When it rains it pours: the energy price challenges coming our way in 2022

The Government needs a strategy that cushions consumers from the incredible hike in energy prices coming in 2022. Over Christmas, there was much media discussion as to the causes of the squeeze on energy prices and therefore what possible solutions should look like.

While the crux of the problem is how we respond to the increase in international wholesale gas prices, this is only one of the cost and energy system challenges we face this year. Energy retailers leaving the market, continued disagreement about the role of the price cap, policy costs, the way we pay for the energy grid and generation, all feature in discussions about how we safeguard bill payers while ensuring reliable supply.

Gas dependence

Global gas prices have surged, but advocates of continued gas use have been quick to blame the pursuit of net zero for our exposure to these prices. Instead, they suggest fracking in the UK would have boosted domestic supplies and reduced our dependence on gas imports.

However this ignores public opinion (only 11% of the UK public supports fracking) and overestimates the feasibility of increased gas use in efforts to reach net zero as well as the scale of the contribution fracked gas could make in addressing security of supply issues.

The Cardiff Business School in 2018 outlined 6000 shale gas wells would be needed to replace half the UK’s gas imports over a 15-year period. ECIU have highlighted that the complex shale geology of the UK compared to the US means the costs and complexity of extraction are considerably higher. UKERC questioned the long-term viability of British fracking and outlined domestic shale was unlikely to deliver sufficient scale to significantly reduce the UK’s import dependence or have a significant impact on gas prices.

That’s before we consider the fact that UK has limited gas storage, and would likely also require subsidy to be maintained if it was being used in stand-by to top up energy supply  (diverting funds from other technologies or cost of living support), or that the inability to predict the probability of earth tremors caused by fracking was what originally led to Conservative ministers withdrawing support for the industry in 2019.

Policy costs and VAT

Critics of the net zero transition have been quick to blame increased prices on environmental policy costs, but when this spike has been caused by international gas prices, this is misleading. Currently, environmental, and social policy costs (including energy efficiency and support for the fuel poor), comprise 25.4% of electricity bills. That green policy costs are only on the electricity side of bill distorts the economics of the shift to electricity powered heating options like heat pumps.

Removing these policy costs from the electricity side of the bill could help lessen the impact of increased gas prices but would also improve the economics of adoption of heat pumps. This does not, however, address, how green and social policies would be funded if they were removed from bills (general taxation is one option). Meanwhile the Government is proposing and consulting on new methods of passing the cost of new nuclear and green gas (including, potentially funding for hydrogen) onto consumer bills.

A further tool to help reduce costs could be the removal of VAT from energy prices. Boris Johnson last night ruled this out. VAT on energy is 5%, and with energy bills expected to rise by as much as 50% this is unlikely to be sufficient to address the crisis.

The price cap and SoLRs

Numerous energy retailers were caught short by the increase in gas prices and have left the market. Some have argued that this is the fault of the price cap, which was originally introduced to prevent retailers from hiking up the bills of disengaged customers to subsidise below cost offers for switching customers. The price cap is set by Ofgem and is recalculated as energy prices change (the forecast price rise in the spring was the result the higher prices on the wholesale market) numerous retailers have left the market because their hedging strategies and the prices they set in order to attract a growing customer base means they were left short by the sudden increase. If we’re assessing what would make bills cheaper, it is surely not the removal of the customer protection that is currently preventing suppliers from immediately passing the full cost of the increase to customers.

The further problem caused by the 26 suppliers that have left the market is the cost of the ‘Supplier of Last Resort’, ‘SoLR,’ scheme. When suppliers go bust, the cost of the supplier collapse is mutualised across the bills other energy users. Cornwall Insight has put a cost of this process of £90 per household, but the cost of supplier failure could rise further. Bulb, for example, has been placed into a Special Administration Regime that will see the Government recoup costs at a later date (more detail on this is expected by the end of January 2022).

Renewables, storage and network prices

Networks continually make the case that increased electrification will require greater reinforcements and expansion of the grid which could see system costs increase. However, how much of this cost should be added to bills and in what way is a fiercely contested subject.

Many new business models in the energy sector rely on incentives being introduced at network level to encourage more efficient use of existing cables, for example by coupling electrification and renewables with flexibility and storage. However, what these incentives look like in terms of price and who gets to reap the rewards and suffer the consequences of inefficiency could have significant impact on customer bills. This for instance could look like lower energy costs when renewables are generating in excess of demand, meaning customers are encouraged to use appliances or charge electric vehicles in times when otherwise, green generation would be paid to switch off. This is not only good for returning money back to consumers but creates a more cost efficient, less wasteful system.

Customers benefiting from an efficient system is the objective of BEIS’ Smart Systems and Flexibility Plan, while there’s a clear opportunity to reduce bills with this workstream, the detail, including how these changes are felt by which part of the energy system is still being thought out and even minor network charge changes are some years away.

Domestic energy efficiency measures

Whatever happens next, we need significant investment in household energy efficiency. However you address the cost of energy, needing less of it helps.

The cost of living crisis has expedited the need for decisions on our future energy system

There are significant issues outlined in the above, and few answers that don’t require a change in energy pricing and the way customers pay the costs of the energy system. However, this is also an opportunity to improve how we use the energy system we have while tackling energy bills. We should insulate homes, shift social and environmental policy costs away from electricity bills, while also changing the way network and generation costs are applied to incentivise renewable generation’s coupling with storage and flexibility. By making these changes we can realign policies so they work in the same, lower cost, lower carbon, direction and help insulate consumers from gas price shocks while advancing our decarbonisation goals. 

What’s clear is that unless significant intervention takes place, an unavoidable and sizeable energy bill will have a crippling effect on millions of households across the country. Whether through bill protection or a strategy to move away from dependence on gas, the Government has to take action now, and it likely has to do both.

Lizzy is Head of Energy and Clean Tech at Seahorse Environmental: lroberts@seahorseenvironmental.co.uk