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RIDERS ON THE STORM – UK AND EU RAMP UP ENERGY CRISIS RESPONSES AS WINTER LOOMS

12 September 2022 | Insight
Legal Briefings – By Paul Butcher

European states vow to protect consumers from soaring energy prices with unprecedented financial support and wholesale market intervention

On her third day as Prime Minister, Liz Truss announced an unprecedented £150 billion support package for households and business alongside emergency electricity market interventions which will feed into a more fundamental ongoing review. The EU also announced radical proposals. 

UK PACKAGE TO HELP HOUSEHOLDS AND BUSINESS

On 8 September, the UK Government announced an unprecedented, potentially £150+ billion package to help households, business, charities and the public sector. This dwarfs the pandemic furlough scheme paying millions of salaries during lockdown in cost and represents well over half total UK income tax receipts for 2021. Unusually, the announcement was not accompanied by official cost estimates. These will be provided in a mini-budget later this month. However, the ultimate cost will be a function, primarily, of what happens to gas prices and, to a lesser extent, how effective the emergency electricity market interventions are.

Households

Following Ofgem's recent announcement, unit prices for the energy price cap were due to rise from a level consistent with the current £1,971 per year for an average household to £3,549 for 1 October 2022 to 31 December. The cap was then predicted to peak at over £6,500 for Q2 2023 before falling to slightly below £6,000 for Q4 2023. The plan to shield households from this comprises, as from 1 October:

  • Mandating a unit price cap for electricity and gas consistent with an average household price cap of £2,500 a year (a 25% increase rather than the planned 80%).
  • Proceeding with the support announced in May 2022 including a £400 non-repayable discount for each household, to offset most of the 25% increase in bills, and the larger additional payments for the most vulnerable.

The unit price cap element will last two years with government reimbursing energy supply companies to cover the difference with Ofgem's unit price caps given that, as Ofgem notes, most continue to make no profit. Part of the unit price cap is covered by temporary government funding of the part of electricity bills covering government social and environmental policies (about £150 on an average bill).

Business and the public sector

Business, charities and the public sector will receive 'equivalent support' to households with mandated unit price caps for electricity and gas from 1 October. However, for business the price caps are for six months only with the government undertaking a review over the next three months. There will then be an announcement on what ongoing support there will be for identified 'vulnerable industries' following the initial six months.

Initial comments on the support packages

  • A key attraction of the mandatory unit price cap is the Office for National Statistics (ONS) can count it as a reduction to official inflation. As a result, revisions to economists' inflation forecasts on the day of the announcement saw consensus shift, broadly, from inflation peaking at around 15% in early 2023 (or even as high as 20% on some assumptions) to an October 2022 peak at around 11%.
  • However, these same economists agree with the Bank of England's Chief Economist that, as a stimulus, such a package increases medium-term domestically-driven inflation. So forecasts for interest rates have also increased.
  • The key drawback of using a unit price cap approach is that, unlike increasing the lump-sum £400 non-repayable discount (which the ONS determined would not count as reducing official inflation) it does not preserve the price signal that will help reduce demand and mitigate winter rationing risks.
  • The judgement has been to go for simplicity, given implementation must happen so fast, and, for example, vulnerable households may also be larger energy users due to poor insulation or medical needs. Furthermore, average household bills will still be over 100% higher this winter than last (not including the special payments). The decision to limit guaranteed support for business to six months is also designed to sustain pressure for operational efficiencies.    

THE WINDFALL TAX DEBATE

In May 2022 the government announced the Energy Profits Levy, a windfall tax increasing the headline tax on the profits of oil and gas companies operating in the UK and UK Continental Shelf from 40% to 65% until 31 December 2025 (or sooner if oil and gas prices return to "historically normal" levels). At the same time, the government said it was looking closely at a windfall tax on electricity generators earning windfall profits due to the current crisis.

As the wholesale electricity market is based on marginal pricing, prices always reflect the value of the final, most expensive, unit of electricity on the system. Given gas generation currently provides the 'on-demand' flexibility this often means prices are set in line with gas prices which reflect most of the marginal costs of such generation. As a result, generators whose costs are not linked to the soaring costs of gas may be experiencing unexpectedly high profits. The caveats on this are:

  • Generators often hedge future electricity generation which complicates expectations on 'windfalls'.
  • The most recently commissioned 10GW of low-carbon generation are paid fixed prices for each unit of electricity through government-backed contracts for difference (CfDs), regardless of wholesale prices.

