BILLS, BILLS, BILLS: How energy price rises could lead to a cost of living crisis

UK Policy Net Zero

BILLS, BILLS, BILLS: How energy price rises could lead to a cost of living crisis

Commentary
Posted on: 8th December 2021
Tim Lord
Associate Senior Fellow | Net Zero

Newspapers have been filled with talk of an energy crisis in recent months – but so far, households have not faced the full impact of increased energy costs.  When the price cap rises in April, it could presage a cost-of-living crisis – and government needs a plan to manage it.

So far, the biggest impact of the unprecedented rises in energy costs has been a crisis for energy retailers, with 25 energy suppliers – around half of those in the market six months ago – going bust.

But while consumers have seen some price rises, the scale of them has been small compared to what lies ahead.  The energy market price cap rose by 12% in October; when it rises again in April, the expectation is that it could increase by as much as 40% compared to its current level.[1]

Customers in the energy market broadly split between those on standard variable deals (usually at or close to the price cap); and those on fixed price deals, which until recently were significantly cheaper.[2] 

To illustrate what the impacts of the price rise in April might be, we can look at two example households, both with average energy usage. The first has been on a standard variable tariff at the price cap throughout; the second on a cheap fixed price deal which expires in April next year.

Since April 2021, the household on the price cap has already seen costs rise by 12%, or around £140 per year.  But the one on a fixed price deal has been protected from a rise – until the deal expires.

For the household on the price cap throughout, a 40% price hike next April would mean that their bill will be £1787 – equivalent to a year-on-year rise of £649, or 57% when the October 2021 and April 2022 increases are combined. 

For the household which was previously on a fixed price tariff, the rise when that tariff ends could be as high as £887[3] – in effect, a doubling of their bill of a year ago.

It’s worth remembering that the figures above are for average household energy use – for those who use more energy, such as large families or those in large or poorly insulated homes, the rises could be even bigger.

A bill increase which could be as high as £900 a year for some households with average energy usage will have an impact almost irrespective of income level.  But inevitably this will impact most severely on the poorest, who could see the percentage of their household income spent on energy rising from 7% to 11% or more.

What should we do about it?

This is not a problem that can be solved easily.  Buying the energy we need has cost many billions more this year than it did last year. That money must come from somewhere – the only questions are whether households pay as consumers or taxpayers, and over what period of time the money is recovered.

Simply telling voters that they have to live with it – that the increases to household bills are unavoidable, and they’ll have to meet them without any new assistance – is likely to be politically impossible.

So what can the government do? It if limits its approach to energy, it has four main options:

  • Taxpayer subsidy: which could be delivered through:
    • A cut in taxes: cutting tax on energy, for example, by temporarily removing VAT, would equate to a saving of around £85 for the average household, at a cost of around £2.4 billion.
    • Shifting “policy costs” off bills and onto taxation: the costs of policies to support renewables and energy efficiency policies currently sit on electricity bills. Moving them into general taxation would cut bills for the average household by around £175, as well as increasing the longer-term incentive for consumers to move from fossil gas to electric heating sources such as heat pumps. It would cost around £5bn per year.
  • Smoothing the cost over time through loans to suppliers: the government could provide loan funding which allows some costs to suppliers which are usually recouped through the electricity bill to be spread over a longer period.  How much that would cut bills depends very heavily on the detail of such an approach, but it could save households around £50 a year and be cost-neutral to the Exchequer.
  • Targeted cash payments: finally, the government could provide support direct to the most fuel-poor households.

That set of measures could reduce the pain for many households – but they’re not cost free.  All of them put additional liabilities on the taxpayer, which will need to be met through tax rises, spending cuts, or increased borrowing.  Tax cuts will be hard to reverse in future, and targeting additional payments to those most in need is not straightforward.

And, most important of all, the increase in energy bills will be only one part of a cost of living squeeze affecting households in all parts of the country, and at all income levels. The government will need to consider not only how to manage energy bill impacts, but broader rises in costs as a result of inflation, and planned tax increases. 

To have a chance of managing the political fallout, it’s going to need to take a strategic approach across the tax and benefit system – and whatever it does, we’re all in for a rough ride over the next 12 months.

[1] We have used this estimate in this analysis, but the broad issues remain the same if a lower estimate (e.g. 30%) is used.  If price cap rise is 30% (to £1660), household on price cap will see rise of £522/45% April 21 and April 22; household previously on fixed price tariff moving to price cap will see rise of £760/84%.

[2] While the data on how the market splits is imperfect, Ofgem numbers indicate that in July this year, the market split roughly 60:40 – with around 6 in 10 customers on standard variable rates, and 4 in 10 on fixed price deals.

[3] https://www.ofgem.gov.uk/energy-data-and-research/data-portal/retail-market-indicators - chart "Cheapest tariff by payment”

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