The long-term sustainability of the energy sector is at risk from the short-term measures being considered as a solution to the energy crisis.
Currently policy makers are focusing too heavily on solutions to manage the upcoming price cap increase, in particular the Default Tariff Cap, without treating the root cause of the energy crisis, according to Gareth Miller, CEO of Cornwall Insight.
This leaves the public vulnerable in the long run, simply delaying the risks and costs within the current market design rather than fixing them.
To future proof the system, Cornwall Insight identified three key areas of focus for the government, including reforming the wholesale market so it can better respond to volatile gas driven balancing costs.
“We need to reconsider our strategy for buying and storing gas, and the balance between importing from abroad and the benefits of using our own resources,” said Miller.
“Particularly as where we get gas from is irrelevant so long as we stick to a declining usage as we move to net zero. We also need to look again at the type of low carbon technology mix that minimises exposure to volatile international fossil fuel prices, and how we encourage a lot more energy efficiency and demand reduction.”
The rise in wholesale electricity prices in the UK have been driven by a 500% increase in the cost of gas in Europe during 2021. This has placed significant pressure on suppliers, who are bound by the price cap in terms of how much they can charge customers for energy. The squeeze between high wholesale prices and what they can recoup through bills led to 27 supplier collapses in 2021, mostly at the end of the year as gas prices surged.
In response to high wholesale prices, the price cap is expected to increase significantly in April, with previous research from Cornwall Insight suggesting it could jump by 46% to £1,865. Furthermore, it is forecasting the winter 2022-23 default tariff price cap to hit £2,240 per annum.
“The cap will not protect consumers from increases in gas and power prices in the long run,” said Miller. “Certainly, the cap has delayed the burden of these costs to consumers, but they will face them anyway as the default tariff cap rises in a lag to the rise in gas and power prices.”
Secondly, Cornwall Insight is calling for a better understanding of the inter-relationship of wholesale prices with consumer costs. This should then be used to determine the fairest route to recover costs over time.
The price cap is set based on the level that Ofgem deems a fair price, one which allows suppliers to adequately cover their costs without making excessive profit. However, if what is considered fair creates hardship, neither energy bills nor market mechanisms can conceivably deal with wholesale power price growth, said Cornwall Insight.
Instead, the tax and welfare system will need to be used by the government to alleviate pressure on vulnerable households.
Finally, there needs to be concerted effort to communicate the benefits of net zero to the public. Research has repeatedly shown that decarbonisation ultimately leads to a reduction in costs along with wider benefits, but this is not always transparently communicated to the general public, said Cornwall Insight.
“These activities are by no means easy and will require upfront investment on top of levies and costs already being paid by consumers,” said Miller. “It is essential that the government is open and honest with the electorate, about the profile of costs but also the accumulation of benefits of net zero. There should be some acceptance of what is controllable and what isn’t, and what are the uncertainties that may change the trajectory as we make progress.”
Proposed pathways to manage the energy crisis
The recommendations from Cornwall Insight follow a slew of calls from MPs, charities and energy companies for the government to take action to protect consumers both in the short and long-term.
Suggestions have included a temporary cut to VAT, a policy backed by Labour amongst other groups, reducing bills by around £90 per household.
While such a move would be broadly welcomed, some have suggested it is not a targeted approach, cutting bills indiscriminately of need.
“We wouldn’t call for a scrapping of VAT, just because although it would give some element of relief to bill payers, it’s probably the least accurate way of doing so,” Good Energy’s policy and regulation manager Kit Dixon recently told Current±.
“The relief would not be targeted at all, you’d be passing some of that relief through to people who don’t necessarily need it. Some people, who might be on fixed term tariffs that they entered into some time ago, and so aren’t actually facing elevated costs at all.”
One benefit of cutting VAT is the speed with which it could be enacted, but given it would work to effectively defer costs, Good Energy is instead backing Ofgem’s proposal to spread the cost of failed energy suppliers over a number of years as a fast path to smoothing the increase in bills.
Another suggestion backed by the Labour Party is a windfall tax on north sea oil and gas producers. “Oil and gas companies have profited excessively from the energy crisis. And if there’s a way to return some of those profits to consumers, then it should be explored further, but will likely probably take too long,” added Dixon.
“I’d also add that actually much of the UK’s renewables are kind of paying a windfall tax of sorts already through the Contracts for Difference schemes. UK renewables will pay back over £100 million in the last three months of 2021. And during that period, gas generators were raking it in to the extent that National Grid have now opened an inquiry into this.”
An extension to the Warm Homes Discount was this week proposed by charity Resolution Foundation, as it highlighted the price cap increase could lead to 6.3 million households experiencing fuel stress. For this to truly provide relief however, changes would be needed to how it is administered, who is eligible and making it funded through general taxation.
The Treasury is said to be considering the possibility of cutting the Energy Company Obligation, although this has been criticised by many as very short-sighted.
Overall, those calling on the government to manage the energy crisis agree that long-term changes must be made to protect consumers and the path to net zero.
A report from the Institute for Government for example, highlighted the importance of managing the current crisis without compromising decarbonisation efforts, as it could risk losing political and public support for net zero if mismanaged.
A spokesperson for Energy UK recently told Current± that the dependence on imported gas leaves the UK “at the mercy of volatile international fossil fuel prices so we need to press ahead with efforts to further increase our own domestic sources of clean power.
“In addition, the current crisis has exposed the fragility of the retail market so Ofgem and Govt need to look at how we can create a sustainable retail market where suppliers can do more than just survive but can also invest and innovate to support their customers through the changes that Net Zero will involve.”
With Citizens’ Advice warning the increase to the price cap could leave a single adult spending a third of their standard allowance under the basic rate of Universal Credit on energy bills, leaving millions at risk of fuel poverty, it’s clear action must be taken by the government and soon.
“None of this is politically easy, and of course the immediate focus is on the real crisis about to impact households in the here and now. However, we urgently also need to look to long-term reforms if we are to avoid lurching from winter crisis to winter crisis in the years to come,” finished Cornwall Insight’s Miller.
