On 6 January 2022, the House of Lords is scheduled to hold a short debate on a motion tabled by Baroness McIntosh of Pickering (Conservative). She will ask the Government what assessment it has made of the effect of rising energy costs on households, pensioners and those on low incomes.

Rising energy prices

Wholesale UK gas market prices hit a new all-time high on 21 December 2021, reaching as far as 470p a therm. This is about nine times higher than prices a year ago. The rise was attributed to cold weather increasing demand while Russian gas supplies to Europe fell.

The new price reached in December followed previous record high prices seen in October 2021. Professor Michael Tamvakis, professor of commodity economics and finance at Bayes Business School (formerly Cass), said that the rise in gas prices in autumn 2021 was partly due to the UK receiving less wind than usual, lowering the output from wind turbines and leading to increased demand for gas for electricity generation. In addition, Professor Tamvakis said that Russia was “refilling [gas] stocks ‘less energetically’, possibly with a view to leveraging a dominant position in opening up gas flow through the controversial Nord Stream 2 [pipeline]”. Finally, Professor Tamvakis noted that high oil prices in east Asia have led to higher gas prices because gas is priced on an oil-indexed basis in that market.

The UK imports approximately 50% of its gas. This makes the UK sensitive to price rises in the global gas market. Changes in the wholesale price of gas can affect domestic consumers. For instance, around 85% of UK homes use gas central heating. Furthermore, gas is used as the fuel to generate around a third of the UK’s electricity, so rising gas prices have led to rising electricity prices.

Energy price cap

Ofgem, the energy regulator, sets a default tariff cap that limits the amount suppliers can charge consumers for a unit of energy on the supplier’s default or standard variable tariff. Each year, Ofgem announces in February the default tariff cap that will apply from April to September, and in August it announces the level that will apply from October to March the following year.

In August 2021, Ofgem announced that it was increasing the cap for the period 1 October 2021 to 31 March 2022 by 12% compared to the previous period. This meant that the annual energy bill for a customer using a typical amount of gas and electricity and paying by direct debit would be £1,277, up from £1,138 under the previous cap. This amount does not represent the maximum that an individual customer could pay. Rather, it is intended to illustrate the amount a reference customer would pay. Ofgem explains that “the default cap sets maximum prices, not maximum bills. For an individual customer, the amount they will pay under the cap varies depending on how much energy they use, where they live, and how they pay for their energy”. Not all customers are on tariffs where the cap applies. For instance, customers on a fixed-rate tariff which guarantees the unit prices they pay for their energy will not see their bills rise for the duration of their fixed rate, even if the default tariff cap rises.

Ofgem said that the rise in the cap was mainly driven by higher wholesale energy costs, amounting to an additional £155 annually for a customer with a typical energy usage pattern.

Ofgem is due to announce in February 2022 what the default tariff cap will be for April to September 2022. As the price cap will factor in wholesale prices over the previous six months, it is expected that the cap will rise. The chief executive of Ofgem said in October 2021 that the rise could be “significant” because of the unprecedented rise in gas prices. Industry and consumer estimates have suggested that the annual amount paid by the typical customer could go up from the current level of £1,277 to between £1,890 and £2,240 in 2022.

The Government confirmed in October 2021 that the current price cap mechanism would remain in place for 2022 “as the conditions for effective competition are not yet in place for domestic supply contracts”. The Domestic Gas and Electricity (Tariff Cap) Act 2018 enables the price cap mechanism to be extended on an annual basis up to the end of 2023.

Ofgem has stated that “the additional costs and uncertainties facing suppliers are likely to be beyond what is accounted for in the existing price cap methodology”. It is running a consultation on proposals to amend the cap. One of the proposals would allow Ofgem to amend the cap outside the routine six-month cycle in exceptional circumstances.

