Holyrood’s Net Zero, Energy and Transport Committee has recently agreed to hold a “snapshot” inquiry into energy costs and security. In July 2020, the then Economy, Energy and Tourism Committee published the findings of its Energy Inquiry – central to that work was consideration of the multiple moving parts of global markets; including radically reducing carbon emissions, ensuring affordability, and providing energy security.
Since then, this complex geopolitical dynamic has intensified, with an unforeseeable and perfect storm of converging issues leading to record price rises; not least due to the world’s largest natural gas exporter invading its neighbour, leading to international condemnation and far reaching sanctions.
This blog explores the key drivers of energy price rises, expert commentary, and some of the responses from Government. Due to the complexity of this issue, this is a longer blog than normal, so we have added a contents popout below to help with navigation:
Why are prices rising, and who will be most affected?
SPICe published a blog in October 2021 looking at the increase in wholesale gas prices – however since then detailed market indicators published by the regulator Ofgem show that prices have more than doubled.
BBC News and Ofgem set out the well documented and key drivers to this crisis, including European gas storage entering winter 2021-22 at historically low levels due to cold temperatures persisting into May 2021; increased gas demand from Asia putting pressure on Liquefied Natural Gas (LNG) supplies; a relatively windless summer in 2021 made it difficult to generate wind energy, leading to reliance on gas fired electricity generation; and French nuclear power generation outages increasing demand for gas.
Designed to stop suppliers from making excessive profits, Ofgem’s Energy Price Cap is updated twice a year and tracks wholesale energy and other costs. On 3 February 2022 Ofgem announced that its Cap would increase by over 50%, noting that:
[…] energy companies cannot afford to supply electricity and gas to their customers for less than they have paid for it.
The Price Cap only applies to domestic customers who are on a default (i.e. standard variable) tariff. It does not apply to those who are on fixed-term or certain green energy tariffs, nor does it apply to those who are not on the gas grid and heated by (for example) fuel oil or Liquefied Petroleum Gas. Commercial energy users are also likely to be paying significantly more for their power, adding to inflationary pressures on goods and other services.
Ofgem is currently consulting on a raft of new measures to boost financial resilience in the energy sector, including introducing “financial stress testing” for all suppliers and increasing the number of times a year that the price cap can be adjusted.
How does the price of gas impact electricity prices?
Whilst around 60% of Scotland’s total electricity generation and around 36% of the total for Great Britain’s market comes from renewable sources, the market is designed so that the wholesale cost reflects the price of the last unit of energy bought to balance the grid and to make sure there is enough to meet demand, which is predominantly gas. So even in energy markets such as GB’s, gas is still driving the wholesale electric price. And as the gas price has soared, so has the price of electricity. This is explained in more detail by Ofgem in a blog on What drives wholesale electricity prices in Britain?
Of course, Scotland and the UK are both producers of oil and gas. The Scottish Government note in their Energy Statistics Hub that in 2018 Scotland produced 62.1% of all UK natural gas production. Although the volume of gas has been falling, the volumes produced in Scotland are equivalent to almost six times Scotland’s gas consumption.
The UK Department for Business, Energy and Industrial Strategy (BEIS) publishes regular statistics on UK energy production and consumption. The latest data shows that total production of oil and gas in the UK was down in 2021, largely because of maintenance in the North Sea. UK Gas production reached a record low, which resulted in imports rising 17% compared to 2020. BEIS notes that in 2021 Norway was the largest supplier of gas imports, accounting for 64%. 28% of the UK’s gas imports are LNG, of which 6.1% come from Russia.
What other costs are included in domestic energy bills?
Ofgem provides a breakdown of costs in your energy bill, which shows that the wholesale cost of fuel amounts to approximately 35%, with the rest made up of transmission and distribution (known as “network”) costs, operational, and social and environmental costs. These are accounted for on an energy bill as the “standing charge”, which is also increasing; Ofgem notes:
Over the last year, 29 energy companies have exited the market or been put in special administration in the wake of soaring global gas prices, affecting around 4.3 million domestic customers.
