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How to tackle the energy poverty crisis?

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What is the crisis?

Charities and consumer rights bodies have warned that a 51% rise in the energy price cap planned for April will mean “people will be left unable to eat regularly or could even be at risk of death from the cold.”

Proposals to respond to this hike include a cut to VAT on fuel, a windfall tax on energy companies, and the abolition of green levies. But why are prices rising, and what -if any- of these measures are the right progressives ones to protect the most vulnerable?

Energy demand

We use a lot of gas, we use it mostly to heat our homes and we get about half of it from abroad.

Burning natural gas provides  41% of the UKs energy. The vast majority of this, 61%, goes to households and the rest to business. The majority of homes, (85% or 23 million) are currently connected to the gas grid, using a boiler and wet-based central heating system.

Around 47% of UK natural gas is imported, around half of it (55% in 2020) from Norway and the rest from Qatar and Russia (with small bits from the US, France and others).

In the last year, wholesale prices on the global market have skyrocketed. This is apparently due to increased demand in the Asia & Europe, paired with a ‘windless’ summer. It goes without saying that these are things no UK government can do much about.   

Price cap going up

How we pay for gas and who can buy it from is regulated by Ofgem – who defined the energy price cap. It is prediction that this will go up by 51% on the first of April has sparked the dire warning from charities and consumer bodies. But what is the cap and why is it going up?

The cap effects the 60% of homes who have a variable, as opposed to fixed, tariff for their energy. These are, according to MSE likely to be those who have not taken the active step to switch tariffs in recent years. Unlike other caps, such as the benefits cap, it does not define a maximum amount a household can be charged/credited. Instead it defines a maximum price per unit. The total charge is still based on consumption.

The price cap is calculated every six months based on the prices energy companies have to pay. A major component of it is the wholesale price of gas, which as we have heard has increased dramatically.

 

Progressive solutions

In the face of the April crisis there are two broad things any government could do. It could try and bring down people’s bills and/or it could try and give them money to pay the higher bills.

Bringing down bills

In the timeframe we have, and possibly ever, there is little the British government could do to bring down the wholesale price of gas. However, Currently, wholesale is less than half an average bill – though with all the volatility it may crack 50% in April. The total share that goes to the energy companies is 81%, profit is apparently as little as 2%.

In total, if government slashed tax and green programmes the most it could knock off current bills is 17%.  That doesn’t mean there isn’t a potentially progressive case for looking at these programmes (should the rich and poor be making the same size contribution to the continued survival of our species?) but it does mean we need to be realistic about what impact it can have in the crisis.  The parts of the bill the government can directly control are VAT and green initiatives, which have drawn particular ire from those on the right who would like to use the crisis to be rid of anything even vaguely green.

Chart showing a breakown of energy bills

Blanket reductions in VAT and green levies are not in themselves progressive. Support should go to those who need it, those of us who can afford to must bear the burden. Labour has pledged to cut VAT which will benefit the worst off for sure, but will also benefit the richest. This is acceptable in the current crisis but cannot be the long term solution.

Labour is right that cutting VAT is more progressive and more practical than cutting green levies. Green levies go directly to activities that mitigate crisis like this and benefit not just the disadvantaged of the UK but people around the world.

A sting in the tail

OFGEN can build measures to compensate for shocks into the price cap (to protect energy companies and essentially mutualise the shock). When multiple OFGEN regulated energy companies failed last year, this generated costs for the companies who took on their customers.

OFGEN expected to add these costs into the price cap and the Citizens Advice Bureau estimates that the cost to bill payers of these supplier failures will be £2.6bn, with £94/customer added to average bills from April. This is all particularly galling when we read Citizens Advice had warned OFGEN about one firm 10 times before it failed.

Instead, the progressive thing and what Labour should support, is this bill is paid out of general taxation. This will be fairer than adding it as flat addition to energy prices regardless of the ability of consumers to pay and is in governments power. It will have the added benefit of focusing minds in government on these market failures and why they were allowed to happen.

Paying peoples bills

So while there are some progressive options to bring down bills, and certainly some thinking around means testing of green levies to be done in future, In the current crisis, as in the covid crisis, it seems the only real option for government to act fast is make money available to affected parties.

It is not ‘fair’ that everyone’s bill are going up, but as progressives we are primarily interested in protecting those whose lives will be materially harmed by these increases. Joseph Rowntree foundation found “Energy bills would amount to 6% of the average income of a middle-income family but 18% for a low-income family. This would rise to 25% for lone parents and couples without children, while single-adult households on low incomes could be forced to spend 54% of their income on gas and electricity”. This regressive distribution of the pain is flatly immoral and what we are setting out to mitigate.

The most efficient move is to use existing infrastructure and there are three candidate payments which could be increased to tackle this crisis.

  • Cold weather payments: People on benefits can claim a small amount of money if there is a continuous period of seven days below 0 degrees Celsius, between November and March. This is paid automatically – which is good, but is highly conditional – which is bad when bills are going up regardless of weather conditions.
  • Winter Fuel Allowance: The flat payment to all older people will support some of the most vulnerable but also some of the least, though this by itself is not enough to discount increasing it. The main issue is that without changing its nature quite dramatically it would not tackle the cold homes of many adults and presumably almost all children.
  • Warm Homes Discount: Available to pensioners and people on low incomes, this ‘discount’ is a payment from government towards electricity bills, and gas bills where the gas and electricity provider is the same.

