As calls grow louder for the government to intervene and soften the impact of soaring energy bills, Giles Wilkes explores the limits of energy policy and regulation – and where the system has failed
Most of the time, “the economy” is an abstract thing – a confection of statistics such as GDP growth, the unemployment rate or the pace of investment. Very occasionally, it cuts straight into people’s lives, directly affecting their wellbeing and sense of security: during a recession, a devaluation crisis, or an episode like the onset of the Covid pandemic. A spell of sharply elevated inflation is another such time, particularly when the inflation is so concentrated upon one highly visible item – the cost of energy.
From my experience advising the Coalition government (2010-14) and May administration (2017-19), UK citizens have never become wholly accustomed to the cost of electricity and gas not being a matter solely for the government. But energy costs are unavoidably the government’s business. One of the key “cut through” moments of the Coalition period was in 2013 when the then leader of the opposition, Ed Miliband, vowed to freeze energy prices. Shares in energy companies fell, ratings for the opposition rose, and energy policy became an urgent priority.
The price rises Miliband meant to address were small compared to what the UK faces now. For most of the last decade, government forecasts for gas prices were between 60p and 100p per therm (forecasts criticized by some for being too high, thereby flattering the case for renewable alternatives). Since mid-2021, they have climbed well above 150p and stayed there, with occasional spikes to 250p and even 450p. The impact on energy suppliers has been extreme, particularly those that failed to hedge and were therefore exposed to the full force of those price changes.
Customers have been protected to some extent so far, either through fixed price contracts, or by the cap imposed on the “standard variable tariff” (SVT) that most people default onto. I was part of the Downing Street team that worked on legislation for that cap, in the face of criticism that government intervention in markets is always risky. Many critics would see the multiple corporate failures of the past few months as strong vindication of that view.
The price cap is recalculated every six months, and the next such moment in April will see an eye-watering increase of almost 50% in the typical household energy bill. For customers – like me – who had hitherto enjoyed a low fixed-price contract with one of the now-failed companies, it will be much more. As Chris Giles pointed out on an IfG podcast, this is a hit to incomes normally only seen in a recession.
Others are discussing what the government can now do (spoiler alert: there are no easy answers). So how fair it is to blame regulation and energy policy for what is about to hit UK households?
It is far from ideal for there to have been so many company failures in energy supply
The high level of company failure largely reflects the high levels of new company entry into the market in recent years, with this being a deliberate policy to reduce reliance on what was once called the Big Six. New entrants’ share of the market rose from 3% in 2017 to around 30% in 2019, and by 2018 there were 70 companies competing to supply households. 16 www.ofgem.gov.uk/publications/state-energy-market-2019
However, the market these companies entered tended to work through very attractive starter deals, offered in the hope that customers would revert to a much higher SVT when those deals expired – a strategy condemned by some as “tease and squeeze”. So long as the spot energy price stayed low and enough customers went onto the SVT, this could work. The introduction of the price cap was intended to address the perceived abuses of tease and squeeze, which was seen as hurting the sort of vulnerable, disengaged customers less likely to shop around or notice when their tariff changed.
Long before the current crisis, there had been a number of company failure, mainly driven by some not preparing for a world where prices may rise, as is the case now. Ofgem’s “supplier of last resort” (SOLR) programme performed perfectly well in transferring the customers of failed companies to a willing competitor, because the cost of the failed contracts had been low. But the landslide of failures in 2021 have pushed this cost up to unacceptable levels, leading to SOLR buckling.
Blaming the price cap misses the target
But it is wrong to blame the price cap for current mess in the energy market. Its existence was a known fact when companies set about creating their trading strategies. Of course, had companies been free to jack up their SVTs as quickly as the gas price rose, more might have remained solvent, but only at the cost of passing these steepling costs onto some of their most vulnerable customers. Had it not existed, the clamour for some kind of cap now would be deafening. It is true, however, that a more regular review of the level of the cap would have been appropriate in such a fast-moving market.
It is fairer to criticize the rose-tinted optimism towards what retail competition can achieve. A glance at any breakdown 17 www.ofgem.gov.uk/energy-advice-households/costs-your-energy-bill ) shows most of the bill to be made up of fixed and unavoidable items: network costs; social and environmental elements; tax; and wholesale costs, which retail companies have to accept as a given. The amount left – operational costs and profit margin – is pretty small, meaning that the underlying gap between the best and worst company is not going to be much more than a few percentage points. Simply adding more companies into the mix does not change this.
Above all, it is quite right to criticize a system that allowed companies to operate with so little equity and such risky trading strategies. In Downing Street I recall one Big Six executive complaining bitterly about companies “that can set themselves up with a mobile phone in a shopping aisle”. Ofgem took action in 2019 after a spate of failures, tightening requirements “to weed out those that are underprepared, under-resourced and unfit.” In retrospect, they might have gone much further, and should have scrutinized much more closely the robustness of companies’ hedging strategies.
Other claimed solutions to the energy price crisis do not survive much scrutiny
Britain might have benefited from more energy storage, but the price of the gas stored there would still have reflected global conditions and therefore high international prices. As former energy official Adam Bell has pointed out, to fully insulate against such fluctuations would have required an unfeasibly large amount of storage. 18 https://twitter.com/Adam_Grant_Bell/status/1445322637446631432 Such storage has to be paid for in normal times –insurance commands a premium.
Faster installation of wind energy to reduce our reliance on gas might have helped, given the sharp falls in the price of offshore wind. It is wrong to call this a crisis of net zero – as MP Anthony Browne puts it, “a gas crisis isn’t fixed with more gas”. 19 https://twitter.com/ab4scambs/status/1479448614854438916 Although wind is intermittent, it is not this intermittency that lies behind the global rise in gas prices. But even with more wind, the marginal price faced by UK retail companies in 2022 would still have been heavily influenced by gas. And for many critics it is simply inconsistent to complain about insufficient renewable installation, when by far the loudest complaints about energy policy in previous years were about too much wind being installed, not too little. 20 See The Economist, “Rueing the waves”, 2014 and the experts quoted there: www.economist.com/britain/2014/01/04/rueing-the-waves
UK households used to pay roughly £30bn for their energy needs. The sharp rises of the past six months raise that to something closer to £40bn. The complicated system that sits between the generators at one end and the kettle at the other could certainly be improved, but that overall cost cannot just disappear. Even if regulation had been perfect, energy companies all fully capitalised and conservatively hedged, a steep rise in energy costs would be due to hit the economy this year. It has to be paid – the question of how is just pure politics.