Industry experts, Cornwall Insight, provide further detail:
When a customer’s supplier fails, they are automatically appointed a new supplier through the Supplier of Last Resort process, with onboarding suppliers able to recover some costs for doing so. The costs are then passed on to the consumer through their electricity bills […]. These additional costs have consequently increased this component of electricity bills by an average of 33.9% in 2022-23.
What are the experts saying?
Unsurprisingly, the recent spike in energy prices coupled with the invasion of Ukraine has led to a widespread questioning of the security of UK and European energy supplies as well as examination of what should be done to find short – medium term responses. Longer term structural solutions will also need to ensure that society and the economy remain on a pathway to the UK’s 2050 net zero emissions target.
Fossil fuels and the global energy mix
In a recent speech, the UN Secretary General warned that short term measures to replace Russian fossil fuels “might create long-term fossil fuel dependence” and jeopardise climate change targets:
Addiction to fossil fuels is mutually assured destruction.
As current events make all too clear, our continued reliance on fossil fuels puts the global economy and energy security at the mercy of geopolitical shocks and crises.
The recently published Business Outlook Report from trade association Offshore Energies UK notes that, unless there is ‘rapid’ investment in new infrastructure, production in the UK will fall by up to 15% a year, which will lead to the UK relying on imports for 80% of its gas by 2030.
The International Energy Agency has set out a series of “short-term emergency actions” focussed on energy demand reduction and efficiency and calls for “decisions to be taken now to “put countries’ oil demand into a structural decline consistent with a pathway towards net zero emissions by 2050”. Proposals relate primarily to transport, and include reducing speed limits, car-free Sundays, making public transport cheaper, and incentivising micromobility, walking and cycling. Some of these measures are similar those implemented in Denmark in response to security of supply concerns during the 1973 oil crisis.
Domestically, due to rises in the energy price cap, addressing demand for gas for heating and electricity generation has been the primary focus. Expert analysis for the Tony Blair Institute for Global Change recognises the short-term attraction of increasing fossil fuel supply and improving UK self-sufficiency, but “the hope that UK production can have a material impact on prices in the international market” is considered to be “unrealistic”:
UK production is around 1% of the global total, and around 5% of Russian production. Under these conditions there is no plausible way the UK could produce enough gas to make a dent in the international price.
Further analysis for the Institute for Global Change has assessed various options (renewables, fossil fuels, nuclear, hydrogen, demand reduction) by their alignment with net zero, improved energy security, affordability, investment costs, and political risks. Results “clearly show” that “choices should be the same irrespective of climate targets, as the green options are now also the biggest, quickest, and cheapest”. Key points include:
- Renewable electricity should be central to medium-term plans but does not present an immediate fix.
- Demand reduction is the cheapest and fastest route off imported gas and towards lower bills.
- New UK sources of fossil fuels will be slow, risky and will not significantly reduce prices.
- Nuclear is essential to the long-term energy mix but will not help this decade.
- Hydrogen is important for storage and industry but is a long-term option and must be green (made from renewables), not blue (made from gas).
The Energy and Climate Intelligence Unit has noted “were it not for the dependence on gas, stronger sanctions could be being placed on Russia”, and that “common sense solutions” are “at risk of being overlooked”. Their analysis shows that:
More UK gas will not cut energy bills.
More insulation and heat pumps will cut bills, but are now also a matter of national security. They can be installed to start cutting demand and imports right away and a concerted deployment campaign would see those savings build into a major contribution to ending our gas dependency
The Chief Executive of trade association Energy UK has also recently echoed many of the above points, arguing for immediate help for customers and the economy, as well as speeding up energy efficiency and demand reduction measures, and energy market reform.
Scottish Ministers are responsible for consenting new large-scale energy generation, and the UK Government has recently called on the Scottish Government to rethink its opposition to nuclear power. However given the costs of transmission charging and the distance to major centres of population and demand, it is not clear whether any new nuclear would be commercially viable in Scotland, even if policies changed.
Energy market reform
Analysis for the Institute for Global Change argues that high and volatile gas prices strengthen the need for market reform. Several EU governments are also calling for restructuring, so that the price paid for electricity is linked to the average cost of generation, instead of being set by the marginal generation technology (predominantly gas). GB and EU energy markets are still closely linked (until 2026), with gas and electricity interconnectors to Belgium, the Netherlands, France and Ireland.
