Spiralling energy prices: the need to directly focus on price pressures and address persistent market failures

Ofgem announced an increase in the price cap on the unit supply of electricity and gas that equates to an 80% increase in the average annual UK household energy bill from 1st October. This was largely anticipated but entirely unwelcome news, and stark warnings have been issued of two thirds of households being pushed into fuel poverty by January 2023 and the risk of a public health emergency. Impacts on average bills vary across households and locations, with disproportionate impacts on those in colder and more remote parts of the UK (e.g., the Shetland Islands), where non-capped increases in non-network heating fuels are already exacerbating fuel poverty.

Short-term fixes won’t bring energy prices and inflation under control

Urgent action is required to alleviate the acute pressures that not only households but a range of organisations and businesses – which the cap does not apply to, with some reporting 1000% and 1400% rises in their energy bills – face in the short-term.

However, it is crucial that attention shifts to focus on what is required to actually address the underlying problem rather than mitigating impacts. That is, what is really needed is action to affect the factors causing energy prices to rise and to slow the resulting wider inflation pressure transmitting through the prices of all goods and services. This will require a more in-depth look at how, and in what markets/stages of the supply chain, energy prices are determined, and to identify where and how policymakers in the UK can intervene to more address persistent market failures in a more effective manner.

Responses to the energy price cap rises

There have been a wide range of proposals from UK Government, political parties, industry and academics for action, including calls to freeze the energy price cap and introduce social tariffs, which merit serious consideration. A renewed push around fracking and removing green levies from energy bills have also been vaunted, both of which are unwelcome distractions. Evidence suggests that fracking is not the answer, with levels of shale gas unproven and years of potentially risky drilling before production could even begin. In terms of the removal of levies, it is unlikely that this would make a significant difference to bills, with a real risk of constraining the types of solution that may enable greater domestic energy security in the UK, while locking in reliance on gas and other fossil fuels that are so dependent on global market conditions. Ultimately, however, none of the proposals grapple with the fundamental questions that need to be asked and addressed around how prices are determined and how Government intervenes to address market failures.

The urgent need to review how prices are set

Understanding and addressing how prices are determined at different points of the energy supply chain will be crucial to identifying long-term solutions to this problem. Here, there are a number of critical questions worth examining in more detail. For example, why is the wholesale price of gas having such an impact on electricity prices? A crucial question is why gas powered electricity generation plants – which produce relatively little of our energy and are now so expensive to fuel – are called on last to meet energy demand in the UK, thereby impacting the price charged for all units supplied to users? Why not call on it earlier, as we initially did with (then) costly renewables?

Another important question is the extent to which standing charges present a growing problem. For example, why are the costs of supplier failure earlier this year now impacting standing charges, and why now, at the worst possible time? Standing charges are fixed costs for supplying energy that apply to all customers but vary across regions (for a variety of reasons, including but not limited to, distance from central generation sites), and types of consumers (including those on prepayment meters). They are inflexible and payable even if no energy is used. For those consuming high levels of energy, fixed charges constitute a small proportion of the total bill, but for low-income households with little energy use, these charges comprise a significant chunk. This means that people might be making undesirable cuts in energy use – risking health and well-being – with limited impact on their bills.

Governments need to act on market failures

Finally, and perhaps most importantly going forward, Government needs to act more effectively to respond to persistent market failures in the energy market and which efforts such as promoting consumer switching have failed to address. Here, it is concerning that the CEO of Ofgem’s statement on Friday included announcing a review “into the mechanism and level of profit margin available under the price cap to ensure that suppliers do not earn excessive profits and receive only a fair return for the services they provide to customers” – was this not the initial role of the price cap?

More generally, in addressing wider inflationary pressure, the UK Government could do worse than to look at the fundamental arguments driving the US Inflation Reduction Act which has just been signed into law on the other side of the Atlantic, with the crucial aim of supporting consumers facing rising prices in the context of enabling the transition away from fossil fuels. The Act gives an indication of the scales and levels of action required to tackle these challenges being faced by countries globally. Crucially, it constitutes a major government plan that does not involve contentious actions such as nationalisation, and focusses on the fact that we cannot hope to resolve the current multi-faceted challenges we face through short-term fixes and tinkering at the edges. Indeed, government taking a leadership role in coordinated planning is likely to reduce the need for costly public intervention further down the line.

Image Credit: The Focal Project, flickr.com, CC BY-NC 2.0