There has been understandable anxiety in the UK about the future course of the economy linked to increases in energy bills, following the announcement of the new electricity price cap to avoid the predicted 80 per cent increase in household bills from the 1st of October and likely future sharp increases. The cost of the cap to the public purse is expected to be in the region of £100bn over two years, and will increase further following the announcement of additional short-term energy price support to firms. That support involves freezing the current price for both electricity and gas per megawatt hour for six months and reducing business and other non-domestic organisations energy costs to some half what they would otherwise have been anticipated. This will be reassessed after three months to see in what form and to which sectors a continued relief could be applied.
But electricity prices are already elevated. Overall business input costs are 20.5 per cent above where they were a year ago. Even for households, the cap still involves a further increase from just under £2,000 after the rise in the electricity cap in April 2022, to £2,500 on average from 1st October when the “freeze” starts applying. It now seems inevitable therefore that despite the support, a recession in the UK will happen as real incomes shrink, as the Bank of England predicted in August. We have seen consumer confidence and business confidence fall back substantially. What’s more, a slowdown in Europe is also evident and will remain a reality, as countries continue to reduce demand for energy, particularly gas, and energy intensive sectors feel the strain. There are rumours of energy rationing to come.
In any case, the UK energy market is ripe for reform. The regulator Ofgem has come under increasing criticism for its earlier handling of the energy supply market. The competitive structure that had been encouraged while a price cap was in operation left companies unable to pass on rising wholesale gas costs and caused many to exit the market (at huge cost to taxpayers and consumers) when the era of cheap and plentiful gas came to an abrupt end. The decoupling of gas from electricity prices when there is so much—and growing—renewable-based electricity to draw on is long overdue.
A similar discussion is going on in the EU, where the problem in continental Europe is arguably even worse given the EU’s over-reliance on Russian gas imports until recently. Russia’s indefinite closing of the Nord Stream 1 Pipeline since late August, ostensibly for maintenance, hasn’t helped. Countries have so far responded to the crisis in wildly different ways. Social tariffs, cuts in VAT and in other taxes, including those aimed at supporting renewables, and direct measures to help vulnerable consumers have all been tried, with varying success.
Windfall taxes on the energy sector have been imposed in Italy, for example, and planned in Germany too in response to super profits, in order to ease the burden on businesses and households. France ordered its main energy provider, EDF, to limit price increases to 4 per cent over the past year, and has since moved to take the company, which needed extra support for its resulting losses, completely into public ownership. Capping prices is also favoured by countries such as Spain and Portugal, which were allowed to temporarily decouple electricity prices from gas and thus kept domestic price increases to a minimum. Others fear that this approach, which requires substantial subsidies, will prove a too great and persistent burden on public finances. Mario Draghi, caretaker PM in Italy until a new government is formed following this week’s general election, has been suggesting for some time that the EU should cap the price it pays for Russian gas, and act in unison when buying from abroad.
There is ample evidence that working for the same goal seems to be leading to results. Being required to restore gas reserves to acceptable levels across Europe, for example, has been successful. Although the process inevitably further propelled gas prices in Europe for a while, reserve levels have been increasing ahead of the deadlines set by the Commission in many countries, including Germany. The Baltic states are no longer importing Russian natural gas, while Poland and Bulgaria have been cut off altogether by Russia, as has Finland. Germany is investing in five floating liquefied natural gas facilities but also considering extending the life of nuclear and coal-fired power stations. The country’s gas storage is up to near 85 per cent of capacity. Ahead of target, gas consumption in July was already some 15 per cent below what it has been for that month on average over the previous five years, according to analysis by the IMF. Just before the Nord Stream 1 pipeline was switched off, dependence on Russian gas suppliers had been reduced from 55 per cent before the invasion to under 9.5 per cent by August, according to the Federal Ministry of Economics.
Across the board, industries are being given incentives to switch from gas to other energy inputs. Though some of this has meant shifting to oil and coal, for the time being at any rate, there are anecdotal reports that the issuing of permits for more renewable generation is apparently being sped up in many countries. A faster move to renewables will of course also require further investment in the electricity grid which may be considerable—an area where a number of European nations may need extra support. Energy utilities are coming under pressure in many countries and some temporary nationalisations across Europe may be the order of the day. There are concerns that some energy rationing may be required in some countries over the winter.
What energised the European Commission to take a bigger leadership role in this issue was the realisation that unless urgent action is taken, the EU’s GDP could well go into freefall in 2023. The summer may have seen a real upswing in tourism and spending on services, but the prospect of a winter of rationing energy while real household incomes plummet is looming. Inflation, though showing signs of plateauing in recent months, is just over 9 percent on average in the Eurozone. In places like Latvia, Estonia and Lithuania it has been above 20 per cent for a while. The markets are putting renewed pressure on the Euro adding to inflationary concerns. The ECB on 8th September raised interest rates by a record 75 basis points and the language remains hawkish. The Euro area Purchasing Managers’ Index (PMI) is already pointing to a recession ahead.
So, taking a fresh look at the functioning of the electricity market is very much of the essence. The European Commission has produced an “emergency intervention” package to ease pain of individuals and businesses, which is expected to receive swift ministerial Council approval. It consists of measures to impose a short-term solidarity tax on excess profits of fossil fuel energy generators (raising some $25bn in 2022 alone) a temporary revenue cap (raising some €117bn on an annual basis) on power producers using technologies such as renewables or nuclear power, and a separate tool to reduce electricity consumption across the board—all to be reviewed every few months. The energy market may soon no long be determined by high gas prices.
With Russia now mobilising for more intense war in Ukraine, the Commission’s moves are timely. But whether a bleak European midwinter can really be avoided remains unclear.
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