Industry experts Foresight Climate and Energy note that:
European electricity markets rely on a complex set of trading arrangements. As a result, any substantial changes would take years to design and implement. Market reform is, therefore, unlikely to provide solutions that alleviate the current energy price crisis. Nevertheless, it can reduce the chance of future crises.
UK Government response
On 3 February 2022, in response to Ofgem’s announcement of a further increase to the Price Cap, the UK Government announced a package of measures to help support households:
- Domestic customers will receive a £200 credit on their energy bills, repaid over the following five years.
- A £150 council tax rebate for houses banded A to D.
- A discretionary fund of £144m for people who do not pay council tax, or live in properties banded E-H.
- An increase to the National Insurance Primary Threshold and Lower Profits Limit.
- A 12-month, 5p per litre cut to duty on petrol and diesel.
- An expansion to the scope of VAT relief available for energy saving materials, and 0% VAT for households buying energy saving materials.
- An extension to business rates relief for SMEs.
What has the Scottish Government done, and what more can it do?
The Scottish Government’s most recent strategic intervention is the Heat in Buildings Strategy (HIBS), published in October 2021, which represents a significant step change in ambition for Scotland’s 2.5 million homes. The strategy undertakes to reduce emissions from buildings by 68% between 2020 and 2030, and to:
- Convert the “vast majority” of off-gas homes that currently use high emissions fossil fuels (170,000), as well as at least 1 million homes, and the equivalent of 50,000 of Scotland’s non-domestic properties, to zero emissions heating.
- Achieve an installation rate of over 200,000 new heating systems per annum in the late 2020s (well above the natural replacement rate for new boilers and the current 3000 renewable heat systems annually installed).
- Provide at least £1.8 billion this Parliament (by 2026).
- Total capital cost (in real terms) of converting Scotland’s buildings to zero emissions is estimated at £33 billion (includes energy efficiency measures).
Following the Chancellor’s announcement on 3 February 2022, the Scottish Government have also implemented a £150 credit for certain council tax payers through the Cost of Living Award 2022. There are several existing Scottish Government policies which aim to alleviate fuel poverty in Scotland, including:
- The £20 per week Scottish Child Payment
- Child Winter Heating Assistance which provides an annual payment to help the families of disabled children and young people with increased heating costs over winter
- Warmer Homes Scotland offers funding and support to households who struggle to stay warm and on top of energy bills
- Winter Support Fund provides support to low income households, including £10 million for fuel poverty.
- Winter Plan for Social Protection announced in November 2020, including £7 million earmarked for fuel poverty.
Prior to the Russian invasion of Ukraine, the Scottish Government published its Fuel Poverty Strategy. During December 2021 two parliamentary committees scrutinised the proposed strategy. On 25 November 2021, the Social Justice and Social Security Committee heard from a panel of groups which support households in fuel poverty, followed by a private meeting with people with experience of living in fuel poverty. On 30 November 2021, the Net Zero, Energy and Transport Committee held an evidence session with the Cabinet Secretary for Net Zero, Energy and Transport.
The strategy aims to address the four drivers of fuel poverty:
- poor energy efficiency in the home
- low household income
- high energy prices
- inefficient use of energy in the home.
While the strategy will try to deal with all four drivers, it operates in the context that aspects of the welfare system and the regulation of the energy market are reserved.
The Scottish Government responded to the Social Security and Social Justice Committee on 23 December 2021, highlighting the role that the new National Public Energy Agency could play in centralising the various funding and support programmes to help consumers manage and reduce their fuel bills. This will launch as a virtual agency in September 2022.
A new UK Energy Security Strategy is expected to be published in the coming weeks, after some delay, with BBC News reporting that this is due to concerns over costs.
The Scottish Government is expected to publish a new Energy Strategy in the autumn of this year.
As recommended by expert commentators above, whilst immediate help is needed to mitigate fuel price increases for those most in need, only structural changes including more renewable electricity, energy efficiency and market re-design will provide the necessary long-term solutions. These are significant challenges, and the two forthcoming energy strategies have much to do to ensure that the systems that deliver heat, light and power to our homes and businesses are secure, sustainable and affordable for the coming decades.
Alasdair Reid and Andrew Feeney-Seale, SPICe research