With firms and households facing surging costs, we explore how the Government could tackle the deepening energy emergency
On 26 August 2022 the UK energy regulator Ofgem announced an 80% jump in the Q4 2022 consumer energy price cap, and new predictions were made for 2023 showing a spike of over 235% from current levels. Against this politically-charged backdrop, we look at likely policy options to deal with the global crisis for consumers and business as well as wider energy policy implications.
Energy price cap for Q4 of 2022 rises to £3,549 and predicted to peak at over £6,500 for Q2 2023 before falling to slightly below £6,000 for Q4 2023
Ofgem announced for the period 1 October 2022 - 31 December the energy price cap will increase from £1,971 to £3,549 per year for dual fuel for an average use household. At the same time, Cornwall Insight's updated predictions for the next four quarters were:
- 1 January - 31 March: £5,387
- 1 April - 30 June: £6,616
- 1 July – 30 September: £5,897
- 1 October – 31 December: £5,887
These predictions could turn out better, or considerably worse. However, ominously the same day European benchmark gas prices hit a new all-time high – with prices up by about a third within the week.
The hit to UK consumers is equivalent to an extra 25% on the basic rate of income tax or 18% on VAT
With the energy price cap below £1,300 throughout 2021, UK households spent around £30 billion on energy during the year. In 2023 the projected spend is around £170 billion. This is equivalent to more than doubling the basic rate of income tax from 20% to 45% or almost doubling VAT from 20% to 38%. Just over 6% of GDP. This is big.
The energy price cap was not designed to protect consumers from rising costs, but to reduce the 'loyalty penalty'
The default energy price cap was not designed to reduce the overall amount consumers paid. Rather its aim was to limit the 'loyalty penalty' less savvy consumers (including the most vulnerable) paid compared to those who regularly switched to the cheapest suppliers.
All sides of the political spectrum agree the existing consumer support package must increase
On 26 May 2022 the government announced a £15 billion package to help with energy bills. Among additional policies for pensioners and the disabled, the key measures were:
- over eight million households on means-tested benefits will be paid £650 in two pre-winter instalments;
- each household will receive a £400 non-repayable discount administered by energy suppliers over 6 months from October 2022.
This package was partly funded by a windfall tax on the profits of North Sea oil and gas companies – expected to raise £5 billion in its first year. Liz Truss, the frontrunner to be Prime Minister from 5 September 2022, has expressed opposition to the tax. However, it is not yet clear if she would repeal it for its remaining period (until 31 December 2025 if oil and gas prices remain elevated) or simply not propose to extend or repeat for other sectors (for example, for energy generators which had been under review).
Two days before this announcement, Ofgem had written to the government estimating the Q4 2022 price cap would rise to £2,800, £749 less than its outturn level.
Unsurprisingly given the scale of the crisis, both contenders to become Prime Minister, and the opposition, are agreed significant additional consumer support is required. However, the size and focus of such additional support is hotly debated.
What are the key proposals for consumers?
- The Labour opposition proposal
Labour would extend the current cap of £1,971 from 1 October for 6 months and directly reimburse energy supply companies for the difference. This is currently estimated to cost over £40 billion. Labour are proposing to partially fund with an additional £8 billion windfall tax on oil and gas producers. After the initial 6-month period this would likely have to be followed up with further support.
Scottish Power reportedly proposed to the government that from 1 October the current cap should be held almost steady at £2,000 for two years. This is estimated to cost well over £100 billion. To put this in context, the government's pandemic furlough scheme that paid millions of salaries during lockdown cost £69 billion. Under this proposal energy supply companies would initially cover the costs by borrowing through a government arranged lending facility with repayments funded through general taxation, consumer bills, or a combination of the two over the next 10-15 years.
- Conservative leadership contenders
Liz Truss has promised to cut the part of electricity bills which cover government social and environmental policies –approximately £155 on the average bill. Her proposals to reverse the April 2022 rise in national insurance contributions at a cost of £13 billion a year would provide a maximum of £214 per year for households in the bottom half of the income scale. She has recently suggested there will be a significant further package of support with the details awaiting an announcement from the new Chancellor likely on 21 September.
Rishi Sunak has proposed temporarily cutting the 5% VAT on energy bills at a cost of about £5 billion (worth about £200 per typical household) and a further £5 billion of payments to around eight million households on means-tested benefits (worth around £650 each).
Is nationalisation on the table?
No, and in any event not for any reason linked to these issues. In July 2022 the Shadow Chancellor, supported by her leader, distanced the Labour Party from its 2019 manifesto commitments on nationalisation saying "to be spending billions of pounds on nationalising things, that just doesn’t stack up against our fiscal rules". The Labour leader also explicitly ruled out previous plans to nationalise energy supply businesses in the context of his proposals to support consumers.
On 26 August 2022 Ofgem reiterated what has been the case for some time now, amid an unprecedented number of energy supply companies going bust in the last two years: "most domestic suppliers are currently not making a profit". Profits are going to other parts of the supply chain - mainly gas producers (around half of which goes abroad through imports), with some going to electricity generators who do not use gas. However, hedging strategies and the fact more recent renewables generating assets are funded by contracts for difference (CfDs) which already pay back, to users' benefit, anything above the agreed strike price make the situation less clear-cut (and particularly difficult for those tasked with devising a windfall tax for the sector).
What about business users?
Much less has been said about support for business users beyond proposals Labour released on 23 August 2022 (including a £1 billion fund to help energy intensive industries and rate cuts for small businesses). However, few informed commentators doubt support will be forthcoming. Many firms in energy intensive industries have already been rationing production, halting operations or making other adaptations. As winter approaches it is likely large industrial energy users will be required to cease operating to protect priority end-users such as hospitals to balance the UK's gas and electricity transmission systems. European energy prices are sending a signal of reduced supply that must be met with reductions in demand notwithstanding that some of the actions by various governments (albeit understandable in the circumstances) have been blunting those signals.
Energy efficiency – a missed opportunity?
Back in April 2022 we noted the government's new Energy Security Strategy had missed the opportunity of an accelerated rollout with return on investment at an all-time high. As winter approaches, we wait to see whether the planned September announcement will prioritise this. Similarly, we wait to see if the UK will mirror the campaigns taking place in several other European countries to encourage steps to reduce energy demand.
What next for UK energy policy? Big new consultation underway
On 18 July 2022, the UK Government launched a review of Great Britain's electricity market design to ensure that it is fit for purpose. Russia's invasion of Ukraine provides policymakers with a more urgent framing for the energy trilemma they have been grappling with for years: the transition to a cleaner energy system; the challenges of soaring energy costs; and the need to ensure security of supply by reducing the UK's exposure to volatile global markets. As everything is on the table, including some radical proposals, we urge investors and market participants to take note (see our briefing here).
One of its most radical ideas would be to split the wholesale market into a separate new market for 'as available' power to run alongside an 'on-demand' market (the latter operating in the same way as the current market). The idea would be the new 'as available' market would replace future rounds of CfDs for new low carbon generation, with a pricing mechanism based on average rather than marginal costs.
An obvious advantage in current conditions would be to decouple electricity prices from soaring gas prices. This is also the driver for similar proposals made by the Greek Government to EU energy ministers on the 26 July 2022. On 29 August the EU Commission President Ursula von der Leyen said: “Currently, gas dominates the price of the electricity market . . . with these exorbitant prices, we’ll have to decouple".
If implemented, such a change would, on its own, be the most fundamental UK energy market reform since 2001. However, it raises many, so far, unanswered questions, such as how would the 'as available' price be derived in practice and how would balance be achieved across the two markets?
For more analysis see our earlier piece, A very British energy crisis