Counting the cost of the energy crisis

The government is under pressure to find ways to mitigate the pain for consumers of the next energy price cap rise. David Blackman looks at the options on the table and gauges expert reaction on which are likely to become a reality.

In 2013, when Ed Miliband shocked the Labour party conference with his pledge to freeze energy bills, the average customers’ annual combined electricity and gas costs added up to around £1,300.

Such figures, which caused so much political consternation nearly a decade ago, look small beer now in the context of predictions that the next review of the energy price cap will see it rise to approximately £1,900 from April.

It seems unlikely the pain will end there, with October’s increase expected to take it over the £2,000 threshold. Forecasters increasingly expect that the soaring wholesale gas price, the key driver of the recent surge, won’t fall soon, spelling elevated energy bills for the next couple of years.

“It (energy) was always going to come back to affordability at some point, it just happened sooner than expected,” says Josh Buckland, special advisor to ex-business secretary Greg Clark.

“With rising inflation more generally in the economy, this becomes a really significant ongoing issue, which ratchets up pressure over the long term.”

“This is fast going from an energy crisis to an economic crisis,” says Simon Markall, deputy director of external relations at Energy UK, pointing out that April’s price cap hike could add up to two per cent to the headline inflation rate.

The timing of the cap increase will be politically awkward for the Conservatives, coming five weeks ahead of May’s local elections, which already look tricky for the government following the revelations surrounding the Downing Street lockdown parties.

“A 50% uplift in energy bills in April would mean that the local elections are devastating for the Tories so there’s no way they won’t do anything”, says Adam Bell, former head of energy strategy at the department for business, energy and industrial strategy (BEIS).

Markall agrees: “The government is going to have to provide some support to customers.”

Mike Foster, chief executive officer of the Energy and Utilities Alliance, says “It is pretty clear what levers that government has at its disposal. It’s just a matter of how much they want to spend.”

So what are the options on the table for mitigating the pain of the next price cap increase for consumers?

Warm Homes Discount

The solution most frequently namechecked by ministers is the Warm Homes Discount,  the supplier-funded scheme that offers a rebate to benefit recipients which is worth £140 per annum (not a week as prime minister Boris Johnson erroneously told the House of Commons repeatedly in one encounter in January).

“This (option) is driven by the acknowledgement that the scale of cost increase is so significant, you risk a real distributional problem if you don’t do something for people in fuel poverty,” says Buckland, who is now a director at public affairs company Flint Global.

A big plus point from the government’s perspective is that the scheme is the source of potential support best targeted at those most exposed to increased bills.  It is also up and running already, meaning it can be extended without any fresh legislation.

Pre-pandemic, the government had said it was already committed to both increasing the rebate to £160, while extending the number of households receiving it.

“The worry is that they will just do what they said in the white paper,” says Markall.

Pointing out that the rebate has been held at £140 for ten years, Foster argues that the Treasury could “double it comfortably”.

The Resolution Foundation thinktank has proposed such an increase, raising the annual discount payment to £300.

The foundation also argues that the discount should be extended automatically to all households receiving in-work and pension credits, nearly quadrupling the total to 8.5 million.

Both the increased headline rate and widened eligibility should be paid for out of general taxation, the thinktank recommends, which would cost the exchequer around £2.5 billion.

Cost smoothing

The industry has been lobbying ministers to introduce a government-backed loan scheme that would enable suppliers to smooth out the cost of the recent price spike in wholesale gas prices into future years’ bills.

Ofgem has already launched a move to allow the costs of failed suppliers, which have entered the supplier of last resort process, to be smoothed out over several years instead of the hit being absorbed immediately.

A loan scheme is a “promising avenue”, says Buckland: “It doesn’t rely on a huge amount of government expenditure now on the basis that the cash can be recovered and would allow slightly more significant support for customers in April.”

“The government will get the money back, while heading off the an immediate risk of £2,000 energy bills”, says Markall, who insists that any loan would “absolutely not” be a bailout for companies.

Bell worries about the risk, if this scheme went ahead, that new entrants to the market would be able to undercut existing suppliers because they would be unburdened by these additional loan costs.

However Foster reckons that the government will want to see its intervention go straight into customers’ pockets, like additional WHD payments (see above), so that ministers can take the credit.

Levies

Since gas prices began to rocket in the late summer, the cry from climate change action sceptics has been to strip from bills the environmental levies, which have been added to stimulate the growth of renewable generation.

The current price spike has proved a “boon” to this campaign by the recently established Net Zero Scrutiny Group of mainly Conservative backbench MPs and peers, says Bell: “They will get some traction and may push back certain policies.”

An important chunk of these policy costs and levies is though the cash it raises for the improvements funded through the ECO scheme, which is of course targeted at the kind of fuel poor customers who will be feeling the pinch most acutely come April.

