The UK government is fast approaching the moment when a crisis rooted in the wonky world of retail energy market regulation morphs into a cost of living scandal as the results land squarely on household bills.
Regulator Ofgem’s feeble vetting and oversight of entrants to the UK’s energy market lies behind this snafu. It is set to announce the new level for the domestic energy price cap in early February.
Bills could jump £700 to around £2,000, according to some analysts, as soaring wholesale prices for gas and power are passed on to consumers. Some customers coming off fixed-tariff deals and on to the cap could find their bills doubling.
Boris Johnson dismissed calls this week to cut or do away with the 5 per cent rate of value added tax on fuel, because he said measures to protect bill payers should be targeted rather than spread across the market. That is right. But such is the scale of the problem now that the response should involve some of both.
Without doubt support should be trained where it’s most needed. The Resolution Foundation (which estimates the rise in bills at £600) points out that, against a backdrop of rising inflation and higher taxes, this rise will hit hardest in the bottom income decile: it could push energy to 12 per cent of their household budgets or three times the level for the top decile.
The trouble is that the possible jump in bills rather dwarfs some of the measures suggested to mitigate it. The various environmental and social levies on bills amount to perhaps £140 per household, according to Investec, money that would need to be found elsewhere to fund the greater share of renewables needed in the energy mix. Scrapping VAT on both electricity and gas would save £95 on bills, but at a cost of about £2bn a year to the Exchequer.
Axing either looks a blunt (and expensive) tool, unless it can be directed at lower-income households. Better perhaps to target funds with a reformed and much expanded Warm Homes Discount, the existing programme that cuts bills for lower-income households.
That doesn’t mean the rest of the market just sucks it up. Twenty-six energy suppliers have failed since August, a result of government policy and flimsy regulation that ended up promoting inefficient competitors rather than true competition, according to Nera Economic Consulting. In 2019, for example, the regulator considered limiting suppliers’ ability to fund themselves from customer credit balances — to reduce both the size and cost of failures — but decided against it.
It’s not clear why consumers should face an affordability squeeze thanks to a regime that embedded moral hazard and risk-taking, with customers encouraged to find the cheapest deal from a range of unsustainable, unhedged suppliers. The current cost of failed regulation is put at £70 to £100 per household, based on Ofgem’s first £1.8bn slug of claims through the supplier of last resort (SOLR) process. That will rise: more failures are expected and the figures don’t include the £1.7bn at risk through the government administration of Bulb, the biggest collapse to date.
The idea of at least smoothing these costs over several years has merit. Ofgem has started consultations on allowing private financiers to pay companies that take over from failed rivals their SOLR costs, and recoup that from network charges over a longer timeframe. The same approach could spread the burden of unprecedented rises in energy costs over several years: one issue, ironically, could be exposing taxpayers via Treasury-backed loans to the struggling energy companies that are still standing.
The challenge for the government and industry is to act fast, with measures needed before the new price cap takes effect in April. But it would be a mistake to pre-empt the more fundamental overhaul that is needed of UK energy supply and regulation. That’s a test that industry proposals for a contract-for-difference mechanism to manage wholesale price volatility, a big change that could shift market risk to the Treasury, probably fails.
Decisions over how to re-regulate the UK energy market will need to be the outcome of a longer, much wonkier conversation.