Notwithstanding the new Prime Minister's objections to windfall taxes, she is leaving the Energy Profits Levy in place for oil and gas profits but has ruled out increasing it or introducing a windfall tax for electricity generators. In contrast, the Labour Party opposition propose to increase the windfall tax on oil and gas companies and having opposed it at the time of the May announcement, are now in favour of a windfall tax on electricity generators too given the further increases in forecast energy costs.

UK PROPOSALS FOR MUCH OF EXISTING RENEWABLES AND NUCLEAR GENERATION TO VOLUNTARY MOVE TO LONG-TERM CFD CONTRACTS IN TIME FOR JANUARY 2023 

The government's alternative to a windfall tax on electricity generators is agreeing with existing nuclear generators and pre-CfD renewable generators (generally those that went live pre-2015) new long-term CfDs with strike prices at levels well below current wholesale prices. The approach had originally been proposed by the UK Energy Research Centre and also has the backing of the trade association Energy UK as such long-term certainty is also attractive to industry. Cornwall Insight estimates that if all such existing nuclear and renewables, representing 60% of Great Britain's power supply, moved to new CfDs then, as against market prices in August 2022, the overall cost of wholesale power could save over £44 billion a year (representing over £400 per average household bill). 

A new Energy Supply Taskforce is leading the negotiations on the new CfDs. Little detail is yet publicly available, but our understanding is that the proposed contracts are for 15-year durations and the aim is for them to go live for the start of 2023.

UK Energy Markets Financing Scheme

The Prime Minister also announced a joint Bank of England and HM Treasury scheme worth up to £40 billion to ensure that firms operating in the wholesale energy market have the liquidity they need to manage price volatility. Details of the scheme are still to follow. Finland and Sweden are among other European countries planning similar measures.

OTHER UK MEASURES TO INCREASE SUPPLY

Other measures announced included:

  • A new oil and gas licensing round will launch as soon as September 2022, expected to lead to over 100 new licences.
  • The moratorium on UK shale gas production will be lifted - enabling developers to seek planning permission where there is local support. See our briefing here.
  • A new review to ensure the net zero 2050 target is met in the most economically efficient way chaired by Chris Skidmore MP and reporting by the end of this year.
  • A new review of energy regulation with the aim to undertake fundamental reforms based on its recommendations.
  • A new Energy Supply Taskforce which is negotiating with domestic and international suppliers to agree long-term natural gas contracts (as well as the new CfDs mentioned above).

The Prime Minister also reiterated support for, and promised to speed up deployment of, clean and renewable technologies including nuclear, hydrogen, solar, carbon capture and storage and wind.  

WHAT NEXT FOR UK ENERGY POLICY? BIG NEW CONSULTATION UNDERWAY

In our recent briefing here we referenced the government's ongoing consultation on Great Britain's electricity market design to ensure that it is fit for purpose as the power system is decarbonised by 2035.

Among other things the consultation includes proposals to decouple some of the wholesale electricity market from gas prices. The urgent plans to move as much of existing nuclear generation and pre-CfD renewables onto CfDs is, of course, itself designed to go a long way to achieve this in practice. However, as explained in our briefing here, the proposals go far beyond this and include potentially radical options for all non-retail electricity markets: the wholesale market, balancing mechanism and ancillary services.

If anything, the new review of the UK energy regulation announced by the Prime Minister underlines the importance of the issues discussed in the consultation and the likelihood that this marks the start of substantive multi-year reforms.

The EU and Member States are also proposing radical measures

On 9 September 2022, EU energy ministers held an emergency meeting to endorse European Commission proposals on temporary measures to mitigate the impact of the energy crisis as winter approaches. Formal legislative proposals from the European Commission are expected to be announced on 13 September which are tipped to include:

  • Capping the revenues of electricity generators such as renewables and nuclear, with levels of €200/MWh discussed. This is similar in effect to a windfall tax.
  • A wholesale or import price cap for natural gas.
  • Targets (not yet clear the extent to which these will be mandatory) to reduce electricity demand.
  • An emergency liquidity support scheme to deal with the same issues as the UK's proposed Energy Markets Financing Scheme.

For more analysis on the malaise in the UK's power markets see our earlier commentary, A very British energy crisis

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