GETTING TO ZERO
"The energy crisis will define the start of the new Prime Minister’s term in office. The challenges are huge, with high energy prices demonstrating that the UK is not immune from Russia’s decision to ration gas supplies to Europe. To get through the crisis, everyone will have to be pragmatic. The new Prime Minister will have to do some things that they won’t want to do or which are politically difficult, like a windfall tax on electricity generators or telling households and businesses to save energy this winter. Green campaigners will need to accept measures to diversify supply. And households will inevitably pay more. But with the right plan, there is a way through this crisis."
Boris Johnson’s successor must be realistic about the scale of the challenge the UK faces and pragmatic about the solutions that are needed.
The UK does not rely directly on gas from Russia, but we are still desperately exposed to the energy crisis that has followed the invasion of Ukraine. The UK is part of the European energy market, which means that UK gas prices are closely linked to those on the continent and that shortages across Europe also affect the UK. The EU typically gets 40% of its gas supplies from Russia. Following Russia’s invasion of Ukraine, supplies are down nearly 50% this year, and there are credible scenarios where Russia cuts off all gas supplies this winter. In other words, we need a crisis plan as urgently as Germany, France or Spain.
High gas prices are a sign of severe shortages across the European energy market, of which the UK is part. If these shortages get worse, then governments and grid operators will have to disconnect industrial users from their electricity and gas grids to protect supplies to households, causing considerable economic damage and political pain. In a more extreme scenario, households could be disconnected from the electricity grid. The consequences of inaction could be severe.
The energy crisis will in all likelihood will dominate the last two years of this Parliament. In October, the UK’s Energy Price Cap will rise to £3,549 per year for a typical household, around three times higher than last winter. Prices are expected to rise further in the new year, potentially to as high as £5,000 per year. This is several multiples of what households have been used to in living memory, and could devastate many households’ finances.
The Government has already committed to help households with £37 billion of support, including a £400 discount on all household energy bills and one-off payments to certain groups. However, ever-rising energy prices mean that the new Prime Minister will need to do more. If the Government doesn’t do enough, then millions will be pushed into poverty and thousands of vulnerable people could die during cold weather.
Existing proposals to address high energy prices – including those from Labour, the Liberal Democrats and the UK’s energy suppliers to freeze prices – are irresponsible and unaffordable. They would cost around £85 billion per year, more than the entire cost of the furlough scheme. In addition, there is no guarantee they would be temporary, and would increase the risk of blackouts by subsidising wealthier households to consume energy at current rates.
To keep energy supplies flowing this winter, there is an urgent need to reduce energy usage and to help businesses and industries to temporarily switch from gas to coal and oil where possible to increase diversity of supply. These measures will be controversial, but the scale of the crisis means that unpalatable choices will ultimately need to be made. Existing proposals have failed to grapple these trade-offs.
Existing proposals also rely too heavily on windfall taxes on oil and gas companies to fund them. Oil and gas companies are an easy target. However, some electricity generators like wind farms have also made extraordinary unexpected profits from high electricity prices. Despite the poor optics of taxing green energy providers, there is a strong argument to extend windfall taxes to some electricity generators.
Finally, existing proposals do not address the risk posed by the potential failure of the European energy market. Markets are under huge strain from high prices, and nervous governments are exploring risky proposals to cap wholesale electricity prices. If these interventions go wrong or shortages get worse, then governments may suspend their energy markets or suspend energy exports, which could make the situation even worse.
The new Energy Price Cap comes into force on 1st October, giving the new Prime Minister just four weeks to put in place an emergency package of financial support. This leaves no time to come up with a new, complex scheme that targets support at the most needy.
The immediate priority should therefore be to help households through to Christmas by accelerating the payment of the planned £400 Energy Bill Support Scheme, paying the full amount to households by Christmas, rather than by the end of winter as planned. This will reduce the average energy bill rise for Q4 2022 from £722 to a more manageable £322, compared to the same period last year. Certain at-risk groups will receive additional support through the planned Cost of Living Payments. This would not cost taxpayers any more, but would simply bring forward existing spend.