Energy company failures

Since August 2021, 26 energy suppliers have gone out of business. Some have blamed the effect of the price cap. For instance, Bulb, which went into special administration in November 2021, said that “the price cap—designed to protect customers—currently means suppliers provide energy at a significant loss”. It noted that the current domestic price cap is 70p per therm, when wholesale prices were reaching up to £4.00 per therm. However, Greg Hands, Minister for Energy, Clean Growth and Climate Change, argued that energy suppliers knew about the tariff cap and should have been “properly hedged”. Hedging allows companies to purchase supplies of energy in advance with the intention of minimising their exposure to fluctuations in the market price. Mr Hands argued that “a well-hedged company has been in a much better position to ride out the big increase in global prices we have seen, in particular in the last two to three months”.

If an energy supplier becomes insolvent, Ofgem can appoint another supplier to take on its customers under the supplier of last resort process. Ofgem must be satisfied that the new supplier can supply the additional customers without prejudicing their ability to continue to supply their existing customers. The customers of most of the energy companies that went out of business in 2021 have been moved to new suppliers using this process. However, if Ofgem cannot appoint a new supplier using this process, for example because of the size of the failing supplier, it can establish a special administration regime. This means that a special administrator is appointed to run the company until it is rescued (eg through restructuring), sold or has its customers transferred to other suppliers. Bulb, the largest company to fail in 2021, has been put in special administration.

The failure of energy companies may have knock-on effects for customers’ energy bills in the future. The administrators appointed to oversee Bulb have access to nearly £1.7bn in the form of a government-backed working capital loan. The Government has said that if there is a shortfall in the value of Bulb’s estate to meet the Government’s financing costs at the end of the special administration, it may recover the residual costs of the special administration from energy suppliers over a period of time at a later date. Ofgem has estimated that UK households will pay an extra £80 to £85 on their energy bills in 2022/23 as a result of the recent supplier collapses. However, it said this estimate should be treated with caution, as it could go up or down depending on wholesale gas prices. Others have produced higher estimates. An analyst at the banking group Investec suggested that the cost of failed suppliers could top £3bn, adding an extra £120 to every household’s energy bill.

Impact on households, pensioners and people on low incomes

Millions of households were in ‘fuel poverty’ before the energy price rises of 2021. The Government measures fuel poverty using the low income low energy efficiency (LILEE) indicator. This considers a household to be fuel poor if it is living in a property with an energy efficiency rating of band D or below and its disposable income after housing costs and energy needs would take it below a disposable income of less than 60% of the national median. Fuel poverty therefore depends on the interaction between energy efficiency, household income and energy prices. According to statistics from the Department for Business, Energy and Industrial Strategy (BEIS), an estimated 13.4% of households in England (3.18 million households) were in fuel poverty in England in 2019, down from 15% (3.52 million) in 2018.

Recent increases in energy prices could lead to an increase in the number of households in fuel poverty. BEIS projections published in April 2021 predicted the proportion and number of households in fuel poverty would fall to 12.5% (3 million) in 2021 under the LILEE metric. However, these projections were modelled on household energy bills being lower in real terms in 2020/21 than in the two preceding years. BEIS projected that on average, a household’s fuel costs would need to fall by £200 for it not to be in fuel poverty in 2021. National Energy Action, a charity committed to ending fuel poverty, estimated in October 2021 that annual energy bills could increase by £400 to £600 for the typical customer over the next year. It feared that this could lead to over 1 million extra households in fuel poverty.

A £600 increase in energy bills is also predicted by the Resolution Foundation. In analysis published in December 2021, it found that this would be most acutely felt by lower income households:

£600 is a huge increase for households of all incomes, but will be felt most acutely by poorer families: households in the bottom income decile will see their energy spend rise from 8.5 to 12 per cent of their total household budget—three times the proportion for those in the top decile.

It also stated that many of these lower income households would face even higher bills, noting that “around one-in-six (15 per cent) of households in the poorest two deciles have energy bills at least 25 per cent above the typical household, meaning they could see an increase of £750 or more in April thanks to having larger families, outdated boilers or poorly-insulated properties”.

Overall, considering predicted energy price increases alongside a reduction in real wages and the planned increase in national insurance contributions, the Resolution Foundation feared a “living standards catastrophe” in 2022. It estimated that taxes and energy bills would rise by an average of £1,200 per household in April 2022 under current government plans.