The Resolution Foundation have landed on the warm homes discount as being the fairest way to make a one off payment in the looming crisis. They advocate using public funds to increase the size of the payment (from £140 to £300) and widening the eligibility criteria.

Based on the average bill we looked at earlier, the 51% increase in the price cap charities are worried about would represent about £640. So while the proposals from the Resolution Foundation are bold, a significant proportion of families, they themselves acknowledge that 22% of households will still experience fuel stress this year.

In the end they advocate for a mix of payments and replacement of green levies and VAT with general taxation to get the final proportion down to 15%.

What if the payment was increased to cover a larger share of the increase in fuel costs? Uplifting the Warm Home Discount to £300 is estimated to cost £2.5bn. Rough maths suggests uplifting it to £600 would cost about £7.2bn.

Politically, such a large payment would be difficult to achieve though it now seems the chancellor is running something similar up the flagpole. The cost to the exchequer is one thing, but perhaps more difficult would be explaining to the part of the electorate on low incomes but not eligible for the benefit why they were not getting support. This could be mitigate somewhat by staggering the size and the rate of payment, making less of a dramatic disparity and less of a political hostage to fortune when somebody uses it to buy a car.

The conservatives will find it hard to take these sensible steps as parallel will be drawn wit the £20 universal credit uplift that they withdrew last year but Labour can make the argument with full force.

 

Who should pay?

As much as there is agreement something must be done, there is disagreement about who should pay for it.

Labour have suggested they will impose a one off ‘windfall tax’ on energy companies and the idea becomes especially tempting when considering the large amount of revenue needed to have a real impact on fuel poverty after the price rise. The treasury going half and half with business would certainly be more palatable and it also feels intuitively fair. High wholesale prices are causing this crisis, but are also causing massive profits for some producers. Shouldn’t one hand wash the other?

But moving from slogan to policy in this case is harder than it might look. Who are ‘the energy companies’ and what are their profits?

The UK government cannot effectively tax the Russian or Qatar based gas suppliers, but it should be able to tax those operating in the North Sea or registered in the UK. As mentioned at the outset they will only have sold around 50% of the more expensive gas.

A report on the windfall tax by Common Wealth  suggests there are two ‘super major’ energy suppliers in the UK that could be the target of a windfall tax (Royal Dutch Shell and BP) as well as five ‘majors’ and five ‘independents’.

The same report finds varying levels of profitability, though argues the most profitable are those who have been involved in the North Sea, which helps build the moral case for a contribution back into the UK system.

It also highlights that while there have been very high dividend payments and share buybacks among some of these companies over the last decade, it is not at all clear what the profits targeted with a windfall tax actually are. It is very hard to know what an appropriate level to set the tax would be, and how much revenue it would raise.

A compromise

It seems fair that those who are benefitting from the wholesale price shock, through the extraction of UK gas, should help with some of the negative externalities that come with it. Industry will argue that it is already very highly taxed and this is to an extent true.

But industry also no doubt wants to be seen as a constructive partner of government as well. Government should open a negotiation on what level of contribution it is willing to make to deal with fuel insecurity this year. To sweeten the offer and make it more politically salient government should also rename the now expanded ‘warm homes discount’ to something along the line of the ‘responsible energy rebate’.

 

Conclusion

In this crisis Labour is right to protect green levies and reduce VAT on bills. It should go further and demand any changes to the energy price cap as a result of market failures are paid for the by the government that oversaw them rather than the poorest consumers (even if ultimately consumers pay in the end).

From opposition it is well placed to argue for a windfall tax and this is also probably the right thing to do, even if hard in practice. In the best case scenario it can be spun up into a positive that may take some of the sting out of it for industry.

This analysis is predicated on the idea that this spike in gas prices is relatively short term. Each measure is supposed to be temporary. But of course the looming question is whether this is really the case. One off windfall taxes and payments could transition into regular fixtures should the crisis persist but they are not long term solutions. In an increasingly turbulent world securing energy supplies while also greening them, and reducing consumption is a big challenge. Short-termism by Conservative government has already added to bills. We may need more fossil fuel storage to guarantee energy security, which might seem against the spirit of Net Zero. And our Net Zero plans are in themselves extremely challenging, as Tony Blair pointed out in a speech yesterday:

“In a little over 10 years we will have to: double electricity supply; replace the present heating systems in 10m homes; turn 20m fossil fuel cars into scrap and buy new EVs; and boost renewables by 4x the present rate. And all whilst losing the revenue which comes from fuel duty, which will amount to an annual shortfall of £20bn by 2035.”

Labour has said it will allocate billions to tackle these challenges. It now needs to build a narrative that links the long term (Net Zero, energy security) with the short (cost of living crisis) in a positive way and a credible set of steps which voters can understand and invest in to match its green spending promises.

For more on the cost of living crisis, this time with a focus on inflation see here.