At the same time, the Government should immediately address the inequality in the energy market that means (typically lower-income) households on prepayment meters pay more for their energy. The Government should fund this premium for the duration of the crisis, costing around £266 million per year.
These measures, when combined with the planned Cost of Living payments, should be sufficient to get households through to the new year, by which time the new Prime Minister and Chancellor need to have put in place a comprehensive emergency energy plan.
The scale of the energy crisis facing the UK is considerable. It will not be enough simply to subsidise bills for a temporary period. The Government will also need to take steps to reduce energy consumption and diversify energy supply, including working in conjunction with other countries. The sums involved mean that they will also need to consider ways to raise revenue to pay for it. In this paper, we recommend an emergency five-point plan to navigate the coming energy storm.
Replacing the existing Cost of Living support scheme, the Government should put in place a new, expanded support scheme. For the first time, this new scheme should include additional payments to families with children, who face extra energy costs. The 2023 scheme should comprise:
These payments should come in six monthly instalments paid during the winter months (January, February, March, and October, November, December 2023). This reflects the fact that energy bills are significantly higher during the winter months. To help those who may need additional support, the Government should add £2 billion to the Local-Authority led Household Support Fund. The 2023 scheme would cost an estimated £47.3 billion.
Many electricity generators have made extraordinary profits during this crisis, especially wind, solar, nuclear and biomass generators. A windfall tax on them could raise between £4 billion and £10 billion per year to help pay for additional support for households.
These profits have arisen in part due to the marginal pricing of electricity. One outcome of marginal pricing is that generators with lower operating costs (for example wind, solar, nuclear and biomass) are paid based on the price of gas, rather than their own underlying costs. This means that, if gas prices rise, these “low-cost generators” get paid more, even though their underlying costs haven’t changed, as demonstrated by the figure below.
In the short term, the best way to reduce market prices for energy is to cut demand and the Government must be honest with the public about this. Ministers should: launch an energy saving campaign for households and small businesses; introduce a new energy-efficiency obligation for landlords and housing associations; and mandate energy-saving measures for businesses, similar to those implemented across Europe.
With gas in short supply, the Government must consider alternative fuel sources to reduce gas demand quickly. Given the immediacy of the crisis, the only options are coal and oil (diesel). To promote fuel switching, the Government should explore options to increase the running hours of coal- and diesel-fired generators, including speeding up the issuance of new permits and potentially suspending some air quality rules in an emergency scenario. This will increase local air pollution, but will reduce the risk of blackouts – an unenviable trade-off.
Europe (including the UK) is at risk of descending into ‘energy nationalism’ if countries limit the export of energy in the event of shortages. This would make shortages worse. The next Prime Minister will need to prevent this through effective diplomacy with our neighbours. The Government should establish a new “European Energy Emergencies Forum”, comprising the UK, the EU and Norway to set rules that ensure that energy can continue to flow through this crisis.
The recommendations in this report include measures that will be ideologically uncomfortable for whoever becomes the next Prime Minister. But not doing these things could equally become politically untenable very quickly. There will be ways that they can make the package more consistent with their values, but this crisis requires the new Prime Minister to prioritise practicality over ideology.
The long-term solutions to the energy crisis include energy market reform boosting UK energy supplies with new renewables, nuclear and domestic gas production and storage, and by cutting demand through insulation. The new Prime Minister will rightly want to make these investments a top priority. But they will only have the space to do this if they put in place a package that addresses the scale and urgency of the immediate energy crisis.
1. Targeted financial support for households
2. A windfall tax on low-cost electricity generators to help pay for support
3. A serious campaign to cut energy demand
4. Increase the use of alternative fuel supplies, including coal and diesel
5. Keep energy flowing across borders
1. Targeted financial support for households
2. A windfall tax on low-cost electricity generators to help pay for support
3. A serious campaign to cut energy demand
4. Increase the use of alternative fuel supplies, including coal and diesel
5. Keep energy flowing across borders
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