Ed Birkett is Head of Energy & Climate at Onward.
If newspaper briefing is to be believed, the new Government will today announce that it is freezing energy prices for households and businesses for up to two years. It is likely to be the single biggest fiscal commitment in recent memory: double the cost of furlough, more expensive than HS2, and potentially more than next year’s NHS budget.
The Government has rightly gauged the scale of the crisis before us, and the real risks to households and firms. All interventions come with trade offs, and you can understand why opposition parties and now the Government have all agreed that a price freeze is the best option. Freezing energy prices gives households and businesses certainty, it is simple for people to understand, and it neutralises a potent Labour attack.
But even taking these benefits into account, Ministers must be clear-eyed about the risks involved. Not least the risk that market prices for energy stay high, or higher, for longer, leaving the Government on the hook for tens of billions of extra borrowing in the years ahead.
Freezing prices also brings a second, important, risk. By significantly subsidising energy prices, the Government risks inadvertently pushing up energy demand, particularly amongst the richest households and biggest businesses that have the most potential to cut back, meaning that if demand exceeds supply then energy will have to be rationed.
It is important, then, that the Government couples financial support with a national energy-saving plan to reduce demand.
Targeted financial support would be cheaper, and would pose fewer risks to short-term energy security.
Gas and electricity are in short supply across the whole of Europe. Financial support for households and businesses is part of the answer, particularly for groups that can’t pay. As we saw during Covid, it’s hard for the Government to accurately tailor support based on households’ actual income. That’s why Onward decided supporting households through a mix of targeted and universal measures was the best way through the crisis, rather than a bills freeze. .
Under Onward’s plan, the Government would give all households a £1,000 discount on their energy bills, plus an extra £1,000 for those on means-tested benefits, including poorer pensioners. Families have higher bills, so they should get an extra £500 per child up to two children. And we thought people with disabilities, who tend to use more energy, should get an extra £500 too.
This scheme would be astronomically expensive, costing £47 billion in 2023. But it would be half the cost of a price freeze, and would keep incentives for richer people to cut back or invest in energy efficiency, helping to reduce the risk of blackouts this winter.
To help pay for this, we do think there should be a windfall tax on “low-cost” electricity generators such as wind, solar, nuclear, or biomass. Many of these generators have made huge unexpected profits during this crisis, and even with such a tax would continue to generate far higher profits than they expected when they built their projects.
Readers may have heard how electricity prices are closely linked to gas prices, even though gas is only used to generate 40 per cent of our electricity. This is because electricity, like all commodities, is priced based on the marginal producer, which in the UK’s electricity market is gas-fired power stations.
There are lots of proposals out there for how to weaken the link between gas and electricity prices, to make sure that prices paid to renewables and nuclear reflect their costs rather than international gas prices. But these measures would take time to deliver, and so a windfall tax is the best way to break this link this winter.
A windfall tax on renewables and nuclear would also be a useful point of difference with Labour, who want further taxes on oil and gas producers, but ignore the huge unexpected profits made by some green generators because they – wrongly – fear a green backlash.
But financial support is not enough. Liz Truss must cut demand, diversify fuel supplies, and keep European energy markets functioning.
Truss’ energy plan is expected to have two elements. Short-term financial support for households, and measures to boost long-term energy supply. The focus on long-term supply is welcome, because this crisis would have been less severe if we had more domestic energy production, whether from wind, solar, nuclear or gas; and more insulation and heat pumps for that matter.
But it will take years to build new sources of energy supply. Gas prices are high now because demand for gas across Europe is outstripping supply. So we also need emergency measures to bring supply and demand back into balance this winter. Without these measures, blackouts are more likely.
In the short term, the most practical option is to cut demand. Governments across Europe have recognised this, and are going hell-for-leather to cut energy demand, with households, businesses and public bodies all expected to do their part.
Similar measures would be straightforward to implement in the UK: a national energy-saving campaign for example, alongside a new basic efficiency obligation on landlords and Housing Associations, and mandatory energy-saving measures for businesses.
There are short-term options to diversify energy supplies, but they don’t involve fracking, oil and gas, or even renewables. The only replacement for gas in this winter is coal and diesel. National Grid ESO has already signed contracts to keep coal power plants available this winter, a good call made by the new Chancellor, Kwasi Kwarteng, while at BEIS. And the Government can do more to allow diesel generators to run more this winter, including issuing new permits quickly and taking powers to suspend some air quality rules in emergency situations.
Finally, there is a risk that European energy markets will stop functioning this winter, either because high and volatile prices bankrupt energy companies or because countries cut off energy exports during times of extreme shortages.
This risk is real – it happened during the pandemic with PPE and vaccines, and the French threatened Jersey’s energy supplies during the Brexit negotiations. To keep supplies flowing this winter, the Government will need to cooperate closely with both the EU and Norway.
Whatever plan the Government puts in place this winter, there will still be severe challenges, both on the financial side and to energy security. To give us the best chance of avoiding rationing or blackouts, the Government needs to put as much focus on reducing demand as it is putting on financial support for customers.