“Removing that from bills would be just stupid. I hope government wouldn’t be so stupid,” says Bell, who is now head of policy at consultancy Stonehaven.

Foster agrees. “It’s the worst possible conclusion anyone could come up with when people are worrying about heating bills: to scrap a mechanism that delivers energy efficiency programmes to the homes of those who can least afford it.”

Savings on the stripped out levies would still be dwarfed by the chunk of the bill from increased wholesale gas costs,” says Buckland: “It doesn’t negate the increase and is a fairly small portion. It’s not as easy as lopping 25% off the bill.”

But while a wholesale stripping out of policy costs and levies is unlikely to happen, the current crisis could provide added impetus for pushing the legacy costs of early renewable support schemes off bills, says Bell: “You might see some of the thinking going into that being used to remove remaining costs of the RO (renewables obligation) and FITs (Feed in Tariffs) off the bill and onto general taxation.”

RO contracts, which makes up a hefty slice of the levies, only have six years left to run, he adds.

In addition, the £6 billion cost of the remaining RO contracts, is fixed and can therefore be quantified by Treasury, says Dr Jonathan Marshall, senior economist at the Resolution Foundation.

“They are pretty much set”, he says.

“If it means a shift to general taxation, it would be a good idea and is more progressive. If it means scrapping them altogether, it’s not a good idea. The real question is whether Treasury is willing to take that on,” says Jess Ralston, analyst at Energy and Climate Intelligence Unit (ECIU).

While there is a “very strong ethical argument” for shifting renewables subsidies from bills to taxation, the risk is they will end up fighting with more politically high profile causes like the NHS, says Foster: “You are competing against all the other policy costs across all government expenditure.”

However, high energy prices will make it harder for the government to bring forward future levies which the government was banking onto to stimulate new low carbon generation.

The first of these will be the £6 per annum green gas levy but bigger headaches will be created by the support that the government has pledged to provide for the Hinkley and Sizewell C nuclear plants, says Buckland: “It becomes much more political and creates greater risks especially over the next two years. It becomes much harder in the context of rising prices.”

VAT

The centrepiece of Labour’s response to the energy costs crisis has been a proposal for a temporary cut to the VAT rate on energy bills.

So far, the government has brushed off the suggestion with Boris Johnson describing it as a “blunt instrument” even though the prime minister campaigned to cut VAT on energy during the Brexit referendum.

Marshall agrees. “It’s not enough and it won’t make a difference.”

A VAT cut on its own won’t address the problems facing cash-strapped customers but could be a useful element of a wider package, says Energy UK’s Markall: “For a time limited period, it should chip away at that price rise.”

And weighing on the Treasury’s mind will be concern that should spiralling energy bills force small firms out of business, the tax take could end up being reduced anyway.

The Treasury will have to weigh up this “trade off”, says Bell: “The actual impact on finances is not as pronounced so we might see more movement.”

While acknowledging that the VAT isn’t a “perfect policy”, Foster says lower income households will benefit more than others because a bigger share of their income goes on paying bills.

And he adds EUA polling, which showed that 83% of voters in Red Wall constituencies back a temporary VAT cut on energy shows that it would be “very popular”.

Weighing up the options

Before the current crisis broke, BEIS was in the middle of an Affordability and Fairness review to help map out how the costs of the transition to net zero can be distributed.

Amongst the thorny issues that this exercise, which was due to be published in the early part of this year, was meant to address was how to shift renewable energy subsidies and other policy costs from electricity to gas bills.

While the scale of the current crisis can only reinforce the case for the review, it is unsurprising that the exercise appears to have gone on the back burner.

Buckland says: “It’s happened very suddenly so there’s an immediate need to react rather than worry about the future structure of the market.

“The political pressure is increasing: the real challenge is whether they can pull something out of the bag in the next couple of weeks.”

The government will show its hand after the price cap announcement, says Foster: “They will make a big play of being seen to respond.”

However, any intervention will fail politically unless it matches the scale of April’s bill increase, says Buckland.

Foster, who used to be a Labour MP, agrees: “It’s an incredibly tough call, they (the government) are damned if they do, damned if they don’t and if they go half-way.”

The government staved off a potential rebellion over the opposition’s motion to cut VAT on energy bills in mid-January by hinting that there will be action further down the line, he says.

The “febrile atmosphere” at Parliament will also have a bearing on the government’s response, he says: “There’s lot of uncertainty at Westminster therefore a lot of uncertainty about how to respond.”

If the beleaguered PM looks vulnerable to an imminent leadership challenge, the chancellor may be tempted to woo fellow Tory MPs by sanctioning a VAT cut, Foster says: “The Treasury might be very generous.”

One thing is certain however, the scale of the crisis warrants a wide-ranging package says Markall: “It will have to be political decision: if they don’t act it will be baking in extra costs for the economy.”