Energy bills are rising again. This is the first significant price increase in three years. The last time fuel bills dominated the news, Ed Miliband announced his famous price freeze at the 2013 Labour Party Conference. The political traction was considerable: The Government reacted by scaling back its environmental policies to ease the pressure on bills. Ofgem also referred the energy market to the Competition and Markets Authority over claims the Big Six were keeping prices artificially high. But what is behind the price hikes in 2016?
Higher wholesale costs seem to be driving most of the current rises. The wholesale costs make up just under half of a household’s dual fuel bill. Since Brexit, the pound has fallen relative to the dollar by nearly 10%. So, as the UK imports over 62% of our gas, this unfavourable exchange rate has increased the wholesale cost of gas. But energy suppliers do not immediately pass on changes in the wholesale price to their customers. They ‘hedge’, by buying capacity in advance to smooth out major market fluctuations. This is why the fall in the pound did not have an immediate impact on consumers’ energy bills.
Some commentators will use this opportunity to blame ‘green levies’ for increasing consumer bills. And it is true that many climate policies are funded through bills. Currently, the Government mandates energy suppliers to install smart meters in homes and businesses throughout the UK, to improve the energy efficiency of some of their customers’ homes, and to support new low-carbon electricity generation, such as nuclear power and renewables. Energy companies then pass on the costs of these schemes to their customers.
But these environmental measures are a much smaller part of consumer bills than the wholesale price. In fact, they make up just 7% of an average dual fuel bill. The cost of some of the schemes are expected to fall in this Parliament. For instance, the cost of the energy efficiency obligation is being cut from £870 million to £640 million. Others will rise. For instance, the support for nuclear and renewables is forecast to rise from £5.1 billion in 2016 to £8.5 billion in 2020. However, reductions in the subsidy tariffs announced in 2015 will control the extent of this increase.
There is also growing evidence that clean energy is helping to reduce wholesale prices. Sunshine and wind are free. So once wind turbines and solar panels have been built, they cost almost nothing to operate and generate electricity. This lowers the overall energy wholesale price, as it reduces the amount of time that fossil fuel plants, which have higher fuel costs, need to run. This is called the merit order effect, and was estimated by the Government to have benefited consumers by between £400 million and £1.4 billion in 2014. Moreover, the lack of fuel requirements for renewables reduces our exposure to volatile gas prices.
Energy efficiency schemes can also reduce bills for consumers, while reducing carbon emissions. For instance, cavity wall insulation costs around £1,000 to install in a typical semi-detached home. Once installed, it saves around £165 a year, meaning the initial investment is repaid after around six years. The National Audit Office has calculated that, while the main energy efficiency scheme cost suppliers £3 billion between 2013 and 2015, it will generate £6.2 billion of bill savings for consumers over the lifetime of the measures.
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There is another important factor in the energy prices debate that is helping to push up bills: the overcharging of customers who do not switch their supplier. The Energy Secretary, Greg Clark, has pledged to tackle a lack of competition, which the Competition and Markets Authority believes is costing consumers £1.4 billion each year. They estimate that this is equivalent to between 7% and 12% of a typical household bill.
How will Theresa May’s Government respond now the cost of gas and electricity is going up again? To date, the Prime Minister’s public statements on energy policy have focused on making energy more affordable. This fits with her overall political focus on supporting those ‘just about managing’. With some forecasters predicting inflation of 4% in the second half of next year, soaring energy bills could coincide with a squeeze on living standards. It seems likely that the Government will then want to act to help struggling families with increased costs.
Bright Blue has called for a new ‘Help to Improve’ loan and ISA scheme to help households afford energy efficiency measures and small-scale renewables. By guaranteeing these loans, the Government could reduce the rate of interest and make the deal more attractive. Energy efficiency measures and small-scale renewables can reduce the amount of energy consumers need to buy from energy suppliers, giving them more control over their bills.
As bills rise, the focus will inevitably return to the cost of environmental policies – and rightly so. Measures to tackle climate change, which insure us against greater future financial liabilities, must be good value-for-money. But green policies should not be the exclusive focus. The unfavourable exchange rate for gas imports and poor competition in the retail energy market are more significant factors. The cost of going green is much smaller than is often claimed, and it can even help cut consumers’ bills in the long term.
Sam Hall is a researcher at Bright Blue.