Want to fix the energy market, Theresa? Forget about your proposed cap

Ben Ramanauskas

September 7, 2018

Energy bills are a burden for many households. With the cost of living crisis in the UK, it is often the poorest people in the country who are the hardest hit – indeed, over 3.7 million people across Britain are classed as being in “fuel poverty”.

Given that rising energy prices are plunging many on low incomes into penury, energy prices have now become a hot topic for politicians. The 2015 Labour manifesto contained a pledge to cap energy prices – a move that was condemned by the Conservative government at the time as “Marxist”.

Then, during Theresa May’s ill-fated bid to increase her majority in the House of Commons by appealing to the “just about managing”, the Conservative manifesto in the 2017 general election contained a very similar commitment. And recently, the Government passed legislation giving Ofgem the authority to place a cap on energy bills. This week, Ofgem proposed a cap of £1,136 a year for “typical usage”.

The desire of politicians to ease economic burdens on low earners is understandable. However, an energy bill price cap will do nothing to solve the problem – it only risks making things even worse. This is because a price cap would not tackle the main factor causing energy bills to be so high: renewable energy subsidies.

A significant proportion of energy prices are the result of the various schemes that force energy companies to include minimum shares of energy from renewable sources in their portfolios. These schemes represent a subsidy to the renewable energy sector which is paid through energy bills. Together with “green” measures, they represent a significant proportion of the retail gas price and retail electricity price.

For example, the annual bill for a typical dual-fuel household in 2016 was around £1,160, of which £615 was for gas use and £545 was for electricity. Approximately £105 (nine per cent) of the bill is the result of low-carbon policies.

Passing on the cost for subsidies to consumers clearly places a burden on households. This is supported by a report by the IFS which found that environmental policies “drive up energy prices directly through the environmental charges in the bill but also indirectly, and significantly, through the impact on the generation and network investment costs”.

The total cost of renewable energy subsidies is also felt in other ways. For example, renewable energy subsidies also raise the cost of production in energy-intensive sectors which, in various ways, will also be passed on to consumers.

The main contributor to energy bills is the wholesale price of gas and electricity. However, it is clear that government intervention in the form of green taxes and subsidies for renewable energy is an important factor in why energy bills are so expensive.

Indeed, a price cap also risks exacerbating the problem through a number of unintended consequences. A cap risks hitting the profits of energy companies, meaning that the energy market becomes less attractive to other companies who would then be deterred from entering the market. This will reduce competition and, therefore, remove the incentive for energy companies to provide a high-quality service and to lower their prices.

It will also negatively impact investment. When a cap was announced, the market responded – the value of shares in energy companies decreased dramatically. This lack of investment in energy companies will decrease the lack of available funds, which will result in companies becoming increasingly hostile to investing in new and more efficient ways of delivering energy to consumers. As a result, pressure will be placed on prices and the quality of services offered to consumers will drop.

And as the British Government moves to increase intervention in the energy market, other countries are moving in exactly the opposite direction. For example, the governments of France and Spain have previously had high levels of state intervention in their energy market. They are now moving away from price caps and are instead introducing a more market-based approach to pricing. Now, consumers are encouraged to switch suppliers, resulting in better value for money and a more efficient market.

In the UK, if the Government wants to see lower energy bills for consumers then it should scrap the regulations that make entry to the market so difficult, as well as the various schemes that result in energy companies becoming – through no fault of their own – inefficient and costly.

If the Government followed these market-based approaches that have been proven to work, then more companies would enter the market, competition would increase and prices would fall for consumers.


Written by Ben Ramanauskas

Ben Ramanauskas is a research economist at Oxford University and a former adviser to the International Trade Secretary.


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