The Resolution Foundation stated that the best long-term solutions to tackle increasing energy bills was to focus on the delivery of renewable energy sources and to improve the insulation of homes. However, it argued that many households would need more immediate government action. Its suggestions included: extending and increasing the warm homes discount; temporarily removing VAT on energy bills; moving environmental and social levies that are currently added to electricity bills into general taxation; and reducing the size of the energy cap increase for those households in receipt of universal credit.

The charity Age UK estimates that around 1 million older households are in fuel poverty, representing 1 in 10 older households and 1.4 million older people. Age UK warned in December 2021 that rising energy prices could push an estimated 150,000 extra older households into fuel poverty this winter. It said it was “extremely concerned that rising energy prices and living costs will lead to some of the poorest pensioners rationing their heating this winter in order to afford higher energy bills”. It added that the problem was exacerbated by the fact that many older people live in older, harder-to-heat homes. It also highlighted that older people find it harder than younger people to regulate their temperature, and cold could be particularly dangerous for those with pre-existing health conditions. Age UK called on the Government to:

  • Provide a one-off £50 payment to all those eligible for cold weather payments and expedite existing payments so they arrive no later than seven days after a period of cold weather.
  • Double the household support fund to £1bn to help safeguard all those on low incomes this winter.
  • Take urgent action to get pension credit, which Age UK described as “a vital benefit and passport to a package of extra financial support”, to all those who are eligible.
  • Ensure the energy price cap is enshrined in law in the shorter term, and then move to re-introduce a social tariff into the energy market to offer protection against high energy costs in the medium term.

The former body Public Health England also linked cold weather and poorly heated homes with excess winter deaths. It listed older people and those on lower incomes among those groups most at risk.

What is the Government doing?

The Government says it is taking a range of actions to support the households most affected by rising energy prices:

The Government is committed to protecting customers, especially the most vulnerable. The energy price cap will continue to protect consumers, ensuring they pay a fair price for their energy this winter. Low income and fuel poor households will continue to be supported with their energy bills through the warm home discount, which provides eligible households with a £140 discount. Winter fuel payments and cold weather payments will also ensure that the most vulnerable are better able to heat their homes over the colder months.

Additionally, the Government announced an extra £500m for local authorities through the new household support fund to help millions with their household bills.

The warm home discount entitles eligible recipients to a one-off discount of £140 on their electricity bill between October 2021 and March 2022. People can qualify if their supplier is part of the scheme and they either receive the guarantee element of pension credit (the core group), or they are on a low income and meet their energy supplier’s criteria for the scheme (the broader group). The scheme is funded by energy suppliers, who generally recoup the costs from customers’ energy bills. The Government sets a spending target each year, aiming to balance providing rebates to as many households as possible with minimising the impact on consumers’ bills. The Government expects around 2.2 million households to receive rebates under the scheme in this financial year. The overall spending target is £354m. The Government ran a consultation in mid-2021 on raising the amount of the discount to £150 from 2022/23.

The winter fuel payment is available to people born before 26 September 1955 who lived in the UK for at least one day during the week of 20 to 26 September 2021. It is paid out automatically to people who receive the state pension or certain other social security benefits; others may need to make a claim to receive the payment. It is worth between £100 and £300 depending on the age and living situation of the recipient.

The cold weather payment is available to people who receive certain benefits or support for mortgage interest. People can claim £25 for each seven-day period of very cold weather between 1 November 2021 and 31 March 2022. This is defined as when the average temperature in an area is recorded as, or forecast to be, 0° Celsius or below over seven consecutive days.

Under the household support fund, the Government is making £421m available to county councils and unitary authorities in England for the period 6 October 2021 to 31 March 2022. Local authorities have discretion over exactly how to use the funding, but the Government says that it should be used “primarily to support households in the most need with food, energy and water bills”. Half of the funding is ring-fenced for households with children. Government guidance to local authorities says the remainder can be used for other households in need of support, which can include households not currently in receipt of welfare benefits. Under the Barnett formula, the Scottish Government will receive £41m, the Welsh Government £25m and the Northern Ireland Executive £14m, bringing the total support to £500m.

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Cover image by Matthew Henry on Unsplash.