase in industrial energy costs – gas prices more than doubled between 2004 and 2008. This stability was maintained until after 2015, when it began to fall again, in a climate of political uncertainty, new trade frictions for a sector that was by now deeply embedded in international supply chains, and regulatory uncertainty.
2022 brought the brutal supply shock following Russia’s invasion of Ukraine and the cutting off of supplies of Russian pipeline gas to Europe, and this has already led to the loss of manufacturing capacity in energy intensive sectors such as chemicals. This gas price spike should have brought home to the UK how much has changed since the late 1990’s: with the UK now a net importer of gas, fully integrated into a world gas trading system where prices are set by global supply and demand. By the beginning of 2024, industrial gas prices were about 3.6 times higher in real terms than they had been twenty years earlier. The increase in electricity prices has been even greater; while gas prices in the UK are broadly comparable with prices elsewhere in Europe, electricity prices are significantly higher. This mostly reflects the greater dependence of the UK’s electricity generating system on gas, which, in the current way the markets operate, sets the price for power. But there’s also a substantial policy component included in the price, to pay in different ways for the decarbonisation and upgrades to the grid. There’s a larger discussion to be had both about how those costs are allocated, and how they can be reduced in the first place.
But we need to face the reality that we aren’t in the world of the late 1990’s any more, when the UK was a substantial energy exporter with cheap and secure energy supplies. We depend on world markets for much (too much, in my view) of our energy, for which we have to pay market prices, and we’re exposed to supply shocks in a very unstable looking geopolitical environment.
This is inevitably going to shape our economy. Different manufacturing sectors have different degrees of exposure to energy prices. At one extreme, Aluminium is essentially electricity in ingot form, ammonium nitrate fertiliser is pretty much natural gas in granules. Less obviously, semiconductor manufacturing is highly energy intensive. If we leave this process to unfold without intervention, we will lose sectors that are strategically important, so deciding how to reallocate energy costs is going to be an important part of industrial strategy. It’s good that the government has recognised the importance of reducing industrial energy costs in its industrial strategy, through the British Industrial Competitiveness Scheme, but it’s going to need to accelerate those efforts, and recognise that there will be difficult choices to be made.