With the largely expected news that Liz Truss would become the new Prime Minister of the United Kingdom, speculation is growing about the support that will be offered to consumers ahead of the increase in the price cap that is due to come into effect on 1 October. Rumours abound that the Government will freeze the cap at close to the current level of £1,971 until the end of next winter (sources say it would be held to £2,500, which would be close to the current level once the existing £400 rebate, which will still be implemented is factored in). Suppliers would receive Government loans to cover the difference which would be repaid through higher bills over 10 or 20 years. This is more or less the proposal that Scottish Power mooted a few weeks ago – it was then, and still is, a bad idea.
“I will deal hands-on with the energy crisis caused by Putin’s war. I will take action this week to deal with energy bills and to secure our future,” – Liz Truss, Prime Minister of the United Kingdom of Great Britain & Northern Ireland
Of course, few consumers can afford energy prices to treble – recent forecasts suggest the cap could exceed £6,000 early next year – and I fully support a subsidy scheme for consumers. But this proposal is not the right way to do it. Not only is it an extremely blunt tool which will subsidise the wealthy to the same degree as the poor, it will fail to incentivise demand reduction and will create a very long-term and complex overhang on the market. It will require the Market Stabilisation Charge to continue until the expiry of the loans, possibly 20 years from now, to make sure that new entrants do not undercut legacy suppliers that hold these loans. It will further stagnate an already moribund retail market.
I would like to send this message to Jacob Rees-Mogg, the new Business Secretary…
An alternative approach
In the short-term, a blunt, market-wide tool is inevitable. There is little time for a more nuanced approach in the short time between now and the start of the new price cap period. But from January, I would like to see a more targeted approach, possibly replacing the subsidised price cap with a social tariff linked to income tax bands. For example, people who do not pay income tax and/or receive benefits would pay the lowest energy costs, people on the marginal tax rate would pay an intermediate amount, and people that pay higher rate tax would pay the market rate. (This is not a million miles away from Ed Birkett’s suggestion of fixed price subsidies for households with higher levels for those on benefits.)
I would also like to see VAT relief on all domestic energy bills, and for green levies and the SOLR costs to be moved to general taxation. Removing the SOLR costs from bills would restore the link between consumption and cost, since half of these costs are applied to the standing charge, meaning consumers cannot avoid them through cutting energy use. Suspending carbon trading would also provide a marginal price benefit, at no detriment to the environment, since there is very little fossil fuel generation left that is not gas, and gas is so much more expensive that the carbon price is not currently providing any indication for fuel switching.
The price cap also does not apply in Northern Ireland. I would like to see some measure of support offered to consumers there, although I am not sufficiently familiar with the political context to comment on how that could be delivered. Similarly, provisions should be made for people that use heating oil or LPG instead of natural gas to heat their homes, and Ofgem needs to quickly get to grips with its new role as heat networks regulator to ensure that those consumers are also protected.
Businesses also need support. Many small businesses are at the brink of failure as a result of high energy prices, and there is no cap outside the domestic market. The failure of small businesses will harm the economy, and high energy costs across the industrial and commercial sector will mean higher prices of goods and services which will also harm consumers. Supporting businesses will help to reduce this type of contagion effect from high energy prices.
In some ways, this lends itself to a wholesale market intervention rather than a retail market intervention, but it’s hard to see how this can be structured. The Iberian scheme has had some unintended consequences – gas-fired generation and electricity exports have both increased since the cap on the gas price for electricity generation was introduced. It would also introduce un-necessary complications, for example where generators buy from other generators to cover unplanned outages.
How it should be paid for
As noted above, I do not agree the subsidy to consumers should be paid for by consumers themselves through higher bills over the long term. Right now, the Government should borrow to fund the subsidy and recover the costs over time through taxation. The Treasury does have a partial hedge for the exposure through its North Sea tax and royalty income – the higher oil and gas prices are, the higher these receipts are. Encouraging more domestic oil and gas production will not only support security of supply, it will also boost this income.
I would not support any extension to the windfall tax on oil and gas producers. Labour would like to close the “loophole” which makes new exploration and production in the North Sea deductible from the profits that drive this tax, but without this deduction, producers might shy away from developing new production on the UKCS in favour of easier territories elsewhere. The North Sea is an increasingly challenging environment for E&P since the “easy” fields have already been exploited. If we are to maximise the benefits of increased global production we need as much of it to take place within the UK as possible, so it is important not to create a dis-incentive to this investment.
Another source of funding should be a windfall tax on renewable generators applicable to anyone with a Renewables Obligation subsidy that doesn’t sell under a fixed price PPA, and CfD holders that have failed to activate their CfDs. In the first instance, a revenue-tax could be applied to renewable generators with an allowance of perhaps £100 /MWh – anyone earning more than this would pay the tax, which would exclude anyone with a fixed price PPA because it is unlikely there are any at that price. I would not include nuclear plants in the windfall tax since (1) there are few of them, and (2) we need EDF to be incentivised to keep them running for as long as possible – a windfall tax would have the opposite effect.
I don’t believe that this will pay for the subsidies in full – I think there is a degree to which we must grit our teeth and accept that we’re in for a difficult few years, and remember that there are times in life when sacrifices are needed to support a greater good. Caving in to Putin now is unlikely to be the end of the story – we caved in in 2014 when we overlooked the annexation of Crimea, and this only encouraged him to invade Ukraine. If we do not stop him now, who’s to say he wouldn’t move on to Poland and/or the Baltic states in a few years’ time once he has re-built his military capability on the back of fossil fuel sales, with his energy blackmail continuing all the while.
As well as providing support for consumers, we need to re-balance our energy markets, to reduce the risks of a similar crisis in the future. I don’t particularly believe in energy independence – there is nothing intrinsically wrong with trading with reliable partners for energy – but we need to rely less on spot market purchases and build a portfolio of long-term fixed price gas contracts from different suppliers over different tenors and at different prices. We should properly explore gas storage, not just Rough, but at a scale that would make a difference in a crisis, proportionally similar to the gas storage in the EU. If we lack sites that can be developed economically then constructing more gas interconnectors with Europe would allow is to store gas in their facilities to be re-imported in winter. We effectively do this at the moment, but only at a small scale over two interconnectors.
Of course, despite not attempting to be energy independent, I would like to see more domestic oil and gas production. Although we may not use oil very much for heating and electricity generation, at times like these, the tax receipts and royalties are useful in defraying the wider costs of the crisis. We also need a more diversified and reliable electricity system with nuclear power providing a hedge against a combination of high gas prices and periodic low wind output. And I would like to pause renewables subsidies in favour of dealing with heat losses in homes – lower energy demand is always useful whereas more wind turbines are only useful when it’s windy. This would provide a significant long-term cost benefit to consumers.
Longer-term, we should also explore changing the way wholesale electricity prices are set so that renewable generation is paid on a cost-plus basis and everything else is paid on the existing marginal cost basis with a weighted average setting the price paid by consumers, ideally without a return to central dispatch.
I have lots of ideas about security of supply and the energy transition, but will